Going Global – The CAGE Distance Framework

Discussion Prompt – Respond to each question in 200 words each

 Your understanding of the CAGE distance framework

• 1. Using the case Kingfisher B&Q, shed light on how the CAGE framework can be used to compare markets from the perspective of a particular company.
• 2. Discuss the role of AAA strategies in the development of Kingfisher (B&Q) in China.   What AAA strategies should Kingfisher adopt to capture a major share of business in the Chinese market?
• 3. In your personal life, what is the country where you wish to visit for your vacation, and why? What factors of the CAGE framework have influenced your decisions

  1

  Differences and the CAGE Distance Framework 1

  Pankaj Ghemawat

   

  After analyzing the cases in section 1, the reality of semiglobalization

  and the importance of cross-country differences should be clear. This

  section introduces the CAGE distance framework, which is used to

  identify and prioritize the differences between countries that companies

  must address when developing cross-border strategies. 2

   

  Begin by considering the example summarized in exhibit 2-1, which

  plots Walmart’s operating margin by country in 2004 against the

  distance between each country’s capital and Walmart’s headquarters in

  Bentonville, Arkansas. The impact of geographic distance is obvious, but

  what other types of difference or distance can you identify that separated

  the markets that were profitable for Walmart from those that weren’t?

   

  Exhibit 2-1

  Walmart International’s Operating Margin by Country (2004 estimates)

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

   

  Figure 2-1: Wal-Mart International’s Operating Margin by

  Country, 2004 (Estimated)

   

   

   

  2

  The CAGE distance framework disaggregates distance or difference into

  four major categories: Cultural, Administrative, Geographic, and

  Economic. Differences along these dimensions generally have a negative

  effect on many cross-border interactions, although in some cases,

  differences along a limited subset of CAGE dimensions can actually

  encourage rather than discourage such interactions. 3 Each of these broad

  types of difference or distance is illustrated by the Walmart example.

   

   Cultural distance: Culture can be defined as the collection of beliefs, values, and social norms—the unwritten, unspoken rules

  of the game—that shape the behavior of individuals and

  organizations. Cultural distance encompasses differences in

  religious beliefs, race/ethnicity, language, and social norms and

  values. Societies even differ in their social attitudes toward

  market power and globalization in ways that have important

  effects, both formally via regulation and informally, on how

  businesses operate. 4

  Interestingly, Walmart’s four profitable

  markets share linguistic, religious and ethnic similarities or, at

  least, ties through large diaspora.

   

   Administrative distance: Historical and political associations between countries—colonial links, free trade agreements, the

  tenor of current relationships—profoundly affect economic

  exchange between them—which is the same as saying that

  differences along these dimensions matter a great deal. So, of

  course, do administrative attributes specific to a particular

  country such as autarchic policies or weak institutions and high

  levels of corruption. In the Walmart example, note that two of the

  profitable countries, Canada and Mexico, partner with the United

  States in a regional free trade agreement, the North American

  Free Trade Agreement (NAFTA). And a third profitable ―country‖

  as classified by Walmart, Puerto Rico, is officially an

  unincorporated territory of the United States.

   

   Geographic distance: The geographic dimension of distance involves more than just how far two countries are from each

  other: other attributes to be considered include contiguity, a

  country’s physical size, within-country distances to borders,

   

   

   

  3

  access to the ocean, topography, and even time zones. Exhibit 2-

  1 makes it clear that the capital city of each of Walmart’s four

  profitable ―countries‖ is geographically closer to Walmart’s

  headquarters than the capitals of any of the unprofitable ones; in

  addition, Canada and Mexico share a common land border with

  the United States.

   

   Economic distance: Consumer wealth and income and the cost of labor are the most obvious (and related) determinants of

  economic distance between countries. Others include differences

  in availability (or lack) of resources, inputs, infrastructure and

  complements, and organizational capabilities. It seems a bit

  harder for Walmart to do well in poorer countries—although the

  number of data points is very limited. Note, however, that

  economic distance has not been entirely or even primarily a

  liability for Walmart. The company saves more money by

  procuring merchandise from China—exploiting economic

  distance, particularly in terms of labor costs—than it makes from

  its entire international store network. We will return to such

  strategies in section 5, which discusses arbitrage.

