2.

Diffferences an GE Distancce Framewoork1

nd the CAG

Pankaj Ghhemawat

Thiss note introoduces the CAGE disttance frameework, whiich is used to

idenntify and prrioritize thee differencess between countries
c thhat companiies
musst address when
w develooping cross--border strattegies.2

Beggin by conssidering thee example summarized in exhibiit 2-1, whiich

plotts Walmartt’s operatinng margin by countrry in 20044 against tthe
distance betweeen each coountry’s cappital and Walmart’s
W heeadquarters in
Benntonville, Arrkansas. Thhe impact off geographicc distance iss obvious, bbut
whaat other typees of differeence or distance can yo
ou identify that
t separatted
the markets thaat were proffitable for Walmart
W from
m those thaat weren’t?

Exhibiit 2-1
Wallmart Internnational’s Operating
O M
Margin ountry (2004 estimates)
by Co

Thee CAGE distance frameework disagggregates diistance or diifference intto

fourr major categories:
c Cultural, Administraative, Geoggraphic, aand
Ecoonomic. Diff
fferences aloong these diimensions generally
g haave a negatiive
(c) Pankaj Ghemaw
wat / For copyrigght permissionss, please e-mail globecourse@gghemawat.com
m
effeect on manny cross-boorder interractions, although in some casees,
diffferences aloong a limited subset of o CAGE dimensions
d can actuallly
encoourage rathher than disccourage succh interactio ons.3 Each of
o these brooad
typees of differeence or distaance is illusstrated by th
he Walmart example.

 Culturaal distance:: Culture can be defin ned as the collection of

beliefs, values, andd social norrms—the un nwritten, unnspoken rulles
of the game—thhat shape the behaviior of inddividuals aand
organizzations. Cuultural distaance encom mpasses differences
d in
religiouus beliefs, race/ethnicit
r ty, languag
ge, and sociial norms aand
values. Societies even diffeer in their social attittudes towaard
market power andd globalizaation in waays that haave importaant
effects, both form mally via reegulation and
a informaally, on hoow
businessses operate. 4 Interesstingly, Waalmart’s foour profitabble
marketss share lingguistic, religious and ethnic simiilarities or, at
least, tiees through large
l diaspoora.

 Adminisstrative disstance: Historical an nd political associatioons

betweenn countriess—colonial links, freee trade agrreements, tthe
tenor ofo current relationshhips—profou undly affeect econom mic
exchangge betweenn them—w which is th he same ass saying thhat
differennces along these dimeensions mattter a greatt deal. So, of
course, do adminnistrative attributes
a specific
s to a particullar
countryy such as auutarchic pollicies or weeak institutiions and high
levels of
o corruptionn. In the Waalmart exam mple, note thhat two of tthe
profitabble countriees, Canada and
a Mexico o, partner wiith the Unitted
States in
i a regionnal free tradde agreemeent, the Norrth Americcan
Free Trrade Agreem ment (NAFT TA). And a third profittable “counttry”
as classsified by Walmart,, Puerto Rico, R is officially an
unincorrporated terrritory of thee United Staates.

 Geograaphic distannce: The geographic

g dimensionn of distannce
involvees more thaan just how w far two countries
c arre from eaach
other: other
o attribbutes to bee considereed include contiguity, a
countryy’s physicaal size, witthin-country y distancess to bordeers,
access to
t the oceann, topographhy, and eveen time zonnes. Exhibit 2-
1 makees it clear thhat the capital city off each of Walmart’s
W foour
profitabble “countrries” is geeographicallly closer to t Walmarrt’s

2
 headquaarters than the capitalss of any of the unprofitable ones; in
additionn, Canada and
a Mexicoo share a co ommon landd border wiith
the Uniited States.

 Econom mic distancee: Consumeer wealth an nd income anda the cost of

labor area the most
m obviouus (and reelated) determinants of
econom mic distancee between countries. Others includde differencces
in availlability (or lack) of reesources, in nputs, infraastructure aand
complements, andd organizattional capaabilities. It seems a bbit
harder forf Walmarrt to do welll in poorer countries— —although tthe
numberr of data points
p is very
v limited. Note, however,
h thhat
econom mic distancee has not been b entireely or evenn primarilyy a
liabilityy for Walm mart. The company saves morre money bby
procurinng merchandise froom China— —exploitinng econom mic
distancee, particularrly in termss of labor co osts—than iti makes froom
its entiire internatiional store network. We W will reeturn to suuch
strategies in sectionn 5, which discusses
d arrbitrage.

