This text was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work’s original creator or licensee. Saylor URL: http://www.saylor.org/books Saylor.org 1 Preface This book looks at the opportunities and risks associated with staking out a global competitive presence and introduces the fundamentals of global strategic thinking. We define crafting a global strategy in terms of change—how a company should change and adapt its core (domestic) business model to achieve a competitive advantage as it expands globally. The conceptual framework behind this definition has three fundamental building blocks: a company’s core business model, the various strategic decisions a company needs to make as it globalizes its operations, and a range of globalization strategies for creating a global competitive advantage. We use Pankaj Ghemawat’s well-known “AAA Triangle” framework to describe three generic approaches to global value creation. Adaptation strategies seek to increase revenues and market share by tailoring one or more components of a company’s business model to suit local requirements or preferences. Aggregation strategies focus on achieving economies of scale or scope by creating regional or global efficiencies; they typically involve standardizing a significant portion of the value proposition and grouping together development and production processes. Arbitrage is about exploiting economic or other differences between national or regional markets, usually by locating separate parts of the supply chain in different places. A business model is simply a description of how a company does business. It has four principal components: (a) market participation, that is, who its customers are, how it reaches them and relates to them; (b) the value proposition, or, what a company offers its customers; (c) the supply-chain infrastructure, that is, with what resources, activities, and partners it creates its offerings; and finally, (d) its management model, or, how it organizes and coordinates its operations. Globalization requires a company to make strategic decisions about each component of the business model. Market participation decisions include choosing which specific markets or segments to serve, domestically or abroad; what methods of distribution to use to reach target customers; and how to promote and advertise the value proposition. A company’s value proposition composes the core of its business model; it includes everything it offers its customers in a specific market or segment. This comprises not only the company’s bundles Saylor URL: http://www.saylor.org/books Saylor.org 2 of products and services—it also affects how it differentiates itself from its competitors. Globalization decisions about the value proposition therefore touch the full range of tangible and intangible benefits a company provides to its customers (stakeholders). The value chain infrastructure dimension of the business model deals with such questions as, what key internal resources and capabilities has the company created to support the chosen value proposition and target markets; what partner network has it assembled to support the business model; and how are these activities organized into an overall, coherent value creation and delivery model? Finally, the management dimension is concerned with a company’s choices about a suitable global organizational structure and decision-making process. Creating a global mind-set is a key determinant of global success. Organization of the Book The book is organized in two sections. Chapter 1 "Competing in a Global World" through Chapter 4 "Global Strategy as Business Model Change" make up the first section. Chapter 1 "Competing in a Global World" assesses how global the world economy has become and what implications that has for companies. Chapter 2 "The Globalization of Companies and Industries" looks at globalization at the industry level. It asks the following questions: What is a global industry? What are the driving forces behind the globalization of industries? and What explains the dominance of particular countries or regions in global industries? Chapter 3 "Generic Strategies for Global Value Creation" looks at generic strategies for creating a global competitive advantage, ranging from adaptation to aggregation to arbitrage. Chapter 4 "Global Strategy as Business Model Change" introduces the concept of a business model to define global strategy formulation as changing or adapting a company’s core (domestic) business model to achieve a competitive advantage as it globalizes its operations or presence. Chapter 5 "Target Markets and Modes of Entry" through Chapter 10 "Globalizing the Management Model" make up the second section of the book. Each chapter looks at the globalization decisions that have to be made about a particular component of a company’s business model or discusses a core competency associated with that component. Chapter 5 "Target Markets and Modes of Entry" looks at Saylor URL: http://www.saylor.org/books Saylor.org 3 decisions regarding which foreign markets to enter and why, when, and how to enter them. In other words, the chapter is about target-market selection and the timing and mode of market entry. Chapter 6 "Globalizing the Value Proposition" discusses the globalization of the company’s core offerings and introduces the concept of a value proposition globalization matrix to guide strategic thinking. Chapter 7 "Global Branding" addresses a related core competency: global branding. Chapter 8 "Globalizing the Value Chain Infrastructure" looks at the globalization of the value-chain infrastructure, from research and development, to product development, to manufacturing, to distribution, to after-sale service. Chapter 9 "Global Supply-Chain Management" follows this discussion with a survey of a closely related core competency: supply-chain management. Chapter 10 "Globalizing the Management Model" rounds out the business model framework by looking at the globalization of a company’s management model. Minicases and Appendices Each chapter features a number of minicases—vignettes about real companies struggling with the issues raised in the main body of the text. They are included to provide context for the various concepts introduced, to create variety in presentation, and to challenge students to link theory to practice. Two appendices are included in the book. The first surveys the various doctrines and regulatory frameworks that guide global trade. The second consists of suggestions for suitable case studies to accompany each chapter of the book. Saylor URL: http://www.saylor.org/books Saylor.org 4 Chapter 1 Competing in a Global World To most of us, globalization—as a political, economic, social, and technological force—appears all but unstoppable. The ever-faster flow of information across the globe has made people aware of the tastes, preferences, and lifestyles of citizens in other countries. Through this information flow, we are all becoming—at varying speeds and at least in economic terms—global citizens. This convergence is controversial, even offensive, to some who consider globalization a threat to their identity and way of life. It is not surprising, therefore, that globalization has evoked counter forces aimed at preserving differences and deepening a sense of local identity. Yet, at the same time, we increasingly take advantage of what a global economy has to offer—we drive BMWs and Toyotas, work with an Apple or IBM notebook, communicate with a Nokia phone or BlackBerry, wear Zara clothes or Nike sneakers, drink Coca-Cola, eat McDonald’s hamburgers, entertain the kids with a Sony PlayStation, and travel with designer luggage. This is equally true for the buying habits of businesses. The market boundaries for IBM global services, Hewlett-Packard computers, General Electric (GE) aircraft engines, or PricewaterhouseCoopers consulting are no longer defined in political or geographic terms. Rather, it is the intrinsic value of the products and services that defines their appeal. Like it or not, we are living in a global economy. Saylor URL: http://www.saylor.org/books Saylor.org 5 1.1 How Global Are We? In 1983, Theodore Levitt, the late Harvard Business School professor and editor of the Harvard Business Review, wrote a controversial article entitled “The Globalization of Markets.” In it, he famously stated, “The globalization of markets is at hand. With that, the multinational commercial world nears its end, and so does the multinational corporation… The multinational operates in a number of countries, and adjust its products and processes in each, at high relative cost. The global corporation operates with resolute constancy… it sells the same things in the same way everywhere” [1] Levitt both overestimated and underestimated globalization. He did not anticipate that some markets would react against globalization, especially against Western globalization. He also underestimated the power of globalization to transform entire nations to actually embrace elements of global capitalism, as is happening in the former Soviet Union, China, and other parts of the world. He was right, however, about the importance of branding and its role in forging the convergence of consumer preferences on a global scale. Think of Coca-Cola, Starbucks, McDonald’s, or Google. [2] More than 20 years later, in 2005, Thomas Friedman, author of The World is Flat: A Brief History of the Twenty-First Century, had much the same idea, this time focused on the globalization of production rather than of markets. Friedman argues that a number of important events, such as the birth of the Internet, coincided to “flatten” the competitive landscape worldwide by increasing globalization and reducing the power of states. Friedman’s list of “flatteners” includes the fall of the Berlin Wall; the rise of Netscape and the dot-com boom that led to a trillion-dollar investment in fiber-optic cable; the emergence of common software platforms and open source code enabling global collaboration; and the rise of outsourcing, offshoring, supply chaining, and in-sourcing. According to Friedman, these flatteners converged around the year 2000, creating “a flat world: a global, web-enabled platform for multiple forms of sharing knowledge and work, irrespective of time, distance, geography and increasingly, language.” [3] And, he observed, at the very moment this platform emerged, three huge economies materialized—those of India, China, and the former Soviet Union, and “three billion people who were out of the game, walked onto the playing field.” [4] Saylor URL: http://www.saylor.org/books Saylor.org 6 Taking a different perspective, Harvard Business School professor Pankaj Ghemawat disputes the idea of fully globalized, integrated, and homogenized future. Instead, he argues that differences between countries and cultures are larger than is generally acknowledged and that “semiglobalization” is the real state of the world today and is likely to remain so for the foreseeable future. To support his contention, he observes that the vast majority of all phone calls, web traffic, and investment around the world remains local; that more than 90% of the fixed investment around the world is still domestic; that while trade flows are growing, the ratio of domestic to international trade is still substantial and is likely to remain so; and, crucially, that borders and distance still matter and that it is important to take a broad view of the differences they demarcate, to identify those that matter the most in a particular industry, and to look at them not just as difficulties to be overcome but also as potential sources of value creation. [5] Moore and Rugman also reject the idea of an emerging single world market for free trade and offer a regional perspective. They note that while companies source goods, technology, information, and capital from around the world, business activity tends to be centered in certain cities or regions around the world, and suggest that regions—rather than global opportunity—should be the focus of strategy analysis and organization. As examples, they cite recent decisions by DuPont and Procter & Gamble to roll their three separate country subsidiaries in the United States, Canada, and Mexico into one