Week Ten Class Notes

Country analysis tools and techniques

I have a confession to make: I've been leading you along for weeks. How? For me, one of the significant purposes of a course like this is to help you devise a model to analyze opportunities for international business at a national level. Everything we've investigated is a dimension of potential difference. The greater the differences, the more uncertainty, the more unknowns - and when these increase, what does the prudent manager do? To put it in financial terms, she must raise the hurdle rate on the investment - which requires that returns to the investment must be even more compelling.

This week, several papers will help you pull together themes from the past eight weeks of work- plus, don't forget the Ghemawat reading from the very first week. The objective here is to help you reflect on your analytic processes and to think about what dimensions should be included and why (i.e. ,what is the theoretical foundation here), what data you might expect to need or use (what are the measurement or assessment techniques), and data sources.

An easy start is with Kurtzman, et al paper who write about the Opacity Index.  In a general sense, opaque means murky, hard to see through but in this paper, it is the  "degree to which (countries) lack clear, accurate, easily discernable and widely accepted practices governing the relationships among businesses, investors, and governments".  The less opaque the systems of a country are, the less uncertainty investors face.  This index measures how countries score along five indices that capture the degree of opacity (or, because academics can rarely resist a pun, how "clear" conditions are).. The five dimensions are:

  • Degree of business/government corruption (C)
  • Effectiveness of legal system (L)
  • Economic policy (E)
  • Accounting and governance practices (A)
  • Regulatory structures (R)

The data are derived from sources like Transparency International, the Index of Economic Freedom, Global Competitiveness Report - overall, 65 objective variables are included. The table on page 40 lists the results of that inquiry, along with the Opacity Premium/Discount. The first issue worth noting is the composition of the top rated countries in terms of the opacity rating. Why these countries are what they are will be the topic of discussion. Also note the premium/discount rating. How would you use this?

As intuitive as this model may be, there are some limitations. First, all factors get the same weight, which requires some justification not present here. Further, as Khanna, et al argue, composites only work for countries with similar institutional regimes. They present a larger, more inclusive approach to handle the problem of dissimilarity.

The Institutional Void model is useful in assessing emerging markets (perhaps in a way the CLEAR model is not). The big issue is, when institutional gaps exist in a target relative to the home environment of a firm, the gaps have to be filled - but by whom? At what cost? Some examples: access to capital (in absence of capital markets, funding gets pointed inward) or the availability of managerial talent (if business schools and other training processes do not exist, mgmt talent has to be imported or built up). As we've discussed previously, these institutional assets (and many others)  are elements we often take for granted but show up as deficits or differences in specialized intermediaries, regulatory systems, contract mechanisms. To briefly reiterate earlier work, institutions are the formal and informal rules governing human behavior. Examples of formal rules include codified legal and political structures, as well as written rules such as constitutions. Informal rules include culture, norms, conventions, and mores not backed by formal law, but by social custom.

Hernando de Soto (2007) makes the point that strong institutions allow us to substitute "knowledge by description" (indirect) for "knowledge by acquaintance" (direct). Knowledge is what permits us to trust others in exchange since the rules for playing (and the penalties) are well known and the detection of/penalties for defection are legitimate and credible. Institutions are our "way of cooperating among millions without knowing each other directly".

The Institutional Gap model has five dimensions:

  • Political/social systems affect product, labor, and capital markets. What you are trying to do here first is map the nominal and real power centers. Second, map across to home country PolEcon institutions (in particular, think about property rights and contracts and how they are enforced)
  • Openness assesses the extent to which the target country actually welcomes and supports business from the outside. An interesting example is the contrast between China and India - the former welcomes FDI but the latter is actually historically more receptive to ideas from the west and the country is more democratic - so which is actually the most open? Short run? Long run?
  • Product markets: getting good information about consumers is often very difficult, particularly for lower income consumers. Market research/advertising there is often under developed. This is important because simple raw data can mislead Western firms.  For example, income levels that characterize the middle class in the US would capture only a very small splinter of Indian or Chinese consumers.  Thus, Western firms often cannot just repackage an old product for sale in a new country - it's too expensive! Consider Revlon entering China and India - their price points, while not unusual here, put them in luxury consumables in both countries. The immensely larger markets were not tapped
  • Labor market analysis addresses how easy it is to attract and hire managers and other skilled workers. Often, in developing countries, there is a deficit of search firms. Also, it is difficult to assess how well the education system is doing in preparing people for the job market
  • Capital markets - firms may/will need to tap local capital markets but this can be difficult because developing states may lack stock exchanges or regulators. Additionally, there are few credit rating agencies, investment analysts, merchant bankers, or VC firms. Finally, how are entering firms to assess the creditworthiness of potential customers?  Collect receivables?


