1

Differences and the CAGE Distance Framework1

Pankaj Ghemawat

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

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

section introduces the CAGE distance framework, which is used to

identify and prioritize the differences between countries that companies

must address when developing cross-border strategies.2

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

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

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

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

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

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

Exhibit 2-1

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

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

Country, 2004 (Estimated)

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The CAGE distance framework disaggregates distance or difference into

four major categories: Cultural, Administrative, Geographic, and

Economic. Differences along these dimensions generally have a negative

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

differences along a limited subset of CAGE dimensions can actually

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

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

Cultural distance: Culture can be defined as the collection of

beliefs, values, and social norms—the unwritten, unspoken rules

of the game—that shape the behavior of individuals and

organizations. Cultural distance encompasses differences in

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

values. Societies even differ in their social attitudes toward

market power and globalization in ways that have important

effects, both formally via regulation and informally, on how

businesses operate.4

Interestingly, Walmart’s four profitable

markets share linguistic, religious and ethnic similarities or, at

least, ties through large diaspora.

Administrative distance: Historical and political associations

between countries—colonial links, free trade agreements, the

tenor of current relationships—profoundly affect economic

exchange between them—which is the same as saying that

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

course, do administrative attributes specific to a particular

country such as autarchic policies or weak institutions and high

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

profitable countries, Canada and Mexico, partner with the United

States in a regional free trade agreement, the North American

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

as classified by Walmart, Puerto Rico, is officially an

unincorporated territory of the United States.

Geographic distance: The geographic dimension of distance

involves more than just how far two countries are from each

other: other attributes to be considered include contiguity, a

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

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

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

profitable ―countries‖ is geographically closer to Walmart’s

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

addition, Canada and Mexico share a common land border with

the United States.

Economic distance: Consumer wealth and income and the cost of

labor are the most obvious (and related) determinants of

economic distance between countries. Others include differences

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

complements, and organizational capabilities. It seems a bit

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

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

economic distance has not been entirely or even primarily a

liability for Walmart. The company saves more money by

procuring merchandise from China—exploiting economic

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

its entire international store network. We will return to such

strategies in section 5, which discusses arbitrage.

What the Numbers Tell Us

International economists have adapted Newton’s law of universal

gravitation to describe trade and other international economic

interactions. Thus, the simplest gravity model of international trade

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

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

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

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

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

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

and economic effects on trade.

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

Dimensions of

Distance/Proximity

Determinant

Change in Trade Cultural

Administrative

Geographic

Economic

Common language

Common regional trading bloc

Colony/colonizer links

Common currency

Differences in corruption

Physical distance: 1% increase

Physical size: 1% increase

Landlockedness

Common land border

Economic size: GDP (1% increase)

Income level: GDP per capita (1% increase)

+42%

+47%

+188%

+114%

–11%

–1.1%

–0.2%

–48%

+125%

+0.8%

+0.7%

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

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

Business School Boston, February 2003.

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

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

many other studies, apparently due to the correction

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

your intuitions (although they cannot be reconciled with a fully

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

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

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

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

ties in generating cultural similarities! The persistence of such large

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

original colonial relationships were dissolved reinforce the conclusion

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

such considerations—is extremely unlikely anytime soon.

Similarities versus differences along many of the same dimensions also

help explain foreign direct investment or companies’ foreign presence.

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

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

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

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

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

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

is that differences between countries—and differences in differences—

matter in significant, predictable ways.

Identifying and Prioritizing Differences

Having highlighted the persistent impact of cross-country differences or

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

framework to identify and prioritize the differences that must be

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

regard by identifying bilateral and unilateral factors to consider for each

of the CAGE categories.

