CHAPTER 9

Global Strategy: Adapting the Business Model

Introduction

Few companies can afford to enter all markets open to them. Even the world’s largest companies such as General Electric or Nestlé must exercise strategic discipline in choosing the markets they serve. They must also decide when to enter them, and weigh the relative advantages of a direct or indirect presence in different regions of the world. Small and midsize companies are often constrained to an indirect presence; for them the key to gaining a global competitive advantage often is creating a worldwide resource network through alliances with suppliers, customers, and sometimes competitors. What is a good strategy for one company, however, might have little chance of succeeding for another.

The track record shows that picking the most attractive foreign markets, the best time to enter them and selecting the right partners and level of investment has proven difficult for many companies, especially when it involves large emerging markets such as China. For example, it is now generally recognized that Western car makers entered China far too early, and overinvested believing a “first-mover advantage” would produce superior returns. Reality was very different. Most lost large amounts of money, had trouble working with local partners, and saw their technological advantage erode due to “leakage”. None achieved the sales volume needed to justify their investment.

Even highly successful global companies often first sustain substantial losses on their overseas ventures, and occasionally have to trim back their foreign operations or even abandon entire countries or regions in the face of ill-timed strategic moves or fast-changing competitive circumstances. Not all of Wal-Mart’s global moves have been successful, for example—a continuing source of frustration to investors. In 1999 the company spent $10.8 billion to buy British grocery chain Asda. Not only was Asda healthy and profitable—it was already positioned as “Wal-Mart lite.” Today, Asda is lagging well behind its No.1 rival, Tesco. Even though Wal-Mart’s UK operations are profitable, sales growth has been down in recent years, and Asda has missed profit targets for several quarters running, and is in danger of slipping further in the UK market.

This result comes on top of Wal-Mart’s costly exit from the German market. In 2005, it sold its 85 stores there to rival Metro at a loss of $1 billion. Eight years after buying into the highly competitive German market, Wal-Mart executives, accustomed to using Wal-Mart’s massive market muscle to squeeze suppliers, admitted they had been unable to attain the economies of scale it needed in Germany to beat rivals’ prices, prompting an early and expensive exit.

Global Market Selection

What makes global market selection and entry so difficult? Research shows there is a pervasive “the grass is always greener” effect that infects global strategic decision making in many, especially globally inexperienced, companies and causes them to overestimate the attractiveness of foreign markets.¹ As noted in Chapter 3 “distance”, broadly defined, unless well-understood and compensated for, can be a major impediment to global success: cultural differences can lead companies to overestimate the appeal of their products or the strength of their brands; administrative differences can slow expansion plans, reduce the ability to attract the right talent and increase the cost of doing business; geographic distance impacts the effectiveness of communication and coordination; and economic distance directly influences revenues and costs.

A related issue is that developing a global presence takes time and requires substantial resources. Ideally, the pace of international expansion is dictated by customer demand. Sometimes it is necessary, however, to expand ahead of direct opportunity in order to secure a long-term competitive advantage. But, as many companies that entered China in anticipation of its membership in the World Trade Organization (WTO) have learned, early commitment to even the most promising long-term market makes earning a satisfactory return on invested capital difficult. As a result, an increasing number of firms, particularly smaller and midsize ones, favor global expansion strategies that minimize direct investment. Strategic alliances have made vertical or horizontal integration less important to profitability and shareholder value in many industries. Alliances boost contribution to fixed cost while expanding a company’s global reach. At the same time, they can be powerful windows on technology, and greatly expand opportunities to create the core competencies needed to effectively compete on a worldwide basis.

Finally, a complicating factor is that a global evaluation of market opportunities requires a multidimensional perspective. In many industries we can distinguish between “must” markets—markets in which a company must compete in order to realize its global ambitions—and “nice-to-be-in” markets—markets in which participation is desirable but not critical. “Must” markets include those that are critical from a volume perspective, markets that define technological leadership, and markets in which key competitive battles are decided. In the cell phone industry, for example, Motorola looks to Europe as a primary competitive battleground, but it derives much of its technology from Japan and sales volume from the United States.

Measuring Global Market Attractiveness

Four key factors in selecting global markets are (1) a market’s size and growth rate, (2) a particular country or region’s institutional contexts, (3) a region’s competitive environment, and (4) a market’s cultural, administrative, geographic and economic distance from other markets the company serves.

Market Size and Growth Rate. A wealth of country-level economic and demographic data is available from a variety of sources including governments, multinational organizations such as the United Nations or the World Bank, and consulting firms specializing in economic intelligence or risk assessment. However, while valuable from an overall investment perspective, such data often reveal little about the prospects for selling products or services in foreign markets to local partners and end users or about the challenges associated with overcoming other elements of distance. Yet, many companies still use this information as their primary guide to market assessment simply because country-market statistics are readily available, whereas real product-market information is often difficult and costly to obtain.