   

  What the Numbers Tell Us

   

  International economists have adapted Newton’s law of universal

  gravitation to describe trade and other international economic

  interactions. Thus, the simplest gravity model of international trade

  between two countries predicts that trade will be directly related to their

  economic sizes (a unilateral attribute of each country) and inversely

  related to the physical distance between them (a bilateral or country-pair

  attribute). Augmented gravity models add measures of other types of

  differences as well as unilateral attributes. Exhibit 2-2 shows the results

  of one such analysis that evaluated cultural, administrative, geographic,

  and economic effects on trade.

   

   

   

   

   

   

   

   

   

  4

  Exhibit 2-2 Effects of Similarities Versus Differences on Bilateral Trade

  Dimensions of

  Distance/Proximity

   

  Determinant

   

  Change in Trade Cultural

   

  Administrative

   

   

   

   

  Geographic

   

   

   

   

  Economic

  Common language

   

  Common regional trading bloc

  Colony/colonizer links

  Common currency

  Differences in corruption

   

  Physical distance: 1% increase

  Physical size: 1% increase

  Landlockedness

  Common land border

   

  Economic size: GDP (1% increase)

  Income level: GDP per capita (1% increase)

  +42%

   

  +47%

  +188%

  +114%

  –11%

   

  –1.1%

  –0.2%

  –48%

  +125%

   

  +0.8%

  +0.7%

   

  Source: Pankaj Ghemawat and Rajiv Mallick, “The Industry-Level Structure of

  International Trade Networks: A Gravity-Based Approach,” working paper, Harvard

  Business School Boston, February 2003.

  The estimates correct for unobserved thresholds for participation in trade and are all

  significant at the 1% level but are, in a number of cases, smaller than those reported in

  many other studies, apparently due to the correction

   

  The signs on most of the estimates in the table probably accord with

  your intuitions (although they cannot be reconciled with a fully

  globalized ―flat‖ world). What are probably more surprising are the

  magnitudes of some of the effects—for example, that countries with

  colonial ties are apt to trade almost three times as much as countries

  without them, or even more if one also accounts for the role of colonial

  ties in generating cultural similarities! The persistence of such large

  effects decades and, in some instances, more than a century after the

  original colonial relationships were dissolved reinforce the conclusion

  that complete globalization—as in the disappearance of the effects of

  such considerations—is extremely unlikely anytime soon.

   

  Similarities versus differences along many of the same dimensions also

  help explain foreign direct investment or companies’ foreign presence.

  Thus, for U.S. companies that operate in just one foreign country, that

   

   

   

  5

  country is Canada 60 percent of the time (and 10 percent of the time it is

  the United Kingdom). 5 Gravity models have also been adapted to explain

  cross-border interactions as diverse as equity trading, e-commerce

  transactions, patent citations, immigrant flows, air traffic, phone calls,

  and even the incidence of wars! The basic conclusion from this literature

  is that differences between countries—and differences in differences—

  matter in significant, predictable ways.

   

  Identifying and Prioritizing Differences

   

  Having highlighted the persistent impact of cross-country differences or

  distances, the rest of this section focuses on using the CAGE distance

  framework to identify and prioritize the differences that must be

  accounted for in developing global strategies. Exhibit 2-3 helps in this

  regard by identifying bilateral and unilateral factors to consider for each

  of the CAGE categories.

  Exhibit 2-3 The CAGE Framework at the Country Level

  Cultural

  Distance

  Administrative

  Distance

  Geographic

  Distance

  Economic

  Distance

  Country pairs

  (bilateral)

   Different languages

   Different ethnicities;

  lack of

  connective

  ethnic or

  social

  networks

   Different religions

   Lack of trust

   Different values, norms,

  and

  dispositions

   Lack of colonial ties

   Lack of shared regional trading

  bloc

   Lack of common currency

   Political hostility

   Physical distance

   Lack of land border

   Differences in time zones

   Differences in climates /

  disease

  environments

   Rich/poor differences

   Other differences in

  cost or quality

  of natural

  resources,

  financial

  resources,

  human

  resources,

  infrastructure,

  and information

  or knowledge

  Countries

  (unilateral)