Exhibit 2-3 The CAGE Framework at the Country Level

Cultural

Distance

Administrative

Distance

Geographic

Distance

Economic

Distance

Country pairs

(bilateral)

Different

languages

Different

ethnicities;

lack of

connective

ethnic or

social

networks

Different

religions

Lack of trust

Different

values, norms,

and

dispositions

Lack of colonial

ties

Lack of shared

regional trading

bloc

Lack of common

currency

Political hostility

Physical

distance

Lack of land

border

Differences in

time zones

Differences in

climates /

disease

environments

Rich/poor

differences

Other

differences in

cost or quality

of natural

resources,

financial

resources,

human

resources,

infrastructure,

and information

or knowledge

Countries

(unilateral)

Insularity

Traditionalism

Nonmarket/closed

economy (home

bias vs. foreign

bias)

Lack of

membership in

international

organizations

Landlockedness

Lack of internal

navigability

Geographic size

Geographic

remoteness

Weak

transportation

Economic size

Low per capita

income

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Weak institutions,

corruption

or

communication

links

The most distinctive feature of the CAGE framework is that it

encompasses the bilateral attributes of country pairs as well as the

unilateral attributes of individual countries. Most of the other

frameworks that have been proposed for thinking about the differences

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

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

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

cardinal indices such as the World Economic Forum’s Global

Competitiveness Index or Transparency International’s Corruption

Perceptions Index but also to ordinal ranking schemes such as Michael

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

competitiveness of different countries as home bases in specific

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

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

More generally, indexicality is incapable of capturing bilateral

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

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

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

Having drawn that distinction between unilateral and bilateral influences,

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

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

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

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

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

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

countries (characterized by unique, ingrown cultures, closed

administrative policies, physical remoteness, or extremely high or low

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

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

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

which countries are close and which ones are farther away.

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

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

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

particular importance to companies dealing in heavy or bulky products.

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

preferences and should be a crucial consideration for a consumer goods

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

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

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

distance.

Exhibit 2-4 The CAGE Framework at the Industry Level

Cultural

Distance

Administrative

Distance

Geographic

Distance

Economic

Distance Cultural differences

matter the most

when:

Products have high

linguistic content

(TV programs)

Products matter to

cultural or national

identity (foods)

Product features

vary in terms of

size (cars) or

standards

(electrical

equipment)

Products carry

country-specific

quality

associations

(wines)

Government

involvement is high in

industries that are:

Producers of staple

goods (electricity)

Producers of other

―entitlements‖ (drugs)

Large employers

(farming)

Large suppliers to

government (mass

transportation)

National champions

(aerospace)

Vital to national

security

(telecommunications)

Exploiters of natural

resources (oil, mining)

Subject to high sunk

costs (infrastructure)

Geography plays a

more important role

when:

Products have a low

value-to-weight or

bulk ratio (cement)

Products are fragile

or perishable (glass,

fruit)

Local supervision

and operational

requirements are

high (services)

Economic differences

make the biggest

impact when:

Nature of demand

varies with income

(cars)

Economics of

standardization or

scale are limited

(cement)

Labor and other

factor cost

differences are

salient (garments)

Distribution or

business systems

are different

(insurance)

Companies need to

be responsive and

agile (home

appliances)

Applications of the CAGE Distance Framework

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

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

the most important ones.

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Making Differences Visible

One application of the CAGE distance framework is to make key

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

worth belaboring, most notable international business debacles can be

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

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

cannot simply fall back on personal experience to ensure adequate

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

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

forgetfulness and cognitive overload in a complex environment.

Understanding the Liability of Foreignness

A second application of the CAGE framework is to pinpoint the

differences across countries that might handicap multinational

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

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

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

When there are substantial liabilities of foreignness, multinationals often

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

these barriers.

Assessing Natural Owners and Comparing Foreign Competitors

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

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

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

of multinationals from different countries. For example, CAGE analysis

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

Latin America, but also why success in Mexico has proved

comparatively easier for U.S. firms.7

Again, such analysis is most

valuable when conducted at the industry level and is indicative rather

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

more than ―natural ownership‖ advantages.

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Comparing Markets and Discounting by Distance

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

perspective of a particular company. One method to conduct quantitative

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

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

While such discounting involves numerous approximations, making

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

how much distance matters, than refraining from making any

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

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

section, on Grolsch).

Conclusion

The CAGE framework helps identify the most important cross-country

differences and their implications for strategy. However, understanding

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

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

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

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

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

profitability? The next three sections help address these questions by

introducing three types of strategies for creating and claiming value in

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

arbitrage.

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

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

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

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

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

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

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

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

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

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

and the references cited therein.

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

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

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

Harvard Business School, Boston, October 2008.

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

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

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

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

Press, 2001).

7 Subramanian Rangan and Aldemir Drummond, ―Explaining Outcomes in

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

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