What is more, a country/regional approach to market selection may not always be the best. Even though Theodore Levitt’s vision of a global market for uniform products and services has not come to pass and global strategies exclusively focused on the “economics of simplicity” and the selling of standardized products all over the world rarely payoff, research increasingly supports an alternative “global segmentation” approach to the issue of market selection, especially for branded products. In particular, surveys show that a growing number of consumers, especially in emerging markets, base their consumption decisions on attributes beyond direct product benefits such as their perception of the global brands behind the offerings.

Companies that use a “global segment” approach to market selection such as Coca-Cola, Sony or Microsoft to name a few, therefore must manage two dimensions for their brands. They must strive for superiority on basics like the brand’s price, performance, features, and imagery and, at the same time, they must learn to manage brands’ global characteristics, which often separate winners from losers. A good example is provided by Samsung, the South Korean electronics maker. In the late 1990s, Samsung launched a global advertising campaign that showed the South Korean giant excelling time after time in engineering, design, and aesthetics. By doing so, Samsung convinced consumers that it could compete successfully directly with technology leaders like Nokia and Sony across the world. As a result, Samsung was able to change the perception that it was a down-market brand, and it became known as a global provider of leading-edge technologies. This brand strategy, in turn, allowed Samsung to use a global segmentation approach to making market selection and entry decisions.

Institutional Contexts. Khanna et al.² developed a five dimensional framework to map a particular country or region’s institutional contexts. Specifically, they suggest careful analysis of a country’s (1) Political and Social Systems, (2) Openness, (3) Product Markets, (4) Labor Markets, and (5) Capital Markets.

A country’s political system affects its product, labor, and capital markets. In socialist societies like China, for instance, workers cannot form independent trade unions in the labor market, which affects wage levels. A country’s social environment is also important. In South Africa, for example, the government’s support for the transfer of assets to the historically disenfranchised native African community has affected the development of the capital market.

Even though developing countries have opened up their product markets during the past 20 years, multinational companies struggle to get reliable information about consumers. Market research and advertising often are less sophisticated and, because there are no well-developed consumer courts and advocacy groups in these countries, people can feel they are at the mercy of big companies.

Labor markets also present ongoing challenges. Recruiting local managers and other skilled workers in developing countries can be difficult. The quality of local credentials can be hard to verify, there are relatively few search firms and recruiting agencies, and the high-quality firms that do exist focus on top-level searches, so companies scramble to identify middle-level managers, engineers, or floor supervisors.

Finally, capital and financial markets in developing countries often lack sophistication. Reliable intermediaries like credit-rating agencies, investment analysts, merchant bankers, or venture capital firms may not exist and multinationals cannot count on raising debt or equity capital locally to finance their operations. Nurturing strong relationships with government officials often is necessary to succeed. Even then, contracts may not be well enforced by the legal system.

Competitive Environment. The number, size, and quality of competitive firms in a particular target market comprise a third set of factors that affect a company’s ability to successfully enter and compete profitably. While country-level economic and demographic data are widely available for most regions of the world, competitive data is much harder to come by, especially when the principal players are subsidiaries of multinational corporations. As a consequence, competitive analysis in foreign countries, especially in emerging markets, is difficult and costly to perform and its findings do not always provide the level of insight needed to make good decisions. Nevertheless, a comprehensive competitive analysis provides a useful framework for developing strategies for growth, and for analyzing current and future primary competitors and their strengths and weaknesses.

Distance. Explicitly considering the four dimensions of distance introduced in Chapter 3 can dramatically change a company’s assessment of the relative attractiveness of foreign markets. In his book The Mirage of Global Markets, David Arnold describes the experience of Mary Kay Cosmetics (MKC) in entering Asian markets. MKC is a direct marketing company that distributes its products through independent “beauty consultants” who buy and resell cosmetics and toiletries to contacts either individually or at social gatherings. When considering market expansion in Asia, the company had to choose: Enter Japan or China first? Country-level data showed Japan to be the most attractive option by far: it had the highest per capita level of spending of any country in the world on cosmetics and toiletries, disposable income was high, it already had a thriving direct marketing industry, and it had a high proportion of women who did not participate in the workforce. MKC learned, however, after participating in both markets, that the market opportunity in China was far greater, mainly because of economic and cultural distance: Chinese women were far more motivated than their Japanese counterparts to boost their income by becoming beauty consultants. Thus, the entrepreneurial opportunity represented by what MKC describes as “the career” (i.e., becoming a beauty consultant) was a far better predictor of the true sales potential than high-level data on incomes and expenditures. As a result of this experience, MKC now employs an additional business-specific indicator of market potential within its market assessment framework: The average wage for a female secretary in a country.³

MKC’s experience underscores the importance of analyzing distance. It also highlights the fact that different product-markets have different success factors; some are brand-sensitive while in others pricing or intensive distribution are key to success. Country-level economic or demographic data do not provide much help in analyzing such issues; only locally gathered marketing intelligence can provide true indications of a market’s potential size and growth rate and its key success factors.

Entry Strategies: Modes of Entry

What is the best way to enter a new market? Should a company first establish an export base or license its products to gain experience in a newly targeted country or region? Or does the potential associated with first-mover status justify a bolder move such as entering an alliance, making an acquisition, or even starting a new subsidiary? Many companies move from exporting to licensing to a higher investment strategy, in effect treating these choices as a learning curve. Each has distinct advantages and disadvantages.