   Insularity

   Traditionalism

   Nonmarket/closed economy (home

  bias vs. foreign

  bias)

   Lack of membership in

  international

  organizations

   Landlockedness

   Lack of internal navigability

   Geographic size

   Geographic remoteness

   Weak transportation

   Economic size

   Low per capita income

   

   

   

  6

   Weak institutions, corruption

  or

  communication

  links

   

  The most distinctive feature of the CAGE framework is that it

  encompasses the bilateral attributes of country pairs as well as the

  unilateral attributes of individual countries. Most of the other

  frameworks that have been proposed for thinking about the differences

  across countries (or locations) focus on just unilateral attributes; that is,

  they assume that countries can be assessed one by one against a common

  set of yardsticks. Note that this characterization applies not only to

  cardinal indices such as the World Economic Forum’s Global

  Competitiveness Index or Transparency International’s Corruption

  Perceptions Index but also to ordinal ranking schemes such as Michael

  Porter’s ―diamond‖ framework for diagnosing the (relative) international

  competitiveness of different countries as home bases in specific

  industries. But indexicality of this sort is restrictive since it can’t deal

  with ideas such as ―The U.S. is closer to Canada than it is to Indonesia.‖

  More generally, indexicality is incapable of capturing bilateral

  differences of the sort necessary to envision countries as existing in (and

  even occupying) space in relation to each other, that is, as nodes in a

  network instead of as an array along a common yardstick. 6

   

  Having drawn that distinction between unilateral and bilateral influences,

  it is useful to add that they can be fitted together into the same overall

  structure. Specifically, unilateral measures of isolation (or integration)

  capturing country-specific attributes that generally decrease (or increase)

  a country’s involvement in cross-border economic activities can be

  treated as a common component of that country’s distances along

  various dimensions from all other countries. For example, really isolated

  countries (characterized by unique, ingrown cultures, closed

  administrative policies, physical remoteness, or extremely high or low

  incomes) can be thought of as being relatively distant from everywhere

  else. That said, one needs to add bilateral indicators to such unilateral

  conceptions to capture the idea that a company’s home base affects

  which countries are close and which ones are farther away.

   

  The other point worthy of even more emphasis is that different types of

  distance matter to different extents in different industries. For instance,

   

   

   

  7

  since geographic distance affects the costs of transportation, it is of

  particular importance to companies dealing in heavy or bulky products.

  Cultural distance, on the other hand, shapes consumers’ product

  preferences and should be a crucial consideration for a consumer goods

  or media company—but is much less important for a cement or steel

  business. Exhibit 2-4 provides a summary of the characteristics that are

  likely to make an industry particularly sensitive to a particular kind of

  distance.

   

  Exhibit 2-4 The CAGE Framework at the Industry Level

   

  Cultural

  Distance

  Administrative

  Distance

  Geographic

  Distance

  Economic

  Distance Cultural differences

  matter the most

  when:

   Products have high linguistic content

  (TV programs)

   Products matter to cultural or national

  identity (foods)

   Product features vary in terms of

  size (cars) or

  standards

  (electrical

  equipment)

   Products carry country-specific

  quality

  associations

  (wines)

  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)

  Geography plays a

  more important role

  when:

   Products have a low value-to-weight or

  bulk ratio (cement)

   Products are fragile or perishable (glass,

  fruit)

   Local supervision and operational

  requirements are

  high (services)

  Economic differences

  make the biggest

  impact when:

   Nature of demand varies with income

  (cars)

   Economics of standardization or

  scale are limited

  (cement)

   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)

   

   

  Applications of the CAGE Distance Framework

   

  The CAGE framework, once it is taken down to the industry level, lends

  itself to a very broad array of applications. Let’s focus here on four of

  the most important ones.

   

   

   

   

   

  8

  Making Differences Visible

   

  One application of the CAGE distance framework is to make key

  differences visible. While this application may seem too obvious to be

  worth belaboring, most notable international business debacles can be

  traced back to a failure to appreciate a key type of cross-country

  difference or distance. Furthermore, in a very diverse world, managers

  cannot simply fall back on personal experience to ensure adequate

  sensitivity to differences. Checklists of the sort embedded in exhibits 2-3

  and 2-4 can help even experienced people avoid errors due to

  forgetfulness and cognitive overload in a complex environment.

