15 Oct 2007  Research & Ideas

Businesses Beware: The World Is Not Flat

With apologies to Thomas Friedman, managers who believe the hype of a flat world do so at their own risk, says HBS professor Pankaj Ghemawat. National borders still matter a lot for business strategists. While identifying similarities from one place to the next is essential, effective cross-border strategies will take careful stock of differences as well. A Q&A and book excerpt follow. Key concepts include:

  • Some indicators of globalization aren't increasing as many experts have claimed.
  • Toyota and Wal-Mart are examples of companies that understand how to deal with distance in a strategic way.
  • Take a broad view of differences, figure out the ones that matter the most in your industry, and look at them not just as difficulties to be overcome but also as potential sources of value creation.

 

Thomas Friedman, author of "The World Is Flat: A Brief History of the Twenty-first Century", opines that a number of events ranging from the fall of the Berlin Wall to the rise of the Internet have flattened the competitive landscape worldwide by increasing globalization and reducing the power of states.

But the world is not flat, argues HBS professor Pankaj Ghemawat. Think of it as partly globalized, or "semiglobalized."

"Strategies that presume complete global integration tend to place far too much emphasis on international standardization and scalar expansion," Ghemawat argues. While identifying similarities from one place to the next is essential, effective cross-border strategies will take careful stock of differences as well.

An expert on global strategy, Ghemawat lays out an action plan for business in his new book, Redefining Global Strategy: Crossing Borders in a World Where Differences Still Matter.

As he sees it, important realities dotting the landscape for business can be grouped into 4 basic areas: cultural, administrative/political, geographic, and economic. Discussions of globalization tend to overlook these factors. And companies that wish to make headway should consider 3 broad ways of dealing with distance: adapt, overcome it, and exploit it.

"What is different about this book on global strategy is its focus on the differences across countries," he writes. "The idea is to help businesses cross borders profitably by seeing the world as it really is, rather than in idealized terms."

Ghemawat explained more via e-mail with HBS Working Knowledge.

Martha Lagace: The subtitle of your book is "Crossing Borders in a World Where Differences Still Matter." Amid the talk around us about an increasingly flat world, what differences have mattered, do matter, and will continue to matter for companies?

Pankaj Ghemawat: The subtitle is meant to emphasize that we continue to live in a semiglobalized world, one where differences between countries and regions continue to matter.

To make this point, it is useful to start with some facts about levels of globalization because, as the late Daniel Patrick Moynihan observed, we are all entitled to our own opinions, but not our own facts. The most commonly cited figure concerns international trade, which represents more than 25 percent of most economies. But when I began to research a broader range of measures including investment, phone calls, tourism, and immigration, I found that, surprisingly, the average extent of globalization is only 10 percent. For example, for every dollar of capital investment globally, only a dime is accounted for by foreign direct investment.

The other thing that surprised me was that some indicators of globalization aren't increasing as many experts have claimed. There is general agreement that the international share of total Internet traffic is decreasing rather than increasing. This calls into question the other common myth that even if the world isn't quite flat today, it will be tomorrow.

The data clearly indicate that national borders still matter. I group the differences that they demarcate into 4 areas: those related to cultural (language, customs, religion, ethnicities, etc.), administrative/political (laws, trading blocs, colonial ties, currency, etc.), geographic (physical distance, lack of land border, time zones, climates, etc.), and economic (income levels, cost of natural resources, financial resources, human resources, infrastructure, information, etc.). It is important to take a broad view of such differences, to figure out the ones that matter the most in your industry, and to look at them not just as difficulties to be overcome but also as potential sources of value creation.

Q: You say Toyota is an example of a company that understands the complexities of global strategy. What approach to globalization has allowed Toyota to thrive among automakers?

A: Toyota has overtaken General Motors to become the largest automaker in the world—while making money in the process. Toyota is distinguished from most of the Western automakers, not just DaimlerChrysler, by the fact it treats market share as the result of building better cars more cheaply than its competitors, and not as an objective in and of itself.

Its globalization has actually been driven by a complex array of coordination mechanisms across different regions, which Chairman Fujio Cho characterizes as the fundamental building blocks of the company's strategy.

"The idea is to help businesses cross borders profitably by seeing the world as it really is."

Note that Toyota's starting point is not a grand, longer-term vision of some distant globality when autos and auto parts can flow freely from anywhere to anywhere. Rather, the company anticipates expanded free-trade agreements within the Americas, Europe, and East Asia, but not across them. This is a more modest—but also more realistic—vision of a semiglobalized world in which neither the bridges nor the barriers between countries can be ignored.