Exporting is the marketing and direct sale of domestically produced goods in another country. Exporting is a traditional and well-established method of reaching foreign markets. Since it does not require that the goods be produced in the target country, no investment in foreign production facilities is required. Most of the costs associated with exporting take the form of marketing expenses.

While relatively low risk, exporting entails substantial costs and limited control. Exporters typically have little control over the marketing and distribution of their products, face high transportation charges and possible tariffs, and must pay distributors for a variety of services. What is more, exporting does not give a company first-hand experience in staking out a competitive position abroad, and it makes it difficult to customize products and services to local tastes and preferences.

Licensing essentially permits a company in the target country to use the property of the licensor. Such property usually is intangible, such as trademarks, patents, and production techniques. The licensee pays a fee in exchange for the rights to use the intangible property and possibly for technical assistance.

Because little investment on the part of the licensor is required, licensing has the potential to provide a very large Return on Investment (ROI). However, because the licensee produces and markets the product, potential returns from manufacturing and marketing activities may be lost. Thus, licensing reduces cost and involves limited risk. However, it does not mitigate the substantial disadvantages associated with operating from a distance. As a rule, licensing strategies inhibit control and produce only moderate returns.

Strategic alliances and joint ventures have become increasingly popular in recent years. They allow companies to share the risks and resources required to enter international markets. And although returns also may have to be shared, they give a company a degree of flexibility not afforded by going it alone through direct investment.

There are several motivations for companies to consider a partnership as they expand globally, including (1) facilitating market entry, (2) risk/reward sharing, (3) technology sharing, (4) joint product development (PD), and (5) conforming to government regulations. Other benefits include political connections and distribution channel access that may depend on relationships. Such alliances often are favorable when (1) the partners’ strategic goals converge while their competitive goals diverge; (2) the partners’ size, market power, and resources are small compared to the industry leaders; and (3) partners are able to learn from one another while limiting access to their own proprietary skills.

The key issues to consider in a joint venture are ownership, control, length of agreement, pricing, technology transfer, local firm capabilities and resources, and government intentions. Potential problems include (1) conflict over asymmetric new investments, (2) mistrust over proprietary knowledge, (3) performance ambiguity—how to split the pie, (4) lack of parent firm support, (5) cultural clashes, and (6) if, how, and when to terminate the relationship.

Acquisitions or greenfield start-ups. Ultimately, most companies will aim at building their own presence through company-owned facilities in important international markets. Acquisitions or greenfield start-ups represent this ultimate commitment. Acquisition is faster but starting a new, wholly owned subsidiary might be the preferred option if no suitable acquisition candidates can be found.

Also known as Foreign Direct Investment, acquisitions and Greenfield start-ups involve the direct ownership of facilities in the target country, and therefore the transfer of resources including capital, technology, and personnel. Direct ownership provides a high degree of control in the operations and the ability to know better the consumers and competitive environment. However, it requires a high level of resources and a high degree of commitment.

Entry Strategies: Timing

In addition to selecting the right mode of entry, timing of entry is critical. Just as many companies have overestimated market potential abroad and underestimated the time and effort needed to create a real market presence, so have they justified their overseas’ expansion on the grounds of an urgent need to participate in the market early. Arguing that there existed a limited window of opportunity in which to act that would reward only those players bold enough to move early, many companies made sizable commitments to foreign markets even though their own financial projections showed they would not be profitable for years to come. This dogmatic belief in the concept of a first-mover advantage (sometimes referred to as pioneer advantage), became one of the most widely established theories of business. It holds that the first entrant in a new market enjoys a unique advantage that later competitors cannot overcome, that is, that the competitive advantage so obtained is structural, and therefore sustainable.

Some companies have found this to be true. Procter & Gamble, for example, has always trailed rivals such as Unilever in certain large markets, including India and some Latin American countries, and the most obvious explanation is that its European rivals were participating in these countries long before Proctor & Gamble (P&G) entered. Given that history, it is understandable that Procter & Gamble erred on the side of urgency in reacting to the opening of large markets such as Russia or China. For many other companies, however, the concept of pioneer advantage was little more than an article of faith, and applied indiscriminately and with disastrous results to country-market entry, to product-market entry, and, in particular, to the “new economy” opportunities created by the Internet.