regional organization. [6] The histories of Toyota, Wal-Mart, and Coca-Cola provide support for the diagnosis of a semiglobalized and regionally divided world. Toyota’s globalization has always had a distinct regional flavor. Its starting point was nota grand, long-term vision of a fully integrated world in which autos and auto parts can flow freely from anywhere to anywhere else. Rather, the company anticipated expanded free-trade agreements within the Americas, Europe, and East Asia but not across them. This reflects a vision of a semiglobalized world in which neither the bridges nor the barriers between countries can be ignored. [7] The globalization of Wal-Mart illustrates the complex realities of a more nuanced global competitive landscape (see the Wal-Mart minicase). It has been successful in markets that are culturally, Saylor URL: http://www.saylor.org/books Saylor.org 7 administratively, geographically, and economically closest to the United States: Canada, Mexico, and the United Kingdom. In other parts of the world, it has yet to meet its profitability targets. The point is not that Wal-Mart should not have ventured into more distant markets, but rather that such opportunities require a different competitive approach. For example, in India, which restricts foreign direct investment in retailing, Wal-Mart was forced to enter a joint venture with an Indian partner, Bharti, that operates the stores, while Wal-Mart deals with the back end of the business. Finally, consider the history of Coca-Cola, which, in the late 1990s under chief executive officer Roberto Goizueta, fully bought into Levitt’s idea that the globalization of markets (rather than production) was imminent. Goizueta embarked on a strategy that involved focusing resources on Coke’s megabrands, an unprecedented amount of standardization, and the official dissolution of the boundaries between Coke’s U.S. and international organizations. Fifteen years later and under new leadership, Coke’s strategy looks very different and is no longer always the same in different parts of the world. In big, emerging markets such as China and India, Coke has lowered price points, reduced costs by localizing inputs and modernizing bottling operations, and upgraded logistics and distribution, especially rurally. The boundaries between the United States and international organizations have been restored, recognizing the fact that Coke faces very different challenges in America than it does in most of the rest of the world. This is because per capita consumption is an order of magnitude that is higher in the United States than elsewhere. Minicase: The Globalization of Wal-Mart [8] In venturing outside the United States, Wal-Mart had the option of entering Europe, Asia, or other countries in the western hemisphere. It realized that it did not have the resources—financial, organizational, and managerial—to enter all of them simultaneously and instead opted for a carefully considered, learning-based approach to market entry. During the first 5 years of its globalization (1991 to 1995), Wal-Mart concentrated heavily on establishing a presence in the Americas: Mexico, Brazil, Argentina, and Canada. This choice was motivated by the fact that the European market was less attractive to Wal-Mart as a first point of entry. The European retail industry was already mature, which meant that a new entrant would have to take market share away from an existing player. There were wellentrenched competitors such as Carrefour in France and Metro AG in Germany that would likely retaliate Saylor URL: http://www.saylor.org/books Saylor.org 8 vigorously. Moreover, European retailers had formats similar to Wal-Mart’s, which would have the effect of reducing Wal-Mart’s competitive advantage. Wal-Mart might have overcome these difficulties by entering Europe through an acquisition, but the higher growth rates of the Latin American and Asian markets would have made a delayed entry into those markets extremely costly in terms of lost opportunities. In contrast, the opportunity costs of delaying acquisition-based entries into European markets were relatively small. Asian markets also presented major opportunities, but they were geographically and culturally more distant. For these reasons, as its first global points of entry, Wal-Mart chose Mexico (1991), Brazil (1994), and Argentina (1995), the countries with the three largest populations in Latin America. By 1996, Wal-Mart felt ready to take on the Asian challenge. It targeted China, with a population of more than 1.2 billion inhabitants in 640 cities, as its primary growth vehicle. This choice made sense in that the lower purchasing power of the Chinese consumer offered huge potential to a low-price retailer like WalMart. Still, China’s cultural, linguistic, and geographical distance from the United States presented relatively high entry barriers, so Wal-Mart established two beachheads as learning vehicles for establishing an Asian presence. From 1992 to 1993, Wal-Mart agreed to sell low-priced products to two Japanese retailers, Ito-Yokado and Yaohan, that would market these products in Japan, Singapore, Hong Kong, Malaysia, Thailand, Indonesia, and the Philippines. Then, in 1994, Wal-Mart formed a joint venture with the C. P. Pokphand Company, a Thailand-based conglomerate, to open three Value Club membership discount stores in Hong Kong. Once Wal-Mart had chosen its target markets, it had to select a mode of entry. It entered Canada through an acquisition. This was rational because Canada was a mature market—adding new retail capacity was unattractive—and because the strong economic and cultural similarities between the U.S. and Canadian markets minimized the need for much learning. For its entry into Mexico, Wal-Mart took a different route. Because there were significant income and cultural differences between the U.S. and Mexican markets about which the company needed to learn, and to which it needed to tailor its operations, a greenfield start-up would have been problematic. Instead, the Saylor URL: http://www.saylor.org/books Saylor.org 9 company chose to form a 50-50 joint venture with Cifra, Mexico’s largest retailer, counting on Cifra to provide operational expertise in the Mexican market. In Latin America, Wal-Mart targeted the region’s next two largest markets: Brazil and Argentina. The company entered Brazil through a joint venture, with Lojas Americana, a local retailer. Wal-Mart was able to leverage its learning from the Mexican experience and chose to establish a 60-40 joint venture in which it had the controlling stake. The successful entry into Brazil gave Wal-Mart even greater experience in Latin America, and it chose to enter Argentina through a wholly owned subsidiary. This decision was reinforced by the presence of only two major markets in Argentina. [1] Levitt (1983, May–June). [2] Ghemawat (2007a), p. 9. [3] Friedman (2007), p. 50. [4] Friedman (2007), p. 205. [5] Ghemawat (2007b). [6] Moore and Rugman (2005a); see also Moore and Rugman (2005b). [7] The Toyota, Wal-Mart, and Coca-Cola examples are taken from Ghemawat (2007a), chap. 1. [8] This mini case study was first published in de Kluyver and Pearce (2009), chap. 8. Saylor URL: http://www.saylor.org/books Saylor.org 10 1.2 Global Competition’s Changing Center of Gravity The rapid emergence of a number of developing economies—notably the socalled BRIC countries (Brazil, Russia, India, and China)—is the latest development shaping the global competitive environment. The impact this development will have on global competition in the next decade is likely to be enormous; these economies are experiencing rates of growth in gross domestic product (GDP), trade, and disposable income that are unprecedented in the developed world. The sheer size of the consumer markets now opening up in emerging economies, especially in India and China, and their rapid growth rates will shift the balance of business activity far more than did the earlier rise of less populous economies such as Japan and South Korea and their handful of “new champions” that seemed to threaten the old order at the time. This shift in the balance of business activity has redefined global opportunity. For the last 50 years, the globalization of business has primarily been interpreted as the expansion of trade from developed to emerging economies. Today’s rapid rise of emerging economies means this view is no longer tenable—business now flows in both directions and increasingly from one developing economy to another. Or, as the authors of “Globality,” consultants at the Boston Consulting Group (BCG), put it, business these days is all about “competing with everyone from everywhere for everything.” [1] The evidence that this latest shift in the global competitive landscape will have seismic proportions is already formidable. Consider, for example, the growing number of companies from emerging markets that appear in the Fortune 500 rankings of the world’s biggest firms. It now stands at 62, mostly from the BRIC economies, up from 31 in 2003, and is set to rise rapidly. What is more, if current trends persist, emerging-market companies will account for one-third of the Fortune list within 10 years. Look also at the recent sharp increase in the number of emerging-market companies acquiring established rich-world businesses and brands, proof that “globalization” is no longer just another word for “Americanization.” For instance, Budweiser, the maker of America’s favorite beer, was Saylor URL: http://www.saylor.org/books Saylor.org 11 bought by a Belgian-Brazilian conglomerate. And several of America’s leading financial institutions avoided bankruptcy only by being bailed out by the sovereign-wealth funds (state-owned investment funds) of various Arab kingdoms and the Chinese government. Another prominent example of this seismic shift in global business is provided by Lenovo, the Chinese computer maker. It became a global brand in 2005, when it paid around $1.75 billion for the personal-computer business of one of America’s best-known companies, IBM, including the ThinkPad laptop range. Lenovo had the right to use the IBM brand for 5 years, but dropped it 2 years ahead of schedule, such was its confidence in its own brand. It just squeezed into 499th place in the Fortune 500, with worldwide revenues of $16.8 billion last year and growth prospects many Western companies envy. The conclusion is that this new phase of “globality” is creating huge opportunities—as well as threats—for developed-world multinationals and new champions from developing countries alike. [1] Sirkin, Hemerling, and Bhattacharya (2008). Saylor URL: http://www.saylor.org/books Saylor.org 12 1.3 Globalization Pressures on Companies Gupta, Govindarajan, and Wang identify five “imperatives” that drive companies to become more global: to pursue growth, efficiency, and knowledge; to better meet customer needs; and to preempt or counter competition. [1] Growth In many industries, markets in the developed countries are maturing at a rapid rate, limiting the rate of growth. Consider household appliances: in the developed part of the world, most households have, or have access to, appliances such as stoves, ovens, washing machines, dryers, and refrigerators. Industry growth is therefore largely determined by population growth and product replacement. In developing markets, in contrast, household penetration rates for major appliances are still low compared to Western standards, thereby offering significant growth opportunities for manufacturers. Efficiency A global presence automatically expands a company’s scale of operations, giving it larger revenues and a larger asset base. A larger scale can help create a competitive advantage if a company undertakes the tough actions needed to convert scale into economies of scale by (a) spreading fixed costs, (b) reducing capital and operating costs, (c) pooling purchasing power, and (d) creating critical mass in a significant portion of the value chain. Whereas economies of scale primarily refer to efficiencies associated with supply-side changes, such as increasing or decreasing the scale of production, economies of scope refer to efficiencies typically associated with demand-side changes, such as increasing or