The Ghemawat paper we read for the first class (Distance Still Matters) introduced the CAGE model. Ghemawat argues that there are four dimensions that define the "distance" between two countries from a business perspective. Mostly, this model just gets us to ask the right questions which I reprise here:  
  • Cultural distance: as we've seen, cultures can vary greatly and on many grounds. Key factors include religious beliefs, race, social norms, and language. For example, trade between countries that share a language is three times greater than between countries without a common language (though whether this is still compete true is not yet clear). Also, differences in the deeply rooted mental models that guide behavior can be different enough to give managers pause. For. example: in China,  it has been argued that the Confucian ethic encourages replication. As Confucius said, "I transmit rather than create, I believe in and love the Ancients" - does this perspective create a different perspective on property rights?'
  • Administrative/political distance: some key factors include the presence of colonial links (e.g., Britain with Singapore, India, Hong Kong, Canada, and the US), the presence of common currency and/or  political union. Another issue is the extent to which entrants target a nation's key industries.
  • Geographic distance: this captures a set of geographic issues:
      • o   Raw distance (this affects products with low weight to value ratios like concrete or steel)
      • o   Lack of common border
      • o   Lack of sea or river access - since most international freight moves by ship, this requires overland transportation, which is much more expensive

o   Transportation/communication infrastructure - obvious reasons as they raise costs, reduce efficiency. One of the key problems for firms starting up in Eastern Europe was a woefully under developed phone system and the cost to build one like we have was staggering. Who would bear the cost of a public good?  Solution?

  • Economic distance: which assesses differences in wealth, income, education, development of human resources, cost of inputs. Thus, what does low average national wealth mean to potential entrants? Is the host country making the investments made that develop qualified human resources?


The last paper for consideration is Scott's "Country Analysis in a Global Village".  I review this last as it has much in common with the other models in that Scott presents a set of criteria for our inquiry and application by mapping strategy and industry analysis concepts to the international business arena. . Ultimately, his approach comes down to assessing a nation's strategy (vision, goals, and policies), its' performance (broadly based on economic indicators), and context or constraints and resources.  We'll use this article as a basis for discussion.


Summary

These are four (often overlapping) approaches to analyzing a nation in terms munificence or opportunity for entering firms. The key here is to ask lots of questions - and get the answers. Note that it is more difficult to say that any particular country is a better opportunity than another - which means it is up to you to make judgments. Also note this is really, really hard. We're just managers and amateurs at this. And even the professionals can get badly surprised sometimes. As an example, consider how the US (and the intelligence community) was surprised by the fall of the Soviet Union. Nonetheless, difficulty is not an excuse for not performing due diligence!


Other readings
De Soto, Hernando (2007) Putting aside differing cultures: It is institutions and systems  Law and Business Review of the Americas.  Vol. 13, Iss. 1; p. 3
Porter, M. (1990)  -  The Competitive Advantage of Nations. Harvard Business Review. Boston: Mar/Apr 1990. Vol. 68, Iss. 2; p. 73 (AN 9005210820)

Recent Discussions

Week 9, Question 1, Group 1: Does NAFTA work?
The relocation of firms like Steris Corp to Mexico has had, as we discussed last week, some significant local effects.…
Week 9, Question 1, Group 2: Does NAFTA work?
The relocation of firms like Steris Corp to Mexico has had, as we discussed last week, some significant local effects.…
Week 9, Question 2, Group 1: The WTO and the role of the BRIC states
What is the current status of WTO negotiations? What are the key stumbling points and where do you see this…

Search This Blog

Full Text  Tag