Q: You have studied and written about Wal-Mart for more than 20 years. Wal-Mart has certainly expanded during that time, but not without criticism and its own miscalculations. What do Wal-Mart's experiences show us about crossing borders? What is it doing differently in new markets such as India?

A: When CEO Lee Scott was asked a few years ago about why he thought Wal-Mart could expand successfully overseas, his response was that naysayers had also questioned the company's ability to move successfully from its home state of Arkansas to Alabama.

Unsurprisingly, the foreign markets in which Wal-Mart has achieved profitability—Canada, Mexico, and the United Kingdom—are the ones culturally, administratively, and geographically closest to the United States.

The point is not that Wal-Mart shouldn't have ventured into more distant markets, but rather, that it needed to think differently about how to compete in them. It is now starting to do so in markets such as India, which does not allow foreign direct investment in retailing. Wal-Mart has therefore entered via a joint venture with an Indian partner, Bharti, that will operate the stores while Wal-Mart deals with the back-end of the business.

More broadly, Wal-Mart's recent strategy illustrates all three broad ways of dealing with distance—adjusting to it (Adaptation), overcoming it (Aggregation), and exploiting it (Arbitrage)—the AAA strategies elaboration of which occupies close to one-half of Redefining Global Strategy.

  • Wal-Mart International is increasingly cognizant of the need to adapt to local contexts—as evinced not only by the India entry strategy but by changes in merchandising policies, clearer definition of decision rights, and even the astonishing job-swap between some of the top managers running the U.S. operations and their counterparts at International.
  • Wal-Mart also tries to aggregate across national boundaries with its IT platform and regional management teams that were created in 2004 to manage global brand development and oversee government and public relations. As John Menzer, who ran International before becoming Wal-Mart's vice chairman, put it, "We're playing 3-D chess: global, regional, local."
  • And finally arbitrage through offshoring, particularly to China, saves Wal-Mart much more money than the operating income generated—on a much larger investment base—by the international store operations. This is, in some sense, what Wal-Mart's global strategy is primarily about.

Q: How do you see business shaping the future of globalization? In which ways are companies playing a big role, and in which ways could or should they step up more to exert a positive influence on society?

A: By recognizing the importance of business in shaping broad outcomes-including those related to the future of globalization. Globalization has gone into reverse before—between the two world wars—and could do so again. Some of the concerns voiced by antiglobalizers include:

  • A declining share of wages in total national income in developed countries at a time when the share of profits is at a multidecade high in many developed countries.
  • The lack of a globalization safety net in many of those countries. (The United States, for instance, is estimated to gain $1 trillion per year from trade, but spend about $1 billion on job-retraining, according to The Economist.)
  • The creation of a 2-track world. As microcredit pioneer Muhammad Yunus put it in his speech accepting the 2006 Nobel Peace Prize, if globalization "is a free-for-all highway, its lanes will be taken over by the giant trucks from powerful economies … [at the expense of] Bangladeshi rickshaws."

It is neither principled nor practical for companies to stick their heads in the sand in response to an issue as fundamental as the distribution of the globalization dividend. Yet, as thoughtful business leaders (e.g., Coke's Neville Isdell) have pointed out, business has not been very active in trying to counter the antiglobalizers. In terms of public discourse and action, in particular, I'd recommend the following steps for companies that favor greater integration (of course, not all will do so):

  • Be careful about your choice of words. Outsourcing often triggers negative vibes, as former Bush economic adviser Greg Mankiw discovered. So does globalization, which, according to U.S. pollster Frank Luntz, "frightens older workers." (Luntz recommends talking about the free-market economy instead, although one suspects that this might work less well in continental Europe.)
  • Try to be concrete rather than abstract about economy-wide benefits of globalization. Findings such as those from the McKinsey Global Institute that for every dollar the United States sends abroad through outsourcing, it gets about $1.12 back are more useful than appeals to the process of market equilibration described in economics textbooks.
  • Dispel globalization bogeymen that don't have a scientific basis, such as the myth that increased global integration necessarily leads to increased global concentration.
  • Support job-retraining programs and, more broadly, social insurance. History shows that support for free trade tends to be fragile in the absence of such programs.
  • Emphasize upgrading and productivity growth as the focus of public as well as business policy. These are what really matter in the long run for the wealth of nations as well as companies.

Q: Do you get exasperated by popular viewpoints that treat globalization as a monolithic force without any shades of gray? What's the best way you counter views that seem more emotional than fact-based?