decreasing the scope of marketing and distribution by entering new markets or regions or by increasing the range of products and services offered. The economic value of global scope can be substantial when serving global customers through providing coordinated services and the ability to leverage a company’s expanded market power. Knowledge Foreign operations can be reservoirs of knowledge. Some locally created knowledge is relevant across multiple countries, and, if leveraged effectively, can yield significant strategic benefits to a global Saylor URL: http://www.saylor.org/books Saylor.org 13 enterprise, such as (a) faster product and process innovation, (b) lower cost of innovation, and (c) reduced risk of competitive preemption. For example, Fiat developed Palio—its global car—in Brazil; Texas Instruments uses a collaborative process between Indian and U.S. engineers to design its most advanced chips; and Procter & Gamble’s liquid Tide was developed as a joint effort by U.S. employees (who had the technology to suspend dirt in water), the Japanese subsidiary (who had the cleaning agents), and the Brussels operations (who had the agents that fight mineral salts found in hard water). Most companies tap only a fraction of the full potential in realizing the economic value inherent in transferring and leveraging knowledge across borders. Significant geographic, cultural, and linguistic distances often separate subsidiaries. The challenge is creating systematic and routine mechanisms that will uncover opportunities for knowledge transfer. Customer Needs and Preferences When customers start to globalize, a firm has little choice but to follow and adapt its business model to accommodate them. Multinationals such as Coca-Cola, GE, and DuPont increasingly insist that their suppliers—from raw material suppliers to advertising agencies to personnel recruitment companies— become more global in their approach and be prepared to serve them whenever and wherever required. Individuals are no different—global travelers insist on consistent worldwide service from airlines, hotel chains, credit card companies, television news, and others. Competition Just as the globalization of customers compels companies to consider globalizing their business model, so does the globalization of one or more major competitors. A competitor who globalizes early may have a first-mover advantage in emerging markets, greater opportunity to create economies of scale and scope, and an ability to cross-subsidize competitive battles, thereby posing a greater threat in the home market. The global beer market provides a good example of these forces at work. Over the past decade, the beer industry has witnessed significant consolidation, and this trend continued during 2008. On a pro forma basis, beer sales by the top 10 players now total approximately 65% of total global sales, compared to less than 40% at the start of the century. In recent major developments, the division of Scottish and Newcastle’s business between Carlsberg and Heineken was completed during the first half of 2008, while Saylor URL: http://www.saylor.org/books Saylor.org 14 InBev acquired Anheuser-Busch in November 2008. SABMiller and Molson Coors combined their operations in the United States and Puerto Rico on July 1, 2008, to form the new MillerCoors brewing joint venture. Minicase: Chocolatiers Look to Asia for Growth [2] Humans first cultivated a taste for chocolate 3,000 years ago, but for India and China this is a more recent phenomenon. Compared to the sweet-toothed Swiss and Brits, both of whom devour about 24 lbs (11 kg) of chocolate per capita annually, Indians consume a paltry 5.8 oz and the Chinese, a mere 3.5 oz (165 g and 99 g, respectively). Western chocolate makers hungry for growth markets are banking on this to change. According to market researcher Euromonitor International, in the past 5 years, the value of chocolate confectionery sales in China has nearly doubled, to $813.1 million, while sales in India have increased 64%, to $393.8 million. That is a pittance compared to the nearly $35-billion European chocolate market. But while European chocolate sales are growing a mere 1% to 2% annually, sales in the two Asian nations show no sign of slowing. European chocolatiers are already making their mark in China. The most aggressive is Swiss food giant Nestlé, which has more than doubled its Chinese sales since 2001 to an estimated $91.5 million—still a relatively small amount. It is closing in on Mars, the longtime market leader, whose sales rose 40% during the same period to $96.7 million. Green Tea Kisses Nestlé’s Kit Kat bar and other wafer-type chocolates are a big hit with the Chinese, helping the Swiss company swipe market share from Mars. Italy’s Ferrero is another up-and-comer. It has boosted China sales nearly 79% since 2001, to $55.6 million, drawing younger consumers with its Kinder chocolate line, while targeting big spenders with the upscale Ferrero Rocher brand. Indeed, its products are so popular that they have spawned Chinese knockoffs, including a Ferrero Rocher look-alike made by a Chinese company that Ferrero has sued for alleged counterfeiting. Despite those problems, the privately owned Saylor URL: http://www.saylor.org/books Saylor.org 15 Ferrero has steadily gained market share against third-ranked Cadbury Schweppes, whose China sales have risen a modest 26% since 2001, to $58.6 million. Until now, U.S.-based Hershey has been a relatively small player in China. But the company has adopted ambitious expansion plans, including hooking up with a local partner to step up its distribution and introducing green-tea-flavored Hershey Kisses to appeal to Asian tastes. Attractively Packaged Underscoring China’s growing importance, Switzerland’s Barry Callebaut, a big chocolate producer that supplies many leading confectioners, opened a factory near Shanghai to alleviate pressure at a Singapore facility that had been operating at capacity. The company also inaugurated a nearby Chocolate Academy, just 1 month after opening a similar facility in Mumbai, to train local confectioners and pastry chefs in using chocolate. Unlike China’s chocolate market, India’s is dominated by only two companies: Cadbury, which entered the country 60 years ago and has nearly 60% market share, and Nestlé, which has about 32% market share. The two have prospered by luring consumers with attractively packaged chocolate assortments to replace the traditional dried fruits and sugar confectioneries offered as gifts on Indian holidays, and by offering lower-priced chocolates, including bite-sized candies costing less than 3 cents. The confectionary companies have been less successful, though, at developing new products adapted to the Indian sweet tooth. In 2005, Nestlé launched a coconut-flavored Munch bar, and Cadbury introduced a dessert called Kalakand Crème, based on a popular local sweet made of chopped nuts and cheese. Both sold poorly and were discontinued. [1] Gupta, Govindarajan, and Wang (2008), p. 28. [2] Fishbein (2008, January 17). Saylor URL: http://www.saylor.org/books Saylor.org 16 1.4 What Is a Global Corporation? One could argue that a global company must have a presence in all major world markets—Europe, the Americas, and Asia. Others may define globality in terms of how globally a company sources, that is, how far its supply chain reaches across the world. Still other definitions use company size, the makeup of the senior management team, or where and how it finances its operations as their primary criterion. Gupta, Govindarajan, and Wang suggest we define corporate globality in terms of four dimensions: a company’s market presence, supply base, capital base, and corporate mind-set. [1] The first dimension—the globalization of market presence—refers to the degree the company has globalized its market presence and customer base. Oil and car companies score high on this dimension. Wal-Mart, the world’s largest retailer, on the other hand, generates less than 30% of its revenues outside the United States. The second dimension—the globalization of the supply base—hints at the extent to which a company sources from different locations and has located key parts of the supply chain in optimal locations around the world. Caterpillar, for example, serves customer in approximately 200 countries around the world, manufactures in 24 of them, and maintains research and development facilities in nine. The third dimension—globalization of the capital base—measures the degree to which a company has globalized its financial structure. This deals with such issues as on what exchanges the company’s shares are listed, where it attracts operating capital, how it finances growth and acquisitions, where it pays taxes, and how it repatriates profits. The final dimension—globalization of the corporate mind-set—refers to a company’s ability to deal with diverse cultures. GE, Nestlé, and Procter & Gamble are examples of companies with an increasingly global mind-set: businesses are run on a global basis, top management is increasingly international, and new ideas routinely come from all parts of the globe. In the years to come, the list of truly “global” companies—companies that are global in all four dimensions—is likely to grow dramatically. Global merger and acquisition activity continues to increase as companies around the world combine forces and restructure themselves to become more globally competitive and to capitalize on opportunities in emerging world markets. We have already Saylor URL: http://www.saylor.org/books Saylor.org 17 seen megamergers involving financial services, leisure, food and drink, media, automobile, and telecommunications companies. There are good reasons to believe that the global mergers and acquisitions (M&A) movement is just in its beginning stages—the economics of globalization point to further consolidation in many industries. In Europe, for example, more deregulation and the EU’s move toward a single currency will encourage further M&A activity and corporate restructuring. [1] Gupta, Govindarajan, and Wang (2008), p. 7 Saylor URL: http://www.saylor.org/books Saylor.org 18 1.5 The Persistence of Distance Metaphors such as “the world is flat” tend to suggest that distance no longer matters—that information technologies and, in particular, global communications are shrinking the world, turning it into a small and relatively homogeneous place. But when it comes to business, that assumption is not only incorrect; it is dangerous. Ghemawat analyzes distance between countries or regions in terms of four dimensions— cultural, administrative, geographic, and economic (CAGE)—each of which influences business in different ways. [1] Cultural Distance A country’s culture shapes how people interact with each other and with organizations. Differences in religious beliefs, race, social norms, and language can quickly become barriers, that is, “create distance.” The influence of some of these attributes is obvious. A common language, for example, makes trade much easier and therefore more likely. The impact of other attributes is much more subtle, however. Social norms—the set of unspoken principles that strongly guides everyday behavior—are mostly invisible. Japanese and European consumers, for example, prefer smaller automobiles and household appliances than Americans, reflecting a social norm that highly values space. The food industry must concern itself with religious attributes—for example, Hindus do not eat beef because it is expressly forbidden by their religion. Thus, cultural distance shapes preference and, ultimately, choice. Administrative or Political Distance Administrative or political distance is created by differences in governmental laws, policies, and institutions, including international relationships between countries, treaties, and membership in international organizations (see Chapter 11 "Appendix A: Global Trade: Doctrines and Regulation" for a brief summary). The greater the distance, the less likely it is that extensive trade relations develop. This explains the advantage that shared historical colonial ties, membership in the same regional trading bloc, and use of a common currency can confer. The integration of the European Union over the last