Whaat the Numbbers Tell Uss

Inteernational economists
e have adaapted Newtton’s law of universsal
gravvitation too describe trade annd other internationaal econom mic
inteeractions. Thus,
T the simplest graavity modeel of internnational traade
betwween two coountries preedicts that trade
t will bee directly reelated to theeir
econnomic sizes (a unilateeral attribuute of each country) and a inverseely
relaated to the physical
p disttance betweeen them (aa bilateral orr country-paair
attriibute). Auggmented graavity modeels add meaasures of other o types of
diffferences as well
w as unillateral attribbutes. Exhib bit 2-2 show ws the resuults
of one
o such annalysis that evaluated cultural,
c admministrativee, geographhic,
and economic effects
e on trrade.

3
 Exhhibit 2-2 Effects of Similaarities Versuss Differences on Bilateraal Trade
D
Dimensions of
o
D
Distance/Proxximity Determinaant Channge in Trade
C
Cultural Common laanguage +42%
%

A
Administrativee Common reegional tradingg bloc +47%
%
Colony/coloonizer links +188%
Common cuurrency +114%
Differencess in corruptionn –11%
%

G
Geographic Physical disstance: 1% inccrease –1.1%
%
Physical sizze: 1% increasse –0.2%
%
Landlockeddness –48%%
Common laand border +125%

E
Economic Economic size:
s GDP (1%% increase) +0.8%
%
Income leveel: GDP per caapita (1% incrrease) +0.7%
%

Sourrce: Pankaj Ghemawat and a Rajiv Mallick,

Ma “The Industry-Levvel Structure of
Interrnational Tradde Networks: A Gravity-Based Approacch,” working paper, Harvaard
Busiiness School Boston,
B Februaary 2003.

The estimates corrrect for unobbserved threshholds for participation in trrade and are all
signiificant at the 1%
1 level but are,
a in a numbber of cases, smaller
s than those
t reportedd in
manyy other studiees, apparently due to the corrrection

Thee signs on most

m of thee estimates in the table probablyy accord wiith
youur intuitions (althoughh they cannot be reeconciled with w a fullly
globbalized “flaat” world). What are probably more m surprrising are tthe
maggnitudes off some of the t effects——for exam mple, that countries wiith
coloonial ties arre apt to trrade almostt three timees as muchh as countriies
withhout them, or even moore if one allso accountts for the roole of colonnial
ties in generatting culturaal similaritiies! The peersistence ofo such larrge
effeects decadess and, in some instannces, more than a centtury after tthe
origginal coloniial relationsships were dissolved reinforce
r thhe conclusion
thatt complete globalizatioon—as in the t disappeearance of the t effects of
suchh considerattions—is exxtremely unnlikely anytiime soon.

Sim
milarities verrsus differeences along many of thhe same dim mensions allso
helpp explain fooreign direcct investmeent or comppanies’ foreeign presencce.
Thuus, for U.S. companiess that operaate in just one
o foreign country, thhat
counntry is Canaada 60 perccent of the time
t (and 10
0 percent off the time itt is

4
the United Kinngdom).5 Grravity modeels have also o been adappted to explaain
crosss-border interactions as diverse as equitty trading, e-commerrce
trannsactions, patent citatioons, immiggrant flows, air traffic,, phone callls,
and even the inncidence of wars! The basicb conclu
usion from this literatuure
is thhat differennces betweeen countriess—and diffferences in differences— —
mattter in signifficant, prediictable wayys.

Idenntifying andd Prioritizinng Differencces

Havving highligghted the peersistent imppact of crosss-country differences

d or
distances, the rest
r of this section foccuses on ussing the CA AGE distannce
fram
mework to identify and a prioritiize the diffferences that
t must be
accoounted for in developiing global strategies.
s Exhibit
E 2-3 helps in thhis
regaard by identtifying bilatteral and unnilateral facctors to conssider for eaach
of thhe CAGE categories.
c

Exhhibit 2-3 The CAGE Fram

mework at thee Country Leevel
Cultural Adminnistrative Geographicc Ecoonomic
Distance Distannce Distance Disstance
Couuntry pairs  Different  Lack of
o colonial  Physical distaance  Ricch/poor
languages ties  Lack of land border
b diff
fferences
(bilaateral)  Different  Lack of
o shared  Differences inn time  Othher
ethnicities; regional trading zones diff
fferences in
lack of bloc  Differences inn cosst or quality
connective  Lack of
o common climates / diseease of nnatural
ethnic or currency environmentss resoources,
social  Political hostility finaancial
networks resoources,
 Different humman
religions resoources,
 Lack of truust infr
frastructure,
 Different andd
values, norrms, info
formation or
and knoowledge
dispositionns
Couuntries  Insularity  Nonmaarket/closed  Landlockedneess  Ecoonomic size
 Traditionallism econom my (home  Lack of internnal  Loww per capita
(uniilateral) bias vss. foreign navigability income
bias)  Geographic siize
 Lack of
o  Geographic
membeership in remoteness
internaational  Weak transpoortation
organizzations or communication
 Weak institutions, links
corruption