A: I don't get exasperated at all because it is precisely the popular view of globalization as an irresistible force leveling everything that stands in its way, including national differences, that makes my message important. Based on surveys that I have done, many managers do believe this view, and suffer from strategic biases as a result.

Emotional denials of the fact of semiglobalization are, past some point (which may come very soon!), better countered with stories than with additional data. I like the story of Coke, because through to the late 1990s, under CEO Roberto Goizueta, it bought into and based its global strategy on the globalization apocalypse that was popular then, the globalization of markets (rather than production), because customers everywhere were supposed to increasingly want the same products and services. As a result, 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 the U.S. organization and the international one.

10 years later, Coke's strategy under CEO Neville Isdell looks very different. Coke is now focused on learning from Japan—where it reportedly offers more than 200 products but makes more money than in any other major international market—for insights into how to pursue the broader objective of injecting more variety into the Coke system. The strategy is no longer always the same one: In big emerging markets such as China and India, Coke has lowered price points, reduced costs by indigenizing inputs and modernizing bottling operations, and upgraded logistics and distribution, especially rurally. And the official boundaries between the U.S. and international organizations have been restored-recognizing the fact that Coke faces very different challenges in the United States than it does in most of the rest of the world since per capita consumption is an order of magnitude higher in the United States.

Coke is therefore a cautionary tale of a company getting carried away with globaloney and paying for it—but is apparently managing to weather the storm. Other companies that went through a similar set of wrenching changes might not have the kind of strategic cushion associated with the world's most valuable brand name. It is generally better for them to ponder the lessons in my book than to seek to experience them all: Offline learning is a lot cheaper than online learning in this context.

Excerpt from Redefining Global Strategy

Readers are probably also looking for specific advice on what might be done to improve their companies' future global trajectories. In response, let me offer some tentative recommendations for making a path toward a better future.

Path Making

How might you improve the path that you follow from today to tomorrow and beyond if the future is shrouded in uncertainty? To be more specific, how might your company improve, in the context of globalization, on the common expedients of sailing in one direction until hitting a sandbar, or playing pinball to the headlines, or simply marking time?

1. Anticipate bumps and detours even if you do believe that the world will eventually become much more integrated. Even if you remain convinced that the apocalyptic vision of close-to-complete integration will be realized sooner or later, recognize that the road from here to there is unlikely to be either smooth or straight. There will be shocks and cycles, in all likelihood, and maybe even another period of stagnation or reversal that will endure for decades. (It's happened before!) Volatility of this sort is particularly worth allowing for in relation to the BRIC (Brazil, Russia, India, and China) economies that Thomas Friedman and other writers have recently emphasized as centers of value creation in the twenty-first century. But even companies that are supposed to be sophisticated about emerging markets trip up on this point. Goldman Sachs—the leader in investment banking in most major markets, the first major Wall Street bank to commit resources to post-Soviet Russia, and one of the institutions responsible for popularizing BRIC countries as an opportunity set—ranked twenty-fourth among investment banks in Russian equity and debt underwriting in 2005.2 Why so low? Because Goldman, like a number of other investment banks, exited after Russia's 1998 financial crisis and debt default, and let several years go by before trying to reestablish its foothold there. Note that strategies such as this often entail buying in at the top of the cycle and exiting at the bottom—usually not a recipe for financial success.

2. Pay attention to other "predictable surprises" as well. Bumps are just one manifestation of "predictable surprises," a term coined by Max Bazerman and Michael Watkins to describe situations where "leaders had all the data and insight they needed to recognize the potential, even the inevitability, of major problems, but failed to respond with effective preventative action."3 A number of predictable or at least possible surprises are in the air as far as the general global environment is concerned: global warming; different kinds of meltdowns in the Middle East, China, India, and the United States, among other possibilities; a global liquidity crisis; a general sociopolitical backlash against globalization; and so on.4 Notions of a global governance gap reinforce the idea that a shock of this sort might have a persistent effect. How many such shocks is your company prepared for? At a minimum, I suggest articulating one or more deglobalization scenarios and analyzing their implications for your company's global strategy, as a prelude to thinking, possibly, of alternatives.