half- Saylor URL: http://www.saylor.org/books Saylor.org 19 century is probably the best example of deliberate efforts to reduce administrative distance among trading partners. Bad relationships can increase administrative distance, however. Although India and Pakistan share a colonial past, a land border, and linguistic ties, their long-standing mutual hostility has reduced official trade to almost nothing. Countries can also create administrative and 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 companies from the United States, for instance, domestic prohibitions on bribery and the prescription of health, safety, and environmental policies have a dampening effect on their international businesses. More commonly, though, it is the target country’s government that raises barriers to foreign competition: tariffs, trade quotas, restrictions on foreign direct investment, and preferences for domestic competitors in the form of subsidies and favoritism in regulation and procurement. Geographic Distance Geographic distance is about more than simply how far away a country is in miles. Other geographic attributes include the physical size of the country, average within-country distances to borders, access to waterways and the ocean, topography, and a country’s transportation and communications infrastructure. Geographic attributes most directly influence transportation costs and are therefore particularly relevant to businesses with low value-to-weight or bulk ratios, such as steel and cement. Likewise, costs for transporting fragile or perishable products become significant across large distances. Intangible goods and services are affected by geographic distance as well, as cross-border equity flows between two countries fall off significantly as the geographic distance between them rises. This is a direct result of differences in information infrastructure, including telephone, Internet, and banking services. Economic Distance Disposable income is the most important economic attribute that creates distance between countries. Rich countries engage in proportionately higher levels of cross-border economic activity than poorer ones. The greater the economic distance between a company’s home country and the host country, the greater Saylor URL: http://www.saylor.org/books Saylor.org 20 the likelihood that it must make significant adaptations to its business model. 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 virtually a carbon copy of the U.S. Wal-Mart. An exception to the distance rule is provided by industries in which competitive advantage is derived from economic arbitrage, that is, the exploitation of cost and price differentials between markets. Companies in industries whose major cost components vary widely across countries, like the garment and footwear industries, where labor costs are important, are particularly likely to target countries with different economic profiles for investment or trade. Whether or not they expand abroad for purposes of replication or arbitrage, all companies find that major disparities in supply chains and distribution channels are significant barriers to business. This suggests that focusing on a limited number of geographies may prove advantageous because of reduced operational complexity. This is evident in the home-appliance business, for instance, where companies—like Maytag—that concentrate on a limited number of geographies produce far better returns for investors than companies like Electrolux and Whirlpool, whose geographic spread has come at the expense of simplicity and profitability. Minicase: Computer Keyboards Abroad: QWERTZ Versus QWERTY Anyone who has traveled to Austria or Germany and has used computers there—in cybercafes, offices, or at the home of friends—will instantly recognize this dimension of “distance”: their keyboards are not the same as ours. Once-familiar letters and symbols look like strangers, and new keys are located where they should not be. [2] Specifically, a German keyboard has a QWERTZ layout, that is, the “Y” and “Z” keys are reversed in comparison with the U.S.-English QWERTY layout. Moreover, in addition to the “normal” letters of the English alphabet, German keyboards have the three umlauted vowels and the “sharp-s” characters of the German alphabet. The “ess-tsett” (ß) key is to the right of the zero (“0”) key. (But this letter is missing on a Swiss-German keyboard, since the “ß” is not used in the Swiss variation of German.) The u-umlaut (ü) key is located just to the right of the “P” key. The o-umlaut (ö) and a-umlaut (ä) keys are to the right of the “L” key. This means, of course, that the symbols or letters that an American is used to finding where the umlauted letters are in the German version turn up somewhere else. All this is enough to bring on a major headache. Saylor URL: http://www.saylor.org/books Saylor.org 21 And just where the heck is that “@” key? E-mail happens to depend on it rather heavily, but on the German keyboard, not only is it NOT at the top of the “2” key but it also seems to have vanished entirely! This is surprising considering that the “at” sign even has a name in German: der Klammeraffe (lit., “clip/bracket monkey”). So how do you type “@”? You have to press the “Alt Gr” key plus “Q” to make “@” appear in your document or e-mail address. Ready for the Excedrin? On most European-language keyboards, the right “Alt” key, which is just to the right of the space bar and different from the regular “Alt” key on the left side, acts as a “Compose” key, making it possible to enter many non-ASCII characters. This configuration applies to PCs; Mac users will need to take an advanced course. Of course, for Europeans using a North American keyboard, the problems are reversed, and they must get used to the weird U.S. English configuration. [1] Ghemawat (2001). [2] http://german.about.com Saylor URL: http://www.saylor.org/books Saylor.org 22 1.6 Global Strategy and Risk Even with the best planning, globalization carries substantial risks. Many globalization strategies represent a considerable stretch of the company’s experience base, resources, and capabilities. [1] The firm might target new markets, often in new—for the company—cultural settings. It might seek new technologies, initiate new partnerships, or adopt market-share objectives that require earlier or greater commitments than current returns can justify. In the process, new and different forms of competition can be encountered, and it could turn out that the economics model that got the company to its current position is no longer applicable. Often, a more global posture implies exposure to different cyclical patterns, currency, and political risk. In addition, there are substantial costs associated with coordinating global operations. As a consequence, before deciding to enter a foreign country or continent, companies should carefully analyze the risks involved. In addition, companies should recognize that the management style that proved successful on a domestic scale might turn out to be ineffective in a global setting. Over the last 25 years, Western companies have expanded their activities into parts of the world that carry risks far greater than those to which they are accustomed. According to Control Risks Group, a London-based international business consultancy, multinational corporations are now active in more than 100 countries that are rated “medium” to “extreme” in terms of risk, and hundreds of billions are invested in countries rated “fairly” to “very” corrupt. To mitigate this risk, companies must understand the specific nature of the relationship between corporate globalization and geopolitics, identify the various types of risk globalization exposes them to, and adopt strategies to enhance their resilience. Such an understanding begins with the recognition that the role of multinational corporations in the evolving global-geopolitical landscape continues to change. The prevailing dogma of the 1990s held that free-market enterprise and a liberal economic agenda would lead to more stable geopolitical relations. The decline of interstate warfare during this period also provided a geopolitical environment that enabled heavy consolidation across industries, resulting in the emergence of “global players,” that is, conglomerates with worldwide reach. The economy was paramount; Saylor URL: http://www.saylor.org/books Saylor.org 23 corporations were almost unconstrained by political and social considerations. The greater international presence of business and increasing geopolitical complexity also heightened the exposure of companies to conflict and violence, however. As they became larger, they became more obvious targets for attack and increasingly vulnerable because their strategies were based on the assumption of fundamentally stable geopolitical relations. In recent years, the term “global player” has acquired a new meaning, however. Previously a reference exclusively to an economic role, the term now describes a company that has, however unwillingly, become a political actor as well. And, as a consequence, to remain a global player today, a firm must be able to survive not only economic downturns but also geopolitical shocks. This requires understanding that risk has become an endemic reality of the globalization process—that is, no longer simply the result of conflict in one country or another but something inherent in the globalized system itself. Globalization risk can be of a political, legal, financial-economic, or sociocultural nature. Political risk relates to politically induced actions and policies initiated by a foreign government. Crises such as the September 11, 2001, terrorist attacks in the United States, the ongoing conflict in Iraq and Pakistan, instability in the Korean peninsula, and the recent global financial crisis have made geopolitical uncertainty a key component of formulating a global strategy. The effect of these events and the associated political decisions on energy, transportation, tourism, insurance, and other sectors demonstrates the massive consequences that crises, wars, and economic meltdowns, wherever and however they may take place, can have on business. Political risk assessment involves an evaluation of the stability of a country’s current government and of its relationships with other countries. A high level of risk affects ownership of physical assets and intellectual property and security of personnel, increasing the potential for trouble. Analysts frequently divide political risk into two subcategories: global and country-specific risk. Global risk affects all of a company’s multinational operations, whereas country-specific risk relates to investments in a specific foreign country. We can distinguish between macro and micro political risk. Macro risk is concerned with how foreign investment in general in a particular country is Saylor URL: http://www.saylor.org/books Saylor.org 24 affected. By reviewing the government’s past use of soft policy instruments, such as blacklisting, indirect control of prices, or strikes in particular industries, and hard policy tools, such as expropriation, confiscation, nationalization, or compulsory local shareholding, a company can be better prepared for potential future government action. At the micro level, risk analysis is focused on a particular company or group of companies. A weak balance sheet, questionable accounting practices, or a regular breach of contracts should give rise to concerns. Legal risk is risk that multinational companies encounter in the legal arena in a particular country. Legal risk is often closely tied to political country risk. An assessment of legal risk requires analyzing the foundations of a country’s legal system and determining whether the laws are properly enforced. Legal risk analysis therefore involves becoming familiar with a country’s enforcement agencies and their scope of operation. As many companies have learned, numerous countries have written laws protecting a multinational’s rights, but these laws are rarely enforced. Entering such countries can expose a company to a host of risks, including the loss of intellectual property, technology, and trademarks. Financial or economic risk in a foreign country is analogous to operating and financial risk at home. The volatility of a country’s macroeconomic performance and the country’s ability to meet its financial obligations directly affect performance. A nation’s currency competitiveness and fluctuation are important indicators of a country’s stability—both financial and political—and its willingness to embrace changes and innovations. In addition, financial risk assessment should consider such factors as how well the economy is being managed, the level of the country’s economic development, working conditions, infrastructure, technological innovation, and the availability of natural and human resources. Societal or cultural risk is associated with operating in a different sociocultural environment. For example, it might be advisable to analyze specific ideologies; the relative importance of ethnic, religious, and nationalistic movements; and the country’s ability to cope with changes that will, sooner or later, be induced by foreign investment. Thus, elements such as the standard of living, Saylor URL: http://www.saylor.org/books Saylor.org 25 patriotism, religious factors, or the presence of charismatic leaders can play a huge role in the evaluation of these risks. [1] This section draws on Behrendt and Khanna (2004). Saylor URL: http://www.saylor.org/books Saylor.org 26 1.7 Points to Remember 1. Although we often speak of global markets and a “flat” world, in reality, the world’s competitive structure is best described as semiglobal. Bilateral and regional trade and investment patterns continue to dominate global ones. 2. The center of gravity of global competition is shifting to the East, with China and India taking center stage. Russia and Brazil, the other two BRIC countries, are not far behind. 