The “get in early” philosophy of pioneer advantage remains popular. And while there clearly are examples of its successful application—the advantages gained by European companies from being early in “colonial” markets provide some evidence of pioneer advantage—first-mover advantage is overrated as a strategic principle. In fact, in many instances there are disadvantages to being first. First, if there is no real first-mover advantage, being first often results in poor business performance as the large number of companies that rushed into Russia and China attests. Second, pioneers may not always be able to recoup their investment in marketing required to “kick-start” the new market. When that happens, a “fast follower” can benefit from the market development funded by the pioneer, and leapfrog into earlier profitability.⁴

This ability of later entrants to free-ride on the pioneer’s market development investment is the most common source of first-mover disadvantage, and suggests two critical conditions necessary for real first-mover advantage to exist. First, there must be a scarce resource in the market that the first entrant can acquire. Second, the first-mover must be able to lock up that scarce resource in such a way that it creates a barrier to entry for potential competitors. A good example is provided by markets in which it is necessary for foreign firms to obtain a government permit or license to sell their products. In such cases, the license, and perhaps government approval more generally, may be a scarce resource that will not be granted to all comers. The second condition is also necessary for first-mover advantage to develop. Many companies believed that brand preference created by being first constituted a valid source of first-mover advantage, only to find later that in most cases consumers consider the alternatives available at the time of their first purchase, not which came first.

Globalizing the Value Proposition

Managers sometimes assume that what works in their home country will work just as well in another part of the world. They take the same product, the same advertising campaign, even the same brand names and packaging, and expect instant success. The result in most cases is failure. Why? Because the assumption that one approach works everywhere fails to consider the complex mosaic of differences that exists between countries and cultures.

Of course, marketing a standardized product with the same positioning and communications strategy around the globe—the purest form of aggregation—has considerable attraction because of its cost effectiveness and simplicity. It is also extremely dangerous, however. Simply assuming that foreign customers will respond positively to an existing product can lead to costly failure. Consider the following classic examples of failure:

With a few exceptions the idea of an identical, fully standardized global value proposition is a myth and few industries are truly global. How to adapt a value proposition in the most effective manner therefore is a key strategic issue.

Value Proposition Adaptation Decisions

Value proposition adaptation deals with a whole range of issues, ranging from the quality and appearance of products to materials, processing, production equipment, packaging, and style. A product may have to be adapted to meet the physical, social or mandatory requirements of a new market. It may have to be modified to conform to government regulations or to operate effectively in country specific geographic and climatic conditions. Or it may be redesigned or repackaged to meet the diverse buyer preferences, or standard of living conditions. A product’s size and packaging may also have to be modified to facilitate shipment or to conform to possible differences in engineering or design standards in a country or regional markets. Other dimensions of value proposition adaptation include changes in brand name, color, size, taste, design, style, features, materials, warranties, after sale service, technological sophistication, and performance.

The need for some changes such as accommodating different electricity requirements will be obvious. Others may require in-depth analysis of societal customs and cultures, the local economy, technological sophistication of people living in the country, and customers’ purchasing power and purchase behavior. Legal, economic, political, technological, and climatic requirements of a country market all may dictate some level of localization or adaptation.

As tariff barriers (tariffs, duties, and quotas) are gradually reduced around the world in accordance with World Trade Organization rules, other, nontariff, barriers, such as product standards, are proliferating. Take regulations for food additives. Many of the U.S. so-called “Generally Recognized as Safe” additives are banned today in foreign countries. In marketing abroad, documentation is important not only for the amount of additive, but also its source, and often additives must be listed on the label of ingredients. As a result, product labeling and packaging must often be adapted to comply with another country’s legal and environmental requirement.

Many products must be adapted to local geographic and climatic conditions. Factors such as topography, humidity, and energy costs can affect the performance of a product or even define its use in a foreign market. The cost of petroleum products along with a country’s infrastructure, for example, may mandate the need to develop products with a greater level of energy efficiency. Hot dusty climates of countries in the Middle East and other emerging markets may force the automakers to adapt the automobiles with different types of filters and clutch systems than those used in North America, Japan, and Europe countries. Even shampoo and cosmetic product makers have to chemically reformulate their shampoo and cosmetic products to make them more suited for people living in hot humid climates.

The availability, performance, and level of sophistication of a commercial infrastructure will also warrant a need for adaptation or localization of products. For example, a company may decide not to market its frozen line of food items in countries where retailers do not have adequate freezer space. Instead, it may choose to develop dehydrated products for such markets. Size of packaging, material used in packaging, before and after sale service and warranties may have to be adapted in view of the scope and level of service provided by the distribution structure in the country markets targeted. In the event post sale servicing facilities are conspicuous by their absence, companies may need to offer simpler, more robust products in overseas markets to reduce the need for maintenance and repairs.

Differences in buyer preferences also are a major driver behind value proposition adaptation. Local customs, such as religion or the use of leisure time, may affect market acceptance. The sensory impact of a product, such as taste or its visual impression, may also be a critical factor. The Japanese consumers’ desire for beautiful packaging, for example, has led many U.S. companies to redesign cartons and packages specifically for this market. At the same time, to make purchasing mass marketed consumer products more affordable in lesser developed countries, makers of products such as razor blades, cigarettes, chewing gum, ball point pens and candy bars repackage them in small single units rather than multiple units prevalent in the developed and more advanced economies.

Expectations about product guarantees also can vary from country to country depending on the level of development, competitive practices, and degree of activism by consumer groups, local standards of production quality, and prevalent product usage patterns. Strong warranties may be required to break into a new market, especially if the company is an unknown supplier. In other cases warranties similar to those in the home country market may not be expected.