5
Thee most disstinctive feeature of the t CAGE E frameworrk is that it
encoompasses thet bilateraal attributess of countrry pairs ass well as tthe
unillateral attrributes of individuall countriess. Most of o the othher
frammeworks that have beeen proposedd for thinking about thhe differencces
acrooss countriees (or locatiions) focus on just uniilateral attributes; that is,
theyy assume thhat countriess can be asssessed one by
b one againnst a comm mon
set of yardsticcks. Note that
t this chharacterizatiion appliess not only to
carddinal indicces such as the World W Econnomic Foruum’s Globbal
Com mpetitiveness Index or Transparency Intternational’ss Corruption
Percceptions Inddex but also to ordinaal ranking schemes succh as Michaael
Portter’s “diamoond” framework for diiagnosing th he (relative)) internationnal
commpetitivenesss of diffeerent counttries as home basess in speciffic
induustries. Butt indexicalitty of this sort
s is restriictive sincee it can’t deeal
withh ideas suchh as “The U.S.
U is closeer to Canadaa than it is to t Indonesiaa.”
Morre generallly, indexiccality is incapable of capturring bilaterral
diffferences of the
t sort neccessary to ennvision cou untries as exxisting in (aand
evenn occupyinng) space inn relation too each otheer, that is, as a nodes inn a
6
netwwork insteadd of as an array along a common yardstick.
y

Havving drawn that distincction betweeen unilateraal and bilateeral influencces,

it iss useful to add
a that theey can be fitted
f togeth
her into the same overrall
struucture. Speccifically, unnilateral meeasures of isolation
i (oor integratioon)
captturing counntry-specificc attributes that
t generallly decreasee (or increasse)
a country’s innvolvement in cross-bborder econ nomic activvities can be
treaated as a common
c coomponent of that co ountry’s disstances along
variious dimenssions from alla other couuntries. Forr example, really
r isolatted
counntries (chharacterizedd by uniique, ingrrown cultuures, clossed
admministrative policies, phhysical rem moteness, orr extremelyy high or loow
incoomes) can be b thought of as beingg relatively distant from m everywheere
elsee. That saidd, one needs to add biilateral indicators to suuch unilaterral
conceptions too capture thhe idea thaat a compaany’s homee base affeccts
whiich countriees are close and which ones
o are farrther away.

Thee other poinnt worthy off even moree emphasis is that diffe
ferent types of
i different industries. For instancce,
distance matterr to differennt extents in
sincce geographhic distancee affects thhe costs off transportaation, it is of
partticular impoortance to companies
c d
dealing in heavy
h or buulky produccts.

6
Culttural distannce, on thhe other hand,
h shapes consum mers’ produuct
prefferences andd should bee a crucial consideratio
c on for a connsumer gooods
or media
m comppany—but is much leess importan nt for a cemment or steeel
busiiness. Exhibbit 2-4 provvides a sum
mmary of th he characterristics that aare
likeely to makee an industrry particularrly sensitive to a partiicular kind of
distance.

Exhibiit 2-4 The CAGE

C Fram
mework at th
he Industry Level
L

Culttural Adminisstrative Geographiic Economic

Disttance Distancee Distance Distance
Culturral differences Governmentt Geography plaays a Econnomic differencces
matterr the most involvementt is high in more importan nt role makke the biggest
when:: industries thhat are: when: impaact when:
 Products have highh  Producerss of staple  Products hav ve a low  Naature of demandd
lingguistic content goods (eleectricity) value-to-weiight or vaaries with incomme
(TVV programs)  Producerss of other bulk ratio (ceement) (caars)
 Products matter to “entitlemeents” (drugs)  Products aree fragile  Ecconomics of
culttural or nationall  Large empployers or perishablee (glass, staandardization oor
idenntity (foods) (farming) fruit) scale are limited
 Product features  Large supppliers to  Local superv vision (ceement)
varyy in terms of governmeent (mass and operatioonal  Laabor and other
sizee (cars) or transportaation) requirementss are facctor cost
stanndards  National champions
c high (servicees) diffferences are
(eleectrical (aerospacee) salient (garmentss)
equuipment)  Vital to naational  Diistribution or
 Products carry security buusiness systems
couuntry-specific (telecomm munications) aree different
quaality  Exploiterss of natural (innsurance)
assoociations resources (oil, mining)  Coompanies need to
(winnes)  Subject too high sunk bee responsive andd
costs (infrrastructure) aggile (home
apppliances)

Appplications off the CAGE

E Distance Framework
F

Thee CAGE fraamework, onnce it is takken down to o the industrry level, lennds
itsellf to a veryy broad arraay of appliccations. Lett’s focus heere on four of
the most imporrtant ones.