3. Add to predictive power by taking things down to the industry and company level. Shocks, cycles, and trends, even when they have crosscutting implications, vary greatly across industries and companies in their effects, in ways that greatly reduce the usefulness of trying to fit one world-historical conception to all of them. Focus on the risks and, more broadly, trends that are most likely to affect your industry or company, and how they are actually to do so. Thus, even the effects of something as potentially far-reaching as global warming depend on whether one looks at the issue from the perspective of a financial investor, a construction firm, an automaker (whose reaction would also depend on its focus on large versus small cars), or a potential supplier of cleaner energy, to cite some varied examples. And depending on the setting, other risks or trends may well be more salient and therefore worth prioritizing. For example, when I first started working with Indian software firm TCS on building useful scenarios about the future, we figured that it made the most sense to start with avian flu, given the nature of the company's business.

4. Recognize the importance of business in shaping broad outcomes—including those related to the future of globalization. The preceding discussion might have seemed to suggest that outcomes will unfold independently of what businesses decide to do. But for many key uncertainties, that is clearly not the case. Consider the broad process of globalization itself. Some of the concerns voiced by antiglobalizers include the following:

  • A declining share of wages in total national income in developed countries at a time when the share of profits is at a multidecade high in many of them.
  • The lack of a globalization safety net in many of those countries (the United States, for instance, is estimated to gain $1 trillion per year from trade, but to spend about $1 billion on retraining)5.
  • The creation of a two-track world. As Muhammad Yunus, the microcredit pioneer, put it in his speech accepting the 2006 Nobel Peace Prize, if globalization "is a free-for-all highway, its lanes will be taken over by the giant trucks from powerful economies ... [at the expense of] Bangladeshi rickshaws."6

It is neither principled nor practical for companies to stick their heads in the sand in response to an issue as fundamental as the distribution of the globalization dividend. In terms of public discourse and action, in particular, I'd recommend the following steps for companies that favor greater integration (note that not all will do so):

  • Be careful about your choice of words. Outsourcing often triggers negative vibes, as former Bush economic adviser Greg Mankiw discovered; so does globalization, which, according to U.S. pollster Frank Luntz, "frightens older workers."7 (Luntz recommends talking about the free-market economy instead—although one suspects that this might work less well in continental Europe.)
  • Try to be concrete rather than abstract about economywide benefits of globalization. Findings such as the McKinsey Global Institute's calculation that for every dollar the United States sends abroad through outsourcing, it gets about $1.12 back are more useful than appeals to the process of market equilibration described in economics textbooks.8
  • Dispel globalization bogeymen that don't have a scientific basis, such as the myth that increased global integration necessarily leads to increased global concentration.
  • Support job-retraining programs and, more broadly, social insurance. History shows that support for free trade tends to be fragile in the absence of such programs.
  • Emphasize upgrading and productivity growth as the focus of public as well as business policy. These are what really matter in the long run for the wealth of nations as well as companies.

5. Don't let a focus on the future crowd out consideration of the here and now. The future, including whether the direction of globalization creates headwinds or tailwinds for global strategies, certainly has a bearing on the success or failure of those strategies. But it should not be allowed to crowd out consideration of other factors that also matter, including those in the here and now. A refrain throughout this book is that the current state of practice of global strategy leaves significant headroom for improvement. One way of exploiting that potential is to get started.

Excerpted with permission from Harvard Business School Press. Copyright 2007 Harvard Business School Publishing Corporation. All rights reserved. To order, call (800)-988-0886 or visit Harvard Business School Press.

See also Pankaj Ghemawat's blog, What in the World, and his Web site, www.ghemawat.org.

2. Heather Timmons, "Goldman Sachs Rediscovers Russia," The New York Times, 3 February 2006.

3. Max H. Bazerman and Michael Watkins, Predictable Surpises: The Disasters You Should Have Seen Coming and How to Prevent Them (Boston: Harvard Business School Press, 2004).

4. For an even longer list, see the twenty-three core global risks discussed in World Economic Forum, Global Risks 2007 (Davos, Switzerland: World Economic Forum, January 2007).

5. On the implications of a general liquidity crisis, see for instance, Niall Ferguson, "Sinking Globalization," Foreign Affairs 84 no. 2 (March - April 2005):64-77.

6. Muhammed Yunus, Nobel lecture, Oslo, Norway, 10 December 2006, accessed at http://nobelprize.org/nobel_prizes/peace/laureates/2006/yunnus-lecture-en.html.

7. Frank Luntz, Words That Work: It's Not What You Say, It's What People Hear (New York: Hyperion, 2007).

8. McKinsey Global Institute, "Offshoring: Is it a Win-Win Game?," (San Francisco, August 2003), http://hei.unige.ch/~baldwin/ComparativeAdvantageMyths/IsOffshoringWinWin_McKinsey.pdf.

About the author

Martha Lagace is the senior editor of HBS Working Knowledge.