As a general rule, packaging design should be based on the customer needs. For industrial products packaging is primarily functional and should consider needs for storage, transportation, protection, preservation, reuse, and so on. For consumer products packaging has additional functionality and should be protective, informative, appealing, conform to legal requirements, and reflect buying habits (e.g., Americans tend to shop less frequently than Europeans, so larger sizes are more popular in the United States).

In analyzing adaptation requirement, careful attention to cultural differences between the target customers in home (country of origin) and those in the host country is extremely important. The greater the cultural differences between the two target markets the greater the need for adaptation. Cultural considerations and customs may influence branding, labeling, and package considerations. Certain colors used on labels and packages may be found unattractive or offensive. Red, for example, stands for good luck and fortune in China and parts of Africa; aggression, danger, or warning in Europe, America and Australia/New Zealand; masculinity in parts of Europe; mourning (dark red) in the Ivory Coast; and death in Turkey. Blue denotes immortality in Iran while purple denotes mourning in Brazil and is a symbol of expense in some Asian cultures. Green is associated with high-tech in Japan, luck in the Middle East, connotes death in South America and countries with dense jungle areas, and is a forbidden color in Indonesia. Yellow is associated with femininity in the United States and many other countries, but denotes mourning in Mexico and strength and reliability in Saudi Arabia. Finally, black is used to signal mourning as well as style and elegance in most Western nations but it stands for trust and quality in China while white is the symbol for cleanliness and purity in the West and denotes mourning in Japan and some other Far Eastern nations.

When potential customers have limited purchasing power, companies may need to develop an entirely new product designed to address the market opportunity at a price point that is within the reach of a potential target market. Conversely companies in lesser developed countries that have achieved local success may find it necessary to adopt an “up-market strategy” whereby the product may have to be designed to meet world class standards.

Adaptation or Aggregation: The Value Proposition Globalization Matrix

A useful construct for analyzing the need to adapt the product/service and message (positioning) dimensions is the value proposition globalization matrix shown in Figure 9.1. It illustrates four generic global strategies: (1) a pure aggregation approach (also sometimes referred to as a “global marketing mix” strategy) under which both the offer and the message are the same, (2) an approach characterized by an identical offer (product/service aggregation) but different positioning (message adaptation) around the world (also called a “global offer” strategy), (3) an approach under which the offer might be different in various parts of the world (product adaptation) but the message is the same (message aggregation) (also referred to as a “global message” strategy), and (4) a “global change” strategy under which both the offer and the message are adapted to local market circumstances.

Figure 9.1 The value proposition globalization matrix

Global mix or pure aggregation strategies are relatively rare because only a few industries are truly global in all respects. They apply (1) when a product’s usage patterns and brand potential are homogeneous on a global scale, (2) when scale and scope cost advantages substantially outweigh the benefits of partial or full adaptation, and (3) when competitive circumstances are such that a long-term, sustainable advantage can be secured using a standardized approach. The best examples are found in industrial product categories such as basic electronic components or certain commodity markets.

Global offer strategies are feasible when the same offer can advantageously be positioned differently in different parts of the world. There are several reasons for considering a differential positioning in different parts of the world. When fixed costs associated with the offer are high, when key core benefits offered are identical, and when there are natural market boundaries, adapting the message for stronger local advantage is tempting. Although such strategies increase local promotional budgets, they give country managers a degree of flexibility in positioning the product or service for maximum local advantage. The primary disadvantage associated with this type of strategy is that it could be difficult to sustain or even dangerous in the long-term as customers become increasingly global in their outlook and confused by the different messages in different parts of the world.

Global message strategies use the same message worldwide but allow for local adaptation of the offer. McDonalds, for example, is positioned virtually identically worldwide, but it serves vegetarian food in India and wine in France. The primary motivation behind this type of strategy is the enormous power behind a global brand. In industries in which customers increasingly develop similar expectations, aspirations, and values, in which customers are highly mobile, and in which the cost of product or service adaptation is fairly low, leveraging the global brand potential represented by one message worldwide often outweighs the possible disadvantages associated with factors such as higher local R&D costs. As with global offer strategies, however, global message strategies can be risky in the long run; global customers might not find elsewhere what they expect and regularly experience at home. This could lead to confusion or even alienation.

Global change strategies define a “best fit” approach and are by far the most common. As we have seen, for most products, some form of adaptation of both the offer and the message is necessary. Differences in a product’s usage patterns, benefits sought, brand image, competitive structures, distribution channels, and governmental and other regulations all dictate some form of local adaptation. Corporate factors also play a role. Companies that have achieved a global reach through acquisition, for example, often prefer to leverage local brand names, distribution systems, and suppliers rather than embark on a risky global one-size-fits-all approach. As the markets they serve and the company itself become more global, selective standardization of the message and/or the offer itself can become more attractive.