3. Global competition is rapidly becoming a two-way street, with new competitors from developing countries taking on traditional companies from developed nations everywhere in every industry. 4. Companies have several major reasons to consider going global: to pursue growth, efficiency, and knowledge; to better meet customer needs; and to preempt or counter competition. 5. Global companies are those that have a global market presence, supply-chain infrastructure, capital base, and corporate mind-set. 6. Although we live in a “global” world, distance still very much matters, and companies must explicitly and thoroughly account for it when they make decisions about global expansion. 7. Distance between countries or regions is usefully analyzed in terms of four dimensions: cultural, administrative, geographic, and economic, each of which influences business in different ways. 8. Even with the best planning, globalization carries substantial risks. Globalization risks can be of a political, legal, financial-economic, or sociocultural nature. Saylor URL: http://www.saylor.org/books Saylor.org 27 Chapter 2 The Globalization of Companies and Industries “Going global” is often described in incremental terms as a more or less gradual process, starting with increased exports or global sourcing, followed by a modest international presence, growing into a multinational organization, and ultimately evolving into a global posture. This appearance of gradualism, however, is deceptive. It obscures the key changes that globalization requires in a company’s mission, core competencies, structure, processes, and culture. As a consequence, it leads managers to underestimate the enormous differences that exist between managing international operations, a multinational enterprise, and managing a global corporation. Research by Diana Farrell of McKinsey & Company shows that industries and companies both tend to globalize in stages, and at each stage, there are different opportunities for and challenges associated with creating value. [1] [1] Farrell (2004, December 2). Saylor URL: http://www.saylor.org/books Saylor.org 28 2.1 The Five Stages of Going Global In the first stage (market entry), companies tend to enter new countries using business models that are very similar to the ones they deploy in their home markets. To gain access to local customers, however, they often need to establish a production presence, either because of the nature of their businesses (as in service industries like food retail or banking) or because of local countries’ regulatory restrictions (as in the auto industry). In the second stage (product specialization), companies transfer the full production process of a particular product to a single, low-cost location and export the goods to various consumer markets. Under this scenario, different locations begin to specialize in different products or components and trade in finished goods. The third stage (value chain disaggregation) represents the next step in the company’s globalization of the supply-chain infrastructure. In this stage, companies start to disaggregate the production process and focus each activity in the most advantageous location. Individual components of a single product might be manufactured in several different locations and assembled into final products elsewhere. Examples include the PC industry market and the decision by companies to offshore some of their business processes and information technology services. In the fourth stage (value chain reengineering) companies seek to further increase their cost savings by reengineering their processes to suit local market conditions, notably by substituting lower-cost labor for capital. General Electric’s (GE) medical equipment division, for example, has tailored its manufacturing processes abroad to take advantage of low labor costs. Not only does it use more labor-intensive production processes—it also designs and builds the capital equipment for its plants locally. Finally, in the fifth stage (the creation of new markets), the focus is on market expansion. The McKinsey Global Institute estimates that the third and fourth stages together have the potential to reduce costs by more than 50% in many industries, which gives companies the opportunity to substantially lower their sticker prices in both old and new markets and to expand demand. Saylor URL: http://www.saylor.org/books Saylor.org 29 Significantly, the value of new revenues generated in this last stage is often greater than the value of cost savings in the other stages. It should be noted that the five stages described above do not define a rigid sequence that all industries follow. As the McKinsey study notes, companies can skip or combine steps. For example, in consumer electronics, product specialization and value chain disaggregation (the second and third stages) occurred together as different locations started to specialize in producing different components (Taiwanese manufacturers focused on semiconductors, while Chinese companies focused on computer keyboards and other components). Saylor URL: http://www.saylor.org/books Saylor.org 30 2.2 Understanding Industry Globalization Executives often ask whether their industry is becoming more global and, if so, what strategies they should consider to take advantage of this development and stake out an enduring global competitive advantage. This may be the wrong question. Simple characterizations such as “the electronics industry is global” are not particularly useful. A better question is how global an industry is, or is likely, to become. Virtually all industries are global in some respects. However, only a handful of industries can be considered truly global today or are likely to become so in the future. Many more will remain hybrids, that is, global in some respects, local in others. Industry globalization, therefore, is a matter of degree. What counts is which elements of an industry are becoming global and how they affect strategic choice. In approaching this issue, we must focus on the drivers of industry globalization and think about how these elements shape strategic choice. We should also make a distinction between industry globalization, global competition, and the degree to which a company has globalized its operations. In traditionally global industries, competition is mostly waged on a worldwide basis and the leaders have created global corporate structures. But the fact that an industry is not truly global does not prevent global competition. And a competitive global posture does not necessarily require a global reorganization of every aspect of a company’s operations. Economies of scale and scope are among the most important drivers of industry globalization; in global industries, the minimum volume required for cost efficiency is simply no longer available in a single country or region. Global competition begins when companies crosssubsidize national market-share battles in pursuit of global brand and distribution positions. A global company structure is characterized by production and distribution systems in key markets around the world that enable cross-subsidization, competitive retaliation on a global basis, and world-scale volume. [1] So why are some industries more global than others? And why do global industries appear to be concentrated in certain countries or regions? Most would consider the oil, auto, and pharmaceutical industries global industries, while tax preparation, many retailing sectors, and real estate are substantially domestic in nature. Others, such as furniture, lie somewhere in the middle. What Saylor URL: http://www.saylor.org/books Saylor.org 31 accounts for the difference? The dominant location of global industries also poses interesting questions. Although the machine tool and semiconductor industries originated in the United States, Asia has emerged as the dominant player in most of their segments today. What accounts for this shift? Why is the worldwide chemical industry concentrated in Germany while the United States continues to dominate in software and entertainment? Can we predict that France and Italy will remain the global centers for fashion and design? These issues are important to strategists. They are also relevant as a matter of public policy as governments attempt to shape effective policies to attract and retain the most attractive industries, and companies must anticipate changes in global competition and locational advantage. Minicase: Cemex’s Globalization Path: First Cement, Then Services When Lorenzo Zambrano became chairman and chief executive officer of Cemex in the 1980s, he pushed the company into foreign markets to protect it from the Latin American debt crisis. Now the giant cement company is moving into services. [2] Zambrano first focused on the United States. But attempts to sell cement north of the border were greeted by hostility from producers, who convinced the U.S. International Trade Commission to levy a stiff antidumping duty. Despite a a General Agreement on Tariffs and Trade’s (GATT) ruling in Cemex’s favor, the company was still paying the fine a dozen years later. Rebuffed in the world’s biggest market, Zambrano turned to Spain, investing in port facilities and outmaneuvering European rivals for control of the country’s two largest cement firms. When he discovered how inefficiently they were run, Zambrano sent a team of his Mexican managers to Spain to introduce his distinctive way of doing business. Called the “Cemex Way,” it is a culture that blends modern, flexible management practices with cutting-edge technology. From Spain, where profits increased from 7% to 24% during Cemex’s first 2 years there, the company expanded around the globe. Blending state-of-the-art technology with the making and selling of one of the world’s most basic products, Cemex has achieved remarkable customer service in some of the most Saylor URL: http://www.saylor.org/books Saylor.org 32 logistically challenged countries. Whether Venezuela, Mexico, or the Philippines, Cemex trucks equipped with GPS navigational systems promise deliveries within 20 minutes. After gaining a solid international footing, Zambrano went back to the United States. In 2000, he bought Houston-based Southdown Cement—one of the largest purchases ever by a Mexican company in the United States. Soon, Cemex was the biggest U.S. cement seller. In less than two decades, Zambrano had transformed Cemex from a domestic company into the world’s third-largest cement firm by investing