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Imagine that, five years ago, your organization expanded into a new overseas market. It had high hopes of success, but the venture turned out to be a big mistake.
First, transport costs were higher than expected because of difficult road conditions. Then, a flood damaged stock at the warehouse. Finally, customers complained that the marketing campaign was culturally inappropriate.
Your organization had to withdraw from this market. It lost money, and the unsuccessful venture damaged its reputation among potential investors.
The expansion went wrong because leaders in your organization had not seen the "bigger picture" in their planning. They saw a large potential market and high levels of disposable income among customers, and assumed that the expansion would bring in more than enough revenue to cover costs.
However, they overlooked a number of other factors that added cost and risk to the venture. These, ultimately, caused it to fail.
In this article, we'll look at the CAGE Distance Framework, a tool that you can use to think about how market-related factors can affect an expansion into a new region. We'll then explain how to use this framework when you're researching a foreign market.
About the Tool
Pankaj Ghemawat, a professor at IESE Business School in Barcelona, Spain, developed the CAGE Distance Framework. He outlined it in the September 2001 Harvard Business Review. [1]
In his research, Ghemawat looked at several failed international expansions, and noted that some of the leaders involved had overestimated the appeal of overseas markets. He also saw that these leaders had underestimated the extent to which differences between the home market and the new foreign one could add cost and risk to their plans.
Ghemawat developed the CAGE Distance Framework as a tool to help leaders explore the impact of these differences, and the effect that they could have on international expansion.
He grouped the differences into four dimensions that he called "distances":
- Cultural distance.
- Administrative and political distance.
- Geographic distance.
- Economic distance.
Reprinted by permission of Harvard Business Review. From "Distance Still Matters" by Pankaj Ghemawat, September 2001. Copyright © 2001 by the Harvard Business School Publishing Corporation; all rights reserved.
He then explained how leaders could use these factors to explore the potential impact of differences between the home market and a foreign one.
When to Use the Tool
You can use the CAGE Distance Framework if you're planning to expand your organization into a specific foreign market.
You can also use this tool to compare a number of new markets. Once you've assessed all of the dimensions in each country, you'll be able to make an informed choice about which new market you should explore in more detail.
Finally, this tool can also be also useful if your company plans to partner with international organizations. You can use the four distances to spot potential problems in advance.
Note:
You can use this tool in conjunction with others to get a full picture of how foreign expansion could affect your organization.
For example, you can combine it with a PEST Analysis, which will help you to explore how other factors could affect your business plan.
We suggest a number of other appropriate tools to use within this article, but you should also use your own judgment – and your knowledge of each market and industry – to make a final decision.
Applying the Framework
Let's look at each dimension of the CAGE Distance Framework in detail, and discuss how you can use it when you research company expansion plans.
Cultural Distance
The cultural differences between countries can be huge, and may relate to any of the following – and more:
- Religious beliefs.
- Language.
- Social norms and values.
- Cultural history.
For example, colors have particular meanings in China, and these are culturally important. However, they have less importance in the United States. If you were to launch a U.S. product in China with no knowledge of this difference in social norms, you could compromise the success of your product.
Action
Think about these questions:
- How could language differences affect the planned expansion? These could include regional differences as well as international ones.
- What are religious beliefs and taboos in this country? Could they affect the appeal of your product?
- Does this country have different social norms from those of your own? These can include social customs and expectations, and preferences around food, packaging, service, style, or colors. How might these affect how your product is perceived?
- Are there any tensions between cultures within this new market that could reduce the size of your market?
Use Trompenaars and Hampden-Turner's Seven Dimensions of Culture to gain a better understanding of the differences that exist between your culture and the one that you're considering, and explore how these could affect your plans.
Administrative and Political Distance
This refers to historical or political associations – both positive and negative – that countries sometimes share.
When your country has positive past ties with the region that you're considering, you'll often have a greater chance of success. However, if those connections are negative, even if they relate to events that happened a long time ago, you could have more obstacles to overcome.
Factors that can create administrative and political distance include:
- A lack of historical links.
- Political instability.
- Differing political styles, or different understandings of the rule of law.
- Restrictive government policies and laws such as taxes and tariffs.
- Different currencies.
- Favoritism towards domestic organizations.
- Differences in employment legislation.
According to Ghemawat, countries that have a common currency or a political union can expect up to a 340 percent increase in trade compared with countries that lack these ties. Countries with a past colonial relationship can expect up to a 900 percent increase in trade.
Action
Use Porter's Diamond to drill down into the business conditions in your proposed new market.
As part of this process, look carefully at the international trade policies of this country. Chances are that at least some restrictive policies are in place. These policies are designed to protect domestic organizations, so they may present barriers to your plans, depending on your industry.
For example, governments often protect industries that employ large numbers of people, such as farming. Trade policies are also prevalent in industries that are important to national security, or those that affect natural resources (such as timber, oil, or mining).
Make sure that you know what these policies are, and how they will affect your costs, supply chain, and market reach.
Geographic Distance
Geographical factors can also add costs to your plans to do business in a new country. These factors include:
- A poor transportation and communications infrastructure.
- A lack of sea or river access.
- Complex topography.
- A harsh climate.
Action
Analyze the physical geography of this region. How might climate or terrain affect your organization's ability to do business there?
Then look at the country's infrastructure. Are roads well maintained and easily accessible? What other transportation and delivery options exist? This could include access to seas and rivers.
Pay careful attention to the frequency of natural disasters such as earthquakes, floods, and wildfires, as these events can disrupt your supply chain. Conduct a Risk Analysis to determine how damaging these events might be for your organization.
Tip:
If you decide to go ahead with the expansion, make sure that you have contingency plans for natural disasters that often occur in this country.
Economic Distance
Many organizations tend to focus on economic distance when they consider foreign expansion. Several factors can create this distance, including:
- Levels of disposable income and consumer wealth.
- Cost, quality, and availability of financial and human resources.
Often, organizations have the best chance of success when they expand into markets that have a similar economic profile. A simple example would be a U.S.-based company expanding into Canada. Canada has many unique attributes, but it's a closer economic match to the United States than a country such as India or South Korea.
Action
List the resources that you will need in this country, including talent and credit lines. How difficult will it be to secure these resources, and what are the likely associated costs? For example, if you need to relocate key staff from your home market, you may need to provide relocation packages.
Key Points
Professor Pankaj Ghemawat developed the CAGE Distance Framework to help organizations explore how distance could affect plans for international expansion. He split distance into four key categories:
- Cultural distance.
- Administrative distance.
- Geographic distance.
- Economic distance.
You can use the framework to explore how these factors could affect your organization's plans to expand into a foreign market.
You can also use it to compare the advantages that different countries present, and to prompt further research into whether expansion is financially viable.
References[1] Ghamawat, P. (2001). 'Distance Still Matters: The Hard Reality of Global Expansion,'
Harvard Business Review, September 2001. Available
here. [Accessed May 2, 2013.]