Combining Aggregation and Adaptation: Global Product Platforms

One way around the trade-off between creating global efficiencies and adapting to local requirements and preferences is to design a global product and/or communication platform that can be adapted efficiently to different markets. This modularized approach to global product design has become particularly popular in the automobile industry. One of the first “world car platforms” was introduced by Ford in 1981. The Escort was assembled simultaneously in three countries—the United States, Germany, and the UK—with parts produced in 10 countries. The U.S. and European models were distinctly different but shared standardized engines, transmissions, and ancillary systems for heating, air conditioning, wheels and seats, thereby saving the company millions of dollars in engineering and development costs.

Combining Adaptation and Arbitrage: Global Product Development⁵

Globalization pressures have changed the practice of product development in many industries in recent years. Rather than using a centralized or local, cross-functional model, companies are moving to a mode of global collaboration in which skilled development teams dispersed around the world collaborate to develop new products. Today, a majority of global corporations have engineering and development operations outside of their home region. China and India offer particularly attractive opportunities; Microsoft, Cisco, and Intel all have made major investments there.

The old model was based on the premise that colocation of cross-functional teams to facilitate close collaboration among engineering, marketing, manufacturing, and supply-chain functions was critical to effective PD. Co-located PD teams were thought to be more effective at concurrently executing the full range of activities involved, from understanding market and customer needs, through conceptual and detailed design, testing, analysis, prototyping, manufacturing engineering, and technical product support/engineering. Such co-located concurrent practices were thought to result in better product designs, faster time to market, and lower-cost production. They were generally located in corporate research and development centers, which maintained linkages to manufacturing sites and sales offices around the world.

Today, best practice emphasizes a highly distributed, networked, and digitally supported development process. The resulting global product development process combines centralized functions with regionally distributed engineering and other development functions. It often involves outsourced engineering work as well as captive offshore engineering. The benefits of this distributed model include greater engineering efficiency (through utilization of lower-cost resources), access to technical expertise internationally, more global input to product design and greater strategic flexibility.

Combining Aggregation, Adaptation, and Arbitrage: Global Innovation⁶

A core competency in global innovation—the ability to leverage new ideas all around the world—has become a major source of global competitive advantage, as companies such as Nokia, Airbus, SAP, and Starbucks demonstrate. They realize that the principal constraint on innovation “performance” is knowledge. Accessing a diverse set of sources of knowledge is therefore a key challenge, and critical to successful differentiation. Companies whose knowledge pool is the same as that of its competitors likely will develop uninspired “me too” products; access to a diversity of knowledge allows a company to move beyond incremental innovation to attention grabbing designs and breakthrough solutions.

To reap the benefits of global innovation, companies must do three things: (1) prospect (find the relevant pockets of knowledge from around the world), (2) assess (decide on the optimal “footprint” for a particular innovation), and (3) mobilize (use cost-effective mechanisms to move distant knowledge without degrading it).⁷

Prospecting, that is, finding valuable new pockets of knowledge to spur innovation may well be the most challenging task. The process involves knowing what to look for, where to look for it, and how to tap into a promising source. Santos et al. cite the efforts of the cosmetics maker Shiseido Co. Ltd. in entering the market for fragrance products. Based in Japan, a country with a very limited tradition of perfume use, Shiseido was initially unsure of the precise knowledge it needed to enter the fragrance business. But the company did know where to look for it. So it bought two exclusive beauty boutique chains in Paris, mainly as a way to experience, firsthand, the personal-care demands of the most sophisticated customers of such products. It also hired the marketing manager of Yves Saint Laurent Parfums and built a plant in Gien, a town located in the French perfume “cluster.” France’s leadership in that industry made the where fairly obvious to Shiseido. The how had also become painfully clear because the company had previously flopped in its efforts to develop perfumes in Japan. Those failures convinced Shiseido executives that, to access such complex knowledge—deeply rooted in local culture and combining customer information, aesthetics, and technology—the company had to immerse itself in the French environment and learn by doing. Having figured out the where and how, Shiseido would gradually learn what knowledge it needed to succeed in the perfume business.

Assessing new sources of innovation, that is, incorporating new knowledge into and optimizing an existing innovation network, is a second major challenge. If a semiconductor manufacturer is developing a new chip set for mobile phones, for example, should it access technical and market knowledge from Silicon Valley, Austin, Hinschu, Seoul, Bangalore, Haifa, Helsinki, and Grenoble? Or should it restrict itself to just some of those sites? At first glance determining the best footprint for innovation does not seem fundamentally different from the trade-offs companies face in optimizing their global supply chains: Adding a new source might reduce the price or improve the quality of a required component, but more locations also may mean additional complexity and cost. Similarly, every time a company adds a source of knowledge into the innovation process it might improve its chances of developing a novel product, but it also increases costs. Determining an optimal innovation footprint is more complicated, however, because the direct and indirect cost relationships are far more imprecise.

Mobilizing the footprint, that is, integrating knowledge from different sources into a virtual melting pot from which new products or technologies can emerge, is the third challenge. To accomplish this, companies must bring the various pieces of (technical) knowledge together that are scattered around the world and provide a suitable organizational form for innovation efforts to flourish. More important, they would have to add the more complex, contextual (market) knowledge to integrate the different pieces into an overall innovation blueprint.