heavily and imaginatively not only in plants and equipment, which is what one would expect in the cement industry, but also in information technology and particularly in Cemex’s people. The corporation has consistently been more profitable than either of its two biggest competitors, France’s Lafarge and Switzerland’s Holcim. Sales in 2008 were almost $22 billion, with an operating margin of almost 12%. Today, Cemex has a presence in more than 50 countries across 5 continents. It has an annual production capacity of close to 96 million metric tons of cement, approximately 77 million cubic meters of ready-mix concrete and more than 240 million metric tons of aggregates. Its resource base includes 64 cement plants, over 2,200 ready-mix concrete facilities, and a minority participation in 15 cement plants, and it operates 493 aggregate quarries, 253 land-distribution centers, and 88 marine terminals. Zambrano’s embrace of technology is central to Cemex’s efficiency. Fiber optics link the system, and satellite communications are used to connect remote outposts. Whether at the Monterrey headquarters or on the road, the chief executive officer can tap into his computer to check kiln temperatures in Bali or cement truck deliveries in Cairo. Because he believes many companies use technology ineffectively, Zambrano spun off Cemex’s technology arm to sell its services. Organized under the CxNetworks Miami subsidiary, which is devoted to creating growth by building innovative businesses around Cemex’s strengths, Zambrano formed a consulting service called Neoris. With more than half of its customers coming from outside Cemex, the operation has already become hugely profitable. It has been grouped with another start-up—Arkio, a distributor of building material products to construction companies in developing nations. “We’re selling logistics,” says Saylor URL: http://www.saylor.org/books Saylor.org 33 the president of CxNetworks. “We can assure our customers that they can have the materials from our warehouse to their construction site within 48 hours.” [1] Hamel and Prahalad (1985, July-August). [2] Lindquist (2002, November 1); and http://www.cemex.com/ Saylor URL: http://www.saylor.org/books Saylor.org 34 2.3 Clustering: Porter’s National Diamond The theory of comparative economic advantage holds that as a result of natural endowments, some countries or regions of the world are more efficient than others in producing particular goods. Australia, for example, is naturally suited to the mining industry; the United States, with its vast temperate landmass, has a natural advantage in agriculture; and more-wooded parts of the world may have a natural advantage in producing timber-based products. This theory is persuasive for industries such as agriculture, mining, and timber. But what about industries such as electronics, entertainment, or fashion design? To explain the clustering of these industries in particular countries or regions, a more comprehensive theory of the geography of competition is needed. In the absence of natural comparative advantages, industrial clustering occurs as a result of a relative advantage that is created by the industry itself.[1] Producers tend to locate manufacturing facilities close to their primary customers. If transportation costs are not too high, and there are strong economies of scale in manufacturing, a large geographic area can be served from this single location. This, in turn, attracts suppliers to the industry. A labor market is likely to develop that begins to act like a magnate for “like” industries requiring similar skills. This colocation of “like” industries can lead to technological interdependencies, which further encourage clustering. Clustering, therefore, is the natural outcome of economic forces. A good example is provided by the semiconductor industry. Together, American and Asian firms supply most of the world’s needs. The industry is capital intensive, research and development costs are high, the manufacturing process is highly complex, but transportation costs are minimal. Technology interdependencies encourage colocation with suppliers, whereas cost and learning curve effects point to scale efficiencies. Clustering, therefore, is mutually advantageous. Only when transportation costs are prohibitive or scale economies are difficult to realize—that is, when there are disincentives to clustering—do more decentralized patterns of industry location define the natural order. The appliance industry illustrates this. Companies such as GE and Whirlpool have globalized their operations in many respects, but the fundamental economics of the industry make clustering unattractive. The production of certain value-added components, such as Saylor URL: http://www.saylor.org/books Saylor.org 35 compressors or electronic parts, can be concentrated to some extent, but the bulky nature of the product and high transportation costs make further concentration economically unattractive. What is more, advances in flexible manufacturing techniques are reducing the minimum scale needed for efficient production. This allows producers to more finely tailor their product offerings to local tastes and preferences, further thwarting the globalization of the industry. Thus, classical economic theory tells us why clustering occurs. However, it does not fully explain why particular regions attract certain global industries. Porter addressed this issue using a framework he calls a “national diamond.”[2] It has six components: factor conditions, home-country demand, related and supporting industries, competitiveness of the home industry, public policy, and chance. Factor Conditions The explanation why particular regions attract particular industries begins with the degree to which a country or region’s endowments match the characteristics and requirements of an industry. Such factor conditions include natural (climate, minerals) as well as created (skill levels, capital, infrastructure) endowments. But to the extent that such factors are mobile, or can be imitated by other countries or regions, factor conditions alone do not fully explain regional dominance. In fact, the opposite is true. When a particular industry is highly profitable and barriers to entry are low, the forces of imitation and diffusion cause such an industry to spread across international borders. [3] The Japanese compete in a number of industries that originated in the United States; Korean firms imitate Japanese strategies; and Central European nations are conquering industries that were founded in Western Europe. Industries that depend on such mobile factors as capital are particularly susceptible. Home-Country Demand Porter’s second factor is the nature and size of the demand in the home country. Large home markets act as a stimulus for industry development. And when a large home market develops before it takes hold elsewhere in the world, experienced firms have ample incentives to look for business abroad when saturation at home begins to set in. The motorcycle industry in Japan, for example, used its scale Saylor URL: http://www.saylor.org/books Saylor.org 36 advantage to create a global presence following an early start at home. [4] Porter found that it is not just the location of early demand but its composition that matters. A product’s fundamental or core design nearly always reflects home-market needs. As such, the nature of the home-market needs and the sophistication of the home-market buyer are important determinants of the potential of the industry to stake out a future global position. It was helpful to the U.S. semiconductor industry, for example, that the government was an early, sophisticated, and relatively cost-insensitive buyer of chips. These conditions encouraged the industry to develop new technologies and provided early opportunities to manufacture on a substantial scale. Related and Supporting Industries The presence of related and supporting industries is the third element of Porter’s framework. This is similar to our earlier observation about clustering. For example, Hollywood is more than just a cluster of moviemakers—it encompasses a host of suppliers and service providers, and it has shaped the labor market in the Los Angeles area. Competitiveness of the Home Industry Firm strategies, the structure, and the rivalry in the home industry define the fourth element of the “national diamond” model. In essence, this element summarizes the “five forces” competitive framework described earlier. The more vigorous the domestic competition is, the more successful firms are likely to compete on a global scale. There is plenty of evidence for this assertion. The fierce rivalry that exists among German pharmaceutical companies has made them a formidable force in the global market. And the intense battle for domestic market share has strengthened the competitive position of Japanese automobile manufacturers abroad. Public Policy and Chance The two final components of Porter’s model are public policy and chance. There can be no doubt that government policy can—through infrastructure, incentives, subsidies, or temporary protection—nurture global industries. Whether such policies are always effective is less clear. Picking “winners” in the global marketplace has never been the strong suit of governments. The chance element allows for the influence Saylor URL: http://www.saylor.org/books Saylor.org 37 of random events such as where and when fundamental scientific breakthroughs occur, the presence of entrepreneurial initiative, and sheer luck. For example, the early U.S. domination of the photography industry is as much attributable to the fact that George Eastman (of Eastman Kodak) and Edwin Land (of Polaroid) were born here than to any other factor. [1] Krugman (1993). [2] Porter (1990). [3] Oster (1994). [4] Oster (1994). Saylor URL: http://www.saylor.org/books Saylor.org 38 2.4 Industry Globalization Drivers Yip identifies four sets of “industry globalization drivers” that underlie conditions in each industry that create the potential for that industry to become more global and, as a consequence, for the potential viability of a global approach to strategy. [1] Market drivers define how customer behavior distribution patterns evolve, including the degree to which customer needs converge around the world, customers procure on a global basis, worldwide channels of distribution develop, marketing platforms are transferable, and “lead” countries in which most innovation takes place can be identified.Cost globalization drivers—the opportunity for global scale or scope economics, experience effects, sourcing efficiencies reflecting differentials in costs between countries or regions, and technology advantages—shape the economics of the industry. Competitive drivers are defined by the actions of competing firms, such as the extent to which competitors from different continents enter the fray, globalize their strategies and corporate capabilities, and create interdependence between geographical markets.Government drivers include such factors as favorable trade policies, a benign regulatory climate, and common product and technology standards. Market Drivers One aspect of globalization is the steady convergence of customer needs. As customers in different parts of the world increasingly demand similar products and services, opportunities for scale arise through the marketing of more or less standardized offerings. How common needs, tastes, and preferences will vary greatly by product and depend on such factors as the importance of cultural variables, disposable incomes, and the degree of homogeneity of the conditions in which the product is consumed or used. This applies to consumer as well as industrial products and services. Coca-Cola offers similar but not identical products around the world. McDonald’s, while adapting to local tastes and preferences, has standardized many elements of its operations. Software, oil products, and accounting services increasingly look alike no matter where they are purchased. The key to exploiting such opportunities for scale lies in understanding which elements of the product or service can be standardized without sacrificing responsiveness to local preferences and conditions. Saylor URL: http://www.saylor.org/books Saylor.org 39 Global customers have emerged as needs continue to converge. Large corporations such as DuPont, Boeing, or GE demand the same level of quality in the products and services they buy no matter where in the world they are procured. In many industries, global distribution channels are emerging to satisfy an increasingly global customer base, further causing a convergence of needs. Finally, as consumption patterns become more homogeneous, global branding and marketing will become increasingly important to global success. Cost Globalization Drivers The globalization of customer needs and the opportunities for scale and standardization it brings will fundamentally alter the economics of many industries. Economies of scale and scope, experience effects, and exploiting differences in factor costs for product development, manufacturing, and sourcing in different parts of the world will assume a greater importance as determinants of global strategy. At bottom is a simple fact: a single market will no longer be large enough to support a competitive strategy on a global scale in many industries. Global scale and scope economics are already having far-reaching effects. On the one hand, the more the new economies of scale and scope shape the strategies of incumbents in global industries, the harder it will be for new entrants to develop an effective competitive threat. Thus, barriers to entry in such industries will get higher. At the same time, the rivalry within such industries is likely to increase, reflecting the broadening scope of competition among interdependent national and regional markets and the fact that true differentiation in such a competitive environment may be harder to achieve. Competitive Drivers Industry characteristics—such as the degree to which total industry sales are made up by export or import volume, the diversity of competitors in terms of their national origin, the extent to which major players have globalized their operations and created an interdependence between their competitive strategies in different parts of the world—also affect the globalization potential of an industry. High levels of trade, competitive diversity, and interdependence increase the potential for industry globalization. Industry evolution plays a role, too. As the underlying characteristics of the industry change, competitors will Saylor URL: http://www.saylor.org/books Saylor.org 40 respond to enhance and preserve their competitive advantage. Sometimes, this causes industry globalization to accelerate. At other times, as in the case of the worldwide major appliance industry, the globalization process may be reversed. Government Drivers Government globalization drivers—such as the presence or absence of favorable trade policies, technical standards, policies and regulations, and government operated or subsidized competitors or customers— affect all other elements of a global strategy and are therefore important in shaping the global competitive environment in an industry. In the past, multinationals almost exclusively relied on governments to negotiate the rules of global competition. Today, however, this is changing. As the politics and economics of global competition become more closely intertwined, multinational companies are beginning to pay greater attention to the so-called nonmarket dimensions of their global strategies aimed at shaping the global competitive environment to their advantage (see the following section). This broadening of the scope of global strategy reflects a subtle but real change in the balance of power between national governments and multinational corporations and is likely to have important consequences for how differences in policies and regulations affecting global competitiveness will be settled in the years to come. Minicase: Global Value Chains in the Automotive Industry: A Nested Structure [2] From a geographic point of view, the world automotive industry, like many others, is in the midst of a profound transition. Since the mid-1980s, it has been shifting from a series of discrete national industries to a more integrated global industry. In the automotive industry, these global ties have been accompanied by strong regional patterns at the operational level. Market saturation, high levels of motorization, and political pressures on automakers to “build where they sell” have encouraged the dispersion of final assembly, which now takes place in many more places than it did 30 years ago. According to Automotive News Market Data Books, while seven countries accounted for about 80% of world production in 1975, 11 countries accounted for the same share in 2005. Saylor URL: http://www.saylor.org/books Saylor.org 41 The widespread expectation that markets in China and India were poised for explosive growth generated a surge of new investment in these countries. Consumer preferences require that automakers alter the design of their vehicles to fit the characteristics of specific markets. They also want their conceptual designers to be close to “tuners” to see how they modify their production vehicles. These motivations led automakers to establish a series of affiliated design centers in places such as China and Southern California. Nevertheless, the heavy engineering work of vehicle development, where conceptual designs are translated into the parts and subsystems that can be assembled into a drivable vehicle, remain centralized in or near the design clusters that have arisen near the headquarters of lead firms. The automotive industry is therefore neither fully global, consisting of a set of linked, specialized clusters, nor tied to the narrow geography of nation states or specific localities, as is the case for some cultural or service industries. Global integration has proceeded at the level of design and vehicle development as firms have sought to leverage engineering effort across regions. Examples include right- versus left-hand drive, more rugged suspension and larger gas tanks for developing countries, and consumer preferences for pick-up trucks in Thailand, Australia, and the United States. The principal automotive design centers in the world are Detroit, Michigan, in the United States (GM, Ford, Chrysler, and, more recently, Toyota and Nissan); Cologne (Ford Europe), Rüsselsheim (Opel, GM’s European division), Wolfsburg (Volkswagen), and Stuttgart (Daimler-Benz) in Germany; Paris, France (Renault); and Tokyo (Nissan and Honda) and Nagoya (Toyota) in Japan. This is just nine products sold in multiple end markets. As suppliers have taken on a larger role in design, they have, in turn, established their own design centers close to those of their major customers in order to facilitate collaboration. On the production side, the dominant trend is regional integration, a pattern that has been intensifying since the mid-1980s for both political and technical reasons. In North America, South America, Europe, Southern Africa, and Asia, regional parts production tends to feed final assembly plants producing largely for regional markets. Political pressure for local production has driven automakers to set up final assembly plants in many of the major established market areas and in the largest emerging market countries, such as Brazil, India, Saylor URL: http://www.saylor.org/books Saylor.org 42 and China. Increasingly, as a precondition to being considered for a new part, lead firms demand that their largest suppliers have a global presence. Because centrally designed vehicles are manufactured in multiple regions, buyer-supplier relationships typically span multiple production regions. Within regions, there is a gradual investment shift toward locations with lower operating costs: the U.S. South and Mexico in North America; Spain and Eastern Europe in Europe; and Southeast Asia and China in Asia. Ironically, perhaps, it is primarily local firms that take advantage of such cost-cutting investments within regions (e.g., the investments of Ford, GM, and Chrysler in Mexico), since the political pressure that drives inward investment is only relieved when jobs are created within the largest target markets (e.g., the investments of Toyota and Honda in the Unites States and Canada). Automotive parts, of course, are more heavily traded between regions than finished vehicles. Within countries, automotive production and employment are typically clustered in one or a few industrial regions. In some cases, these clusters specialize in specific aspects of the business, such as vehicle design, final assembly, or the manufacture of parts that share a common characteristic, such as electronic content or labor intensity. Because of deep investments in capital equipment and skills, regional automotive clusters tend to be very long-lived. To sum up the complex economic geography of the automotive industry, we can say that global integration has proceeded the farthest at the level of buyer-supplier relationships, especially between automakers and their largest suppliers. Production tends to be organized regionally or nationally, with bulky, heavy, and model-specific parts production concentrated close to final assembly plants to assure timely delivery, and with lighter, more generic parts produced at a distance to take advantage of scale economies and low labor costs. Vehicle development is concentrated in a few design centers. As a result, local, national, and regional value chains in the automotive industry are “nested” within the global organizational structures and business relationships of the largest firms. While clusters play a major role in the automotive industry, and have “pipelines” that link them, there are also global and regional structures that need to be explained and theorized in a way that does not discount the power of localization. Saylor URL: http://www.saylor.org/books Saylor.org 43 [1] George S. Yip first developed this framework in his book Total global strategy: Managing for worldwide competitive advantage (1992), chaps. 1 and 2. [2] Sturgeon, Van Biesebroeck, and Gereffi (2009). Saylor URL: http://www.saylor.org/books Saylor.org 44 2.5 Globalization and Industry Structure Yoffie suggests 5 propositions that help explain how the structure of an industry can evolve depending on, among other factors, the dynamics that shape competition in the industry and the role governments play in stimulating or obstructing the globalization process. [1] Proposition 1 is that when industries are relatively fragmented and competitive, national environments (factors of production, domestic market and domestic demand, and so forth) will largely shape the international advantage of domestically headquartered firms and the patterns of trade. A correlate to this proposition is that in emerging industries, country advantages also play a dominant role in determining global competitive advantage. In other words, in fragmented industries relative cost is a key determinant of global success, and since countries differ in terms of their factor costs, as long as entry barriers remain low, production will gravitate to the lowest cost, highest efficiency manufacturing location. Another way of saying this is that the presence of multinational firms, by itself, should not influence the pattern of international trade in globally competitive, fragmented industries; other things being equal, country factors determine the location of production and the direction of exports. Oligopolistic global industry structures define a very different strategic context, as the next proposition illustrates. Proposition 2 stipulates that if an industry becomes globally concentrated with high barriers to entry, then location, activity concentration, export, and other strategic decisions by multinational companies are determined to a greater extent by the nature of the global oligopolistic rivalry. Thus, while in concentrated industries country characteristics remain important, the dynamics of the global, oligopolistic competitive climate become the principal drivers of global strategy. This is intuitive. In global oligopolies, more so than in fragmented market structures, the success of one firm is directly affected by that of a few, immediate competitors. Entry into the industry is often restricted in some