7
Makking Differeences Visible

Onee applicatioon of the CAGE distance fram mework is to t make kkey

diffferences vissible. Whilee this appliccation may seem too obvious
o to be
worrth belaboriing, most notable
n inteernational business
b debbacles can be
tracced back too a failuree to apprecciate a key y type of cross-counttry
diffference or distance.
d Fuurthermore, in a very diverse
d worrld, manageers
cannnot simplyy fall back on personnal experien nce to enssure adequaate
senssitivity to differences. Checklists
C o the sort embedded
of e inn exhibits 22-3
and 2-4 can help evenn experienced peoplee avoid errrors due to
forggetfulness annd cognitivve overload in a compleex environmment.

Undderstanding the Liabilitty of Foreiggnness

A second
s appplication off the CAG GE framew work is to pinpoint tthe
diffferences accross counntries thatt might handicap multinationnal
com
mpanies rellative to local comppetitors—thee so-calledd liability of
foreeignness—oor more gennerally affect their relaative positioons. This ccan
be a useful exeercise for both
b multinaationals andd their locall competitors.
When there aree substantiaal liabilities of foreignn
ness, multinnationals oftten
lookk to acquire or set upp joint venttures with local
l firms to overcom me
thesse barriers.

Asssessing Natuural Ownerss and Compparing Foreiign Competiitors

Eveen if multinnationals caan be confiddent that th hey are goiing to prevvail

overr local commpetitors in a particularr market, th he CAGE frramework ccan
be used
u at a finner level of resolution to
t shed lighht on the rellative position
of multinationa
m als from diffferent counntries. For example,
e CAAGE analyssis
can help explaain why Spaanish firmss do well in n many induustries acrooss
Latiin Americca, but allso why success in n Mexico has provved
com
mparatively easier for U.S. firm ms. 7 Again, such anallysis is moost
valuuable whenn conductedd at the inddustry level and is inddicative rathher
thann decisive. Thus,
T particcularly goodd or bad glo
obal strategiies can mattter
morre than “nattural ownersship” advanntages.

8
Com
mparing Maarkets and Discounting
D by Distancce

Thee CAGE fraamework caan also be used to com mpare markkets from tthe
persspective of a particularr company. One method to conducct quantitatiive
anallysis of thiss type is to discount (sppecifically, divide) raw
w measures of
marrket size orr potential with meassures of disstance, broadly defineed.
While such discounting
d involves numerous
n approximati
a ions, making
som
me adjustmeents of markket potentiaal for distan nce is a betteer idea, givven
howw much distance
d m
matters, thaan refraining from making aany
adjuustments at all. Some companies
c d formally
do y use methods of this soort
in deciding
d to enter or exiit markets (as
( describeed in the firsst case in thhis
secttion, on Groolsch).

1Pankajj Ghemawatt And Jordan n I. Siegel, “Cases

“ on Reedefining Global
Strategy” , (Harv
vard Business Review Preess, 2011):59
9-69
2
For a more extendeed treatment of this mateerial, see Pannkaj Ghemaw wat,
“Disstance Still Matters:
M The Hard
H Reality of Global Exxpansion,” Harvard
Ha Business
Reviiew, Septembeer 2001. This topic is also addressed at substantially
s g
greater lengthh in
chappter 2 of Pankkaj Ghemawatt, Redefining Global Strateegy (Harvard Business
B Schoool
Press, 2007), andd chapter 3 off Pankaj Ghem mawat, World d 3.0: Globall Prosperity aand
Howw to Achieve ItI (Harvard Buusiness Revieew Press, 2011). For a colllection of maaps
that highlight distaance effects, see
s www.ghem mawat.com.
3
For furtther discussionn of the ways in which CAG GE differencees can encouraage
ratheer than discouurage cross-boorder activity, see the discussion of arbitrrage in sectionn 5
t referencess cited therein.
and the
4
For an original disccussion of cultural distance and how itt affects foreiign
direcct investmennt, see Jorddan Siegel, Amir Lich ht, and Shaalom Schwarrtz,
“Egaalitarianism, Cultural Disttance, and FDI: A New Approach,” working papper,
Harvvard Business School, Bostoon, October 2008.
2
5Susan E. Feinberg g, “The Expansion and Location Paatterns of UU.S.
Mulltinationals,”” unpublished working paper,
p Rutgerrs University
y, 2005.
6
For a more
m extendedd discussion of
o indexicality
y in a broadeer social sciennce
context, see Andrrew Abbott, Chaos of Dissciplines (Chiicago: Univerrsity of Chicaago
Press, 2001).
7
Subram
manian Rangaan and Aldem nd, “Explaininng Outcomes in
mir Drummon
Com
mpetition amoong Foreign Multinationaals in a Foccal Host Maarket,” Strateggic
Mannagement Jourrnal 25, no. 3:: 285–293.