Globalizing the Sourcing Dimension

To Outsource or Not to Outsource⁸

Few companies, especially ones with a global presence, are self-sufficient in all of the activities that make up their value chain. Competitive pressures force companies to focus on those activities that they judge critical to their success and excel at—core capabilities in which they have a distinct competitive advantage—and that can be leveraged across geographies and lines of business. Which activities should be kept in-house and which ones can effectively be outsourced depends on a host of factors, most prominently the nature of the company’s core strategy, partner network, and asset base.

Firms tend to concentrate their investments in global value chain activities that contribute directly to their competitive advantage and, at the same time, help the company retain the right amount of strategic flexibility. Making such decisions is a formidable challenge; capabilities that may seem unrelated at first glance can turn out to be critical for creating an essential advantage when they are combined. As an example consider the case of a leading consumer packaged goods company that created strong embedded capabilities in sales. Its smaller brands showed up on retailers’ shelves far more regularly than comparable brands from competitors. It was also known for the efficacy of its short-term R&D in rapidly bringing product variations to market. These capabilities are worth investing in separately, but together they add up to a substantial advantage over competitors, especially in introducing new products.

Outsourcing and offshoring of component manufacturing and support services can offer compelling strategic and financial advantages including lower costs, greater flexibility, enhanced expertise, greater discipline, and the freedom to focus on core business activities.

Lower Costs. Savings may result from lower inherent, structural, systemic or realized costs. A detailed analysis of each of these cost categories can identify the potential sources of advantage. For example, larger suppliers may capture greater scale benefits than the internal organization. The risk is that efficiency gains lead to lower quality or reliability. Offshoring typically offers significant infrastructure and labor cost advantages over traditional outsourcing. In addition, many offshoring providers have established very large-scale operations not economically possible for domestic providers.

Greater Flexibility. Using an outside supplier can sometimes add flexibility to a company such that it can adjust the scale and scope of production rapidly at low cost. As we have learned from the Japanese keiretsu and Korean chaebol conglomerates, networks of organizations can often adjust to demand more easily than fully integrated organizations.

Enhanced Expertise. Some suppliers may have proprietary access to technology or other intellectual property advantages that a firm cannot access by itself. Such technology may improve operational reliability, productivity, efficiency or long-term total costs and production. The significant scale of today’s offshore manufacturers, in particular, allows them to invest in technology that may be cost prohibitive for domestic providers.

Greater Discipline. Separation of purchasers and providers can assist with transparency and accountability to identify true costs and benefits of certain activities. This can enable transactions under market-based contracts where the focus is on output not input. At the same time, competition among suppliers creates choice for purchasers and encourages the adoption of innovative work practices.

Focus on Core Activities. The ability to focus frees up resources internally to concentrate on those activities where the company has distinctive capability and scale, experience or differentiation to yield economic benefits. In other words, focus allows a company to concentrate on creating relative advantage to maximize total value and allow others to produce supportive goods and services.

While outsourcing is largely about scale and the ability to provide services at a more competitive cost, offshoring is primarily driven by the dramatic wage-cost differentials that exist between developed and developing nations. However, cost should not be the only consideration in making offshoring decisions; other relevant factors include the quality and reliability of labor continuous process improvements, environment, and infrastructure. Political stability and broad economic and legal frameworks should also be taken into account. In reality, even very significant labor cost differentials between countries cannot be the sole driver of offshoring decisions. Companies need to be assured of quality and reliability in the services they are outsourcing. This is the same whether services are outsourced domestically or offshore.

Risks Associated with Outsourcing⁹

Outsourcing can have significant benefits but is not without risk. Some risks, such as potentially higher overall costs due to the eroding value of the U.S. dollar, can be anticipated and addressed through contracts by employing financial hedging strategies. Others, however, are harder to anticipate or deal with.

Risks associated with outsourcing typically fall into four general categories: loss of control, loss of innovation, loss of organizational trust, and higher-than-expected transaction costs:

Loss of Control. Managers often complain about loss of control over their own process technologies and quality standards when specific processes or services are outsourced. The consequences can be severe. When tasks previously performed by company personnel are given to outsiders over whom the firm has little or no control, quality may suffer, production schedules may be disrupted or contractual disagreements may develop. If outsourcing contracts inappropriately or incorrectly detail work specifications outsourcers may be tempted to behave opportunistically—for example, by using subcontractors, or by charging unforeseen or unwarranted price increases to exploit the company’s dependency. Control issues can also be exacerbated by geographic distance, particularly when the vendor is offshore. Monitoring performance and productivity can be challenging, and coordination and communication maybe difficult with offshore vendors. The inability to engage in face-to-face discussions, brainstorm, or explore nuances of obstacles could cripple a project’s flow. Distance, too, can increase the likelihood of outages disabling the communication infrastructure between the vendor and the outsourcing firm. Depending on where the outsourced work is performed, there can be critical cultural or language-related differences between the outsourcing company and the vendor. Such differences can have important customer implications. For example, if customer call centers are outsourced, the manner in which an agent answers, interprets, and reacts to customer telephone calls (especially complaints) may be affected by local culture and language.