way—by factors such as economies of scale or scope, high levels of capital investment, and the like, or by restrictions imposed by governments. Furthermore, in many global oligopolies, participating firms earn above-average returns, which may make the difference in cost between producing locally and exporting a less critical determinant of strategy. Opportunities to crossSaylor URL: http://www.saylor.org/books Saylor.org 45 subsidize businesses and geographies further reduce the importance of geography in production or export decisions. As a consequence, the moves and countermoves of direct, global competitors heavily influence company strategies. For example, it is quite common for companies to enter some other firm’s home market, not just because that market is likely to generate additional profits but mainly to weaken its global competitive position. This line of reasoning directly leads to a third proposition, which relates organizational and strategic attributes of global competitors to global strategic choice. Proposition 3 suggests that in global oligopolies, specific firm characteristics—the structure of ownership, strategies employed, and organizational factors, to name a few—directly affect strategic posture, the pattern of trade, and, sometimes, the competitiveness of nations. In global oligopolies with a relatively small number of competitors, issues such as who owns the resources necessary for creating value and who sets the global priorities take on a greater strategic significance. Executives from different cultures approach strategy differently—state-owned enterprises are often more motivated by public policy considerations, employment, and other nonprofit concerns. These differences can have a direct impact on the relative attractiveness of global strategy options. The influence of governments in global markets is captured further in the fourth proposition. Proposition 4 suggests that extensive government intervention in global oligopolistic industries can alter the relative balance between firms of different countries—even in fragmented industries, it can alter the direction of trade and affect major corporate trade decisions. The degree and influence of government intervention varies from industry to industry. Whereas in fragmented industries the influence of governments is naturally somewhat limited by market conditions, government intervention can have a pronounced influence in industries with significant economies of scale effects or other market imperfections. For example, governments can protect “infant” industries with such characteristics. While a case can be made for the temporary protection of strategically important industries, in reality, such protection is rarely temporary. This can create a global strategic environment in which anticipating and capitalizing on the actions of governments become the driving forces of global strategy. Saylor URL: http://www.saylor.org/books Saylor.org 46 Proposition 5 suggests that in industries where firms make long-term commitments, corporate adjustments and patterns of trade tend to be “sticky.” This fifth and final proposition addresses the issue of corporate inertia. Although the global competitive climate changes every day, choices made by multinational companies and governments tend to have an enduring impact on the industry environment. This proposition has at least two implications. First, the study of how industries evolve globally and what decisions different competitors made and how they made them is relevant to understanding what drives strategy in a particular global context. Second, the commitments already made by industry participants and governments may spell opportunity or impose constraints for years to come. These 5 propositions define 2 important dimensions for classifying globalizing industries according to the nature of the strategic challenge they represent: the degree of global concentration and the extent to which governments intervene. In industries with a relatively low degree of concentration and little government intervention, the classical economic laws of comparative advantage are the primary drivers of international competition. Here, factor costs are a primary determinant of global competitiveness. It would seem natural, therefore, to focus on a global strategy aimed at minimizing costs. But this can be extremely difficult in a fast-changing world. Comparative country costs change continuously. In cars, semiconductors, and computers, among other industries, the comparative (cost) advantage has shifted a number of times since World War II from the United States to Japan to East Asia to Southeast Asia. What is more, there is good reason to believe it will shift again, perhaps to Africa or Latin America. And, with new technological breakthroughs, Western nations may once again become the low-cost production centers. So what should companies do? While companies should definitely take advantage of opportunities to minimize costs, especially in their initial investments, Yoffie suggests that long-term global strategic choices should emphasize commitments to countries that are likely to act as the best platforms over time for a broad array of activities. [2] In globally concentrated industries where the role of governments is limited, characterized by oligopolistic competition, company strategies are often heavily influenced by the moves and countermoves of direct competitors. Strategies such as making significant investments in Saylor URL: http://www.saylor.org/books Saylor.org 47 competitors’ markets, regardless of their short- or medium-run profitability—which would not work in highly competitive markets—can only be explained in terms of a strategic posture aimed at maintaining a long-term global competitive balance between the various participants. Caterpillar invested heavily in Japan while Komatsu and European construction equipment manufacturing moved into the United States at a time when such moves offered limited immediate returns. In this kind of competitive environment, the potential for overglobalization—the globalization of different aspects of strategy well in advance of proven benefits—exists as the relatively small number of competitors and high barriers to entry encourage “follow-the-leader” competitive behavior. On the other hand, not responding directly to major competitors can be equally dangerous. Komatsu’s challenge to Caterpillar, in part, was made possible because, early on, Caterpillar focused its strategy on keeping John Deere, International Harvester, and Dresser Industries at bay rather than on beating Komatsu. This suggests a number of strategic implications. First, while imitation cannot be the sole basis for developing strategy, in oligopolies, it may be necessary, at times, to match a competitor in order to reduce the risk of competitive disadvantage. A related implication is that in global oligopolies, companies cannot allow their competitors to have uncontested home markets in which profit sanctuaries can be used to subsidize global competitive moves. This explains Kodak’s extraordinary efforts to pry open the Japanese market—it knew Fuji would be at a considerable advantage if it remained dominant in Japan. Finally, the use of alliances can make such global moves more affordable, flexible, and effective. Alliances can be powerful vehicles for rapidly entering new countries, acquiring new technologies, or otherwise supporting a global strategy at a relatively low cost. [3] Dealing effectively with governments is a prerequisite for global success in oligopolistic industries such as telecommunications, where extensive government intervention creates a global competitive climate known asregulated competition. Here, nonmarket dimensions of global strategy may well be as important as market dimensions. Political involvement may be necessary to create, preserve, or enhance global competitive advantage since government regulations—whether in infant or established industries—are critical to success. As a consequence, strategy in global, regulated Saylor URL: http://www.saylor.org/books Saylor.org 48 industries should be focused as much on shaping the global competitive environment as on capitalizing on the opportunities it offers. Political competition, characteristic of fragmented industries with significant government intervention, also calls for a judicious mix of market and nonmarket-based strategic thinking. In contrast to regulated competition, in which government policy has a direct impact on individual companies, however, government intervention in political competition often pits one country or region of the world against another. This encourages a whole range of cooperative strategies between similarly affected players and strategic action at the country-industry level. Finally, it is worth remembering that patterns of competition are not static. Industries evolve continuously, sometimes dramatically. Similarly, the focus of government action in different industries can change as national priorities change and the global competitive environment evolves. [1] Yoffie (1993), chaps. 1 and 10. The reader is encouraged to consult this excellent book for further details. [2] Yoffie (1993), 432. [3] Yoffie (1993), 433, 434. Saylor URL: http://www.saylor.org/books Saylor.org 49 2.6 Points to Remember 1. Industries and companies tend to globalize in stages, and at each stage, there are different opportunities for, and challenges associated with, creating value. 2. Simple characterizations such as “the electronics industry is global” are not particularly useful. A better question is how global an industry is or is likely to become; industry globalization is a matter of degree. 3. A distinction must be made between industry globalization, global competition, and the degree to which a company has globalized its operations. Porter explains industry clustering using a framework he calls a “national diamond.” It has six components: factor conditions, home country demand, related and supporting industries, competitiveness of the home industry, public policy, and chance. 4. Yip identifies four sets of “industry globalization drivers”—underlying conditions in each industry that create the potential for that industry to become more global and, as a consequence, for the potential viability of a global approach to strategy. These drivers are market drivers, cost drivers, competitive drivers, and government drivers. 5. Yoffie offers five propositions that help explain how the structure of an industry can evolve depending on, among other factors, the dynamics that shape competition in the industry and the role governments play in stimulating or obstructing the globalization process. These propositions define two important dimensions for classifying globalizing industries according to the nature of the strategic challenge they represent: the degree of global concentration and the extent to which governments intervene. Saylor URL: http://www.saylor.org/books Saylor.org 50 Chapter 3 Generic Strategies for Global Value Creation In this chapter, we introduce three generic strategies for creating value in a global context— adaptation, aggregation, and arbitrage—and a number of variants for each. [1] This conceptualization was first introduced by Pankaj Ghemawat in his important book Redefining Global Strategy and, as such, is not new. In the next chapter, we extend this framework, however, by integrating these generic strategies with the proposition that global strategy formulation is about changing a company’s business model to create a global competitive advantage. [1] This chapter draws substantially on Ghemawat (2007b). Saylor URL: http://www.saylor.org/books Saylor.org 51 3.1 Ghemawat’s “AAA” Global Strategy Framework Ghemawat so-called AAA framework offers three generic approaches to global value creation. Adaptation strategies seek to increase revenues and market share by tailoring one or more components of a company’s business model to suit local requirements or preferences. Aggregation strategies focus on achieving economies of scale or scope by creating regional or global efficiencies; they typically involve standardizing a significant portion of the va...
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