   

  Understanding the Liability of Foreignness

   

  A second application of the CAGE framework is to pinpoint the

  differences across countries that might handicap multinational

  companies relative to local competitors—the so-called liability of

  foreignness—or more generally affect their relative positions. This can

  be a useful exercise for both multinationals and their local competitors.

  When there are substantial liabilities of foreignness, multinationals often

  look to acquire or set up joint ventures with local firms to overcome

  these barriers.

   

  Assessing Natural Owners and Comparing Foreign Competitors

   

  Even if multinationals can be confident that they are going to prevail

  over local competitors in a particular market, the CAGE framework can

  be used at a finer level of resolution to shed light on the relative position

  of multinationals from different countries. For example, CAGE analysis

  can help explain why Spanish firms do well in many industries across

  Latin America, but also why success in Mexico has proved

  comparatively easier for U.S. firms. 7

  Again, such analysis is most

  valuable when conducted at the industry level and is indicative rather

  than decisive. Thus, particularly good or bad global strategies can matter

  more than ―natural ownership‖ advantages.

   

   

   

   

   

   

   

  9

  Comparing Markets and Discounting by Distance

   

  The CAGE framework can also be used to compare markets from the

  perspective of a particular company. One method to conduct quantitative

  analysis of this type is to discount (specifically, divide) raw measures of

  market size or potential with measures of distance, broadly defined.

  While such discounting involves numerous approximations, making

  some adjustments of market potential for distance is a better idea, given

  how much distance matters, than refraining from making any

  adjustments at all. Some companies do formally use methods of this sort

  in deciding to enter or exit markets (as described in the first case in this

  section, on Grolsch).

   

  Conclusion

   

  The CAGE framework helps identify the most important cross-country

  differences and their implications for strategy. However, understanding

  differences is not a sufficient basis for setting global strategy. Think

  back to the ADDING value scorecard from the previous section and ask

  yourself how each type of difference or distance affects the six levers for

  value addition and subtraction. Is it a challenge that must be accounted

  for and addressed? Or does it offer an opportunity to improve economic

  profitability? The next three sections help address these questions by

  introducing three types of strategies for creating and claiming value in

  the presence of cross-border differences: adaptation, aggregation, and

  arbitrage.

   

   

   

  1 Pankaj Ghemawat And Jordan I. Siegel, ―Cases on Redefining Global

  Strategy‖ , (Harvard Business Review Press, 2011):59-69 2 For a more extended treatment of this material, see Pankaj Ghemawat,

  ―Distance Still Matters: The Hard Reality of Global Expansion,‖ Harvard Business

  Review, September 2001. This topic is also addressed at substantially greater length in

  chapter 2 of Pankaj Ghemawat, Redefining Global Strategy (Harvard Business School

  Press, 2007), and chapter 3 of Pankaj Ghemawat, World 3.0: Global Prosperity and

  How to Achieve It (Harvard Business Review Press, 2011). For a collection of maps

  that highlight distance effects, see www.ghemawat.com.

   

   

   

  10

  3 For further discussion of the ways in which CAGE differences can encourage

  rather than discourage cross-border activity, see the discussion of arbitrage in section 5

  and the references cited therein.

  4 For an original discussion of cultural distance and how it affects foreign

  direct investment, see Jordan Siegel, Amir Licht, and Shalom Schwartz,

  ―Egalitarianism, Cultural Distance, and FDI: A New Approach,‖ working paper,

  Harvard Business School, Boston, October 2008.

  5 Susan E. Feinberg, ―The Expansion and Location Patterns of U.S.

  Multinationals,‖ unpublished working paper, Rutgers University, 2005.

  6 For a more extended discussion of indexicality in a broader social science

  context, see Andrew Abbott, Chaos of Disciplines (Chicago: University of Chicago

  Press, 2001).

  7 Subramanian Rangan and Aldemir Drummond, ―Explaining Outcomes in

  Competition among Foreign Multinationals in a Focal Host Market,‖ Strategic

  Management Journal 25, no. 3: 285–293.

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