Loss of Innovation. Companies pursuing innovation strategies recognize the need to recruit and hire highly qualified individuals, provide them a long-term focus and minimal control, and appraise their performance for positive long-run impact. When certain support services—such as IT, software development, or materials management—are outsourced, innovation may be impaired. Moreover, when external providers are hired for the purposes of cutting costs, gaining labor pool flexibility, or adjusting to market fluctuations, long-standing cooperative work patterns are interrupted which may adversely affect the company’s corporate culture.

Loss of Organizational Trust. For many firms, a significant nonquantifiable risk occurs because outsourcing, especially of services, can be perceived as a breach in the employer–employee relationship. Employees may wonder which group or what function will be the next to be outsourced. Workers displaced into an outsourced organization often feel conflicted as to who their ‘‘real’’ boss is: The new external service contractor, or the client company by which they were previously employed?

Higher-than-Expected Transaction Costs. Some outsourcing costs and benefits are easily identified and quantified because they are captured by the accounting system. Other costs and benefits are decision-relevant but not part of the accounting system; such factors cannot be ignored simply because they are difficult to obtain or require the use of estimates. One of the most important and least understood considerations in the make-or-buy decision is the cost of outsourcing risk.

There are many other factors to consider in selecting the right level of participation in the value chain and the location for key value-added activities. Factor conditions, the presence of supporting industrial activity, the nature and location of the demand for the product, and industry rivalry all should be considered. In addition, such issues as tax consequences, the ability to repatriate profits, currency, and political risk, the ability to manage and coordinate in different locations, and synergies with other elements of the company’s overall strategy should be factored in.

Partnering

Formulating cooperative strategies—joint ventures, strategic alliances, and other partnering arrangements—is the complement of outsourcing. Globalization is an important factor in the rise of cooperative ventures. In a global competitive environment, going it alone often means taking extraordinary risks. Escalating fixed costs associated with achieving global market coverage, keeping up with the latest technology, and increased exposure to currency and political risk all make risk-sharing a necessity in many industries. For many companies, a global strategic posture without alliances would be untenable.

Cooperative strategies take many forms and are considered for many different reasons. However, the fundamental motivation in every case is the corporation’s ability to spread its investments over a range of options, each with a different risk profile. Essentially, the corporation is trading off the likelihood of a major payoff against the ability to optimize its investments by betting on multiple options. The key drivers that attract executives to cooperative strategies include the need for risk-sharing, the corporation’s funding limitations, and the desire to gain market and technology access.

Risk Sharing. Most companies cannot afford “bet the company” moves to participate in all product markets of strategic interest. Whether a corporation is considering entry into a global market or investments in new technologies, the dominant logic dictates that companies prioritize their strategic interests and balance them according to risk.

Funding Limitations. Historically, many companies focused on building sustainable advantage by establishing dominance in all of the business’ value creating activities. Through cumulative investment and vertical integration, they attempted to build barriers to entry that were hard to penetrate. However, as the globalization of the business environment accelerated and the technology race intensified, such a strategic posture became increasingly difficult to sustain. Going it alone is no longer practical in many industries. To compete in the global arena, companies must incur immense fixed costs with a shorter payback period and at a higher level of risk.

Market Access. Companies usually recognize their lack of prerequisite knowledge, infrastructure, or critical relationships necessary for the distribution of their products to new customers. Cooperative strategies can help them fill the gaps. For example, Hitachi has an alliance with Deere & Company in North America and with Fiat Allis in Europe to distribute its hydraulic excavators. This arrangement makes sense because Hitachi’s product line is too narrow to justify a separate distribution network. What is more, customers benefit because the gaps in its product line are filled with quality products such as bulldozers and wheel loaders from its alliance partners.

Technology Access. A large number of products rely on so many different technologies that few companies can afford to remain at the forefront of all of them. Carmakers increasingly rely on advances in electronics; application software developers depend on new features delivered by Microsoft in its next generation operating platform, and advertising agencies need more and more sophisticated tracking data to formulate schedules for clients. At the same time, the pace at which technology is spreading globally is increasing, making time an even more critical variable in developing and sustaining competitive advantage. It is usually beyond the capabilities, resources, and good luck in R&D of any corporation to garner the technological advantage needed to independently create disruption in the marketplace. Therefore, partnering with technologically compatible companies to achieve the prerequisite level of excellence is often essential. The implementation of such strategies, in turn, increases the speed at which technology diffuses around the world.

Other reasons to pursue a cooperative strategy are a lack of particular management skills; an inability to add value in-house; and a lack of acquisition opportunities because of size, geographical, or ownership restrictions.

Cooperative strategies cover a wide spectrum of nonequity, cross-equity, and shared-equity arrangements. Selecting the most-appropriate arrangement involves analyzing the nature of the opportunity, the mutual strategic interests in the cooperative venture, and prior experience with joint ventures of both partners. The essential question is: How can we structure this opportunity to maximize the benefit(s) to both parties?