L5: CAGE Framework www.lecturenotes638.wordpress.com BBK3363 | International Management Prepared by Khairul Anuar L5: CAGE Framework www.lecturenotes638.wordpress.com

Agenda Introduction to Cage Distance Framework Gravity Model China and India Using CAGE Cage at the Industry Level Application of the CAGE framework

CAGE Distance Framework Tool to measure the closeness of countries among themselves along 4 dimensions. Applicable at the Country and Industry level. Not for Cross-industry Analysis because influenced by industry characteristics. The Idea Behind the Concept The world is semi-globalized (not globalized). Frontiers still matter a great deal in international trade.

The 4 Dimensions C (cultural distance) A (administrative distance) G (geographic distance) E (economic distance)

Cultural Dimension Attributes of a society sustained by interactions among people (Not the State) Greater Cultural Differences Leads to lower Amount of International Trade.

Long lasting economic interactions Cultural Dimension Long lasting economic interactions Leads to weakening effect of cultural differences. More malleable over the long-run than differences in language, ethnicity and religion.

Examples of CAGE - Culture Different languages Different ethnicities Lack of connective ethnic or social networks. Different religions Different Values, norms and dispositions

Administrative Dimension Refers to: Laws Policies Government run institutions International organizations Treaties the country either support or has created.

Administrative Dimension Factors Impacting FDI Quality of Political Infrastructures Country’s Political Stability. Tariffs Non-Tariff Barrier Quotas

Examples of CAGE - Administration Colonial ties Shared regional trading bloc Common currency Political hostility

Examples of CAGE - Administration Closed economy Extent of home bias Lack of membership in international organizations Weak institutions corruption

Geographical Dimension As distance increase, chances of a profitable economic relationship decrease. Communication and Transportation Infrastructures can either be interpret as geographic or economic attributes.

Geographical Dimension As distance Increase, Transportation costs increase Businesses tend to opt for FDI. However, the greater the distance, the less likely countries are to invest overseas since communication costs increase as well.

Examples of CAGE - Geography Physical distance Differences in climates and disease environments Differences in time zones Lack of land border Landlocked geography Lack of internal navigability Geographic size, remoteness Weak transportation/ communication links

Economic mechanisms that affect international trade. Economic Dimension Economic mechanisms that affect international trade. High per capita income Leads to high labour costs

Examples of CAGE - Economy Rich-poor differences Natural resources, financial resources, human resources, infrastructure, information or knowledge Economic size Low per-capita income

More success in similar countries than in very different ones. Wal-Mart More success in similar countries than in very different ones. Most profitable international markets: Canada, U.K., Mexico and Puerto Rico

U.K. and Canada Canada and Mexico Profitable Countries Common language Colony-colonizer ties Canada and Mexico NAFTA members Share a common land border with the U.S.

Trade is directly related to economic sizes Gravity Models Trade is directly related to economic sizes And inversely related to physical distance 1% size of the economy Leads to 0.7-0.8% in Trade 1% in distance Leads to 1% in Trade

Frameworks for Country Analysis Unilateral attributes Only look at one particular country and ignores its link with other ones Examples: Finance Technology Labour Management Institutions

Frameworks for Country Analysis Multilateral attributes Takes into account the differences between the home and foreign country. Examples: Openness Tariffs Hidden import barriers

China and India Using CAGE India & the United States Cultural dimension: English language Between 100M and 300M people Westernized elites Administrative dimension: Common colonizers Common law Political friendship

India & the United States Economic Dimension: Specialized labour Profitability Firm strategy and upgrading Soft infrastructure

China and India Using CAGE China & the United States Cultural Dimension: Linguistic and ethnic homogeneity Diaspora Geographical Dimension: Closer to U.S. West Coast Superior ports and other infrastructure East Asian production network

China and India Using CAGE China & the United States Administrative Dimension: Ease of doing business Economic Dimension: Larger markets Labour inputs and productivity Capital availability Supply chains Foreign companies as export bridges

Conclusions In general terms, China is more attractive to American investors on both geographic and economic grounds while India tends to win over investors valuing cultural and administrative ones.

Cultural difference matter most when: Cultural Sensitivity Cultural difference matter most when: Products have high linguistic content (TV programs) Products matter to cultural/national identity (Food) Product features vary in terms of size and/or standards (cars) Products carry country-specific quality associations (wine) Image source: http://www.scu.edu.au/equity/index.php/7/

CAGE at the Industry Level Different product are sensitive to different dimensions. Industry characteristics need to be taken into consideration.

Administrative Sensitivity Government involvement is high in industries that: Produce staple goods Produce “entitlements,” Exploit natural resources Are large employers or large gov’t suppliers Are national champions Vital to national security Subject to high sunk costs

Geographic Sensitivity Geography plays a more important role when: Products have a low value-to weight or value-to-bulk ratio (cement) Products are fragile/perishable Local supervision and operational requirements are high

Economic differences have the biggest impact when: Economic Sensitivity Economic differences have the biggest impact when: Nature of demand varies with income level Economics of standardization or scale are limited (cement) Labour and other factor cost differences are salient (garments) Companies need to be responsive and agile

Applications of the CAGE Framework Making Differences Visible Understanding the Liability of Foreignness Assessing Natural Owners and Comparing Foreign Competitors Comparing Markets Discounting by Distance

Making Differences Visible Visible differences reduce the risk of bad decisions Need to consider all 4 dimensions of distance As the Star TV Case: Failing to consider all dimensions can lead to erroneous decisions.

Cultural Disadvantages of MNCs Idiosyncratic tastes Different designs Different standards Entrenched taste for local products Local biases in demand (“buy local”) Lack of social connectivity or networks

Understanding the Liability of Foreignness People tend to believe that MNCs always triumph over local companies. The CAGE framework suggests that MNCs are often disadvantaged over local firms.

Administrative Disadvantages of MNCs High government involvement, domestic resistance to displacement National patrimony effects Constraints by home government, multiple regulatory requirements

Geographical Disadvantages of MNCs High transport costs Lack of required infrastructures Communications Transportation Intense local supervision requirements Local performance requirements

Economical Disadvantages of MNCs Cost disadvantages (e.g. labour) Disadvantages in agility/responsiveness Susceptibility to global pricing squeezed, dilution of profitability Late-mover disadvantages Less perceived commitment to particular market

Comparing Foreign Competitors The CAGE framework can be used to compare the chances of success of different countries in a given foreign market. For example, US companies would likely win over European ones should Cuba open up its border to FDI.

Companies can use the CAGE framework to choose where to invest. Comparing Markets Companies can use the CAGE framework to choose where to invest. (e.g. Should they invest in China or India) The answer varies across industries.

Discounting by Distance Intuitively, China may look more attractive to US investor than Mexico. However, its closeness to the United States along the CAGE dimensions suggests favouring Mexico over China.

Global Generalizations In a semi-globalized world, differences and similarities between countries must be accounted for. Effects of differences and similarities on cross-border economic activity are enormous. Distance suggests a good set of metrics for capturing the degree of difference vs. similarity between countries. 4. Distance should be thought of as a multidimensional construct with four types components (CAGE framework). 5. CAGE framework is typically most fruitfully applied at industry level. 6. Applications include making differences visible, understanding the liability of foreignness, comparing competitors, comparing markets, and discounting markets by size.