In sorting out which markets to focus on, it’s important to note that the law of distance applies to foreign direct investment as well as trade. Although FDI is less sensitive to geographic distance than trade is, I estimate the effect of a common language and a colony-colonizer link to be similar and FDI to be more sensitive to differences in per capita income.
So as companies today weigh their options, they should look for opportunities where they can find cultural, administrative/political, geographic, and economic affinities. This resonates even more strongly as we recall that country relationships became even more important during the 1930s. As the political environment shifts, business leaders need to keep a careful eye on how their home countries are realigning their international ties, and engage in their own corporate diplomacy.
Remember too that staying at home is an option. Only about 0.1% of the world’s firms are multinationals, although since multinationalization is highly skewed toward larger firms, this greatly understates their overall impact. (Their foreign affiliates generate 10% of global GDP, and the multinationals themselves account for more than 50% of world trade.) For companies based in large emerging economies, focusing on the domestic market, where they enjoy home court advantage as well as rapid growth, can be a particularly attractive proposition.
Leaders must resist the idea that a global company has to compete in every market.
Of course, trade can occur without multinationalization, and this is what some tout as the wave of the future: The Economist points to “a rising cohort of small firms using e-commerce to buy and sell on a global scale.” But e-commerce is still significantly less internationalized than off-line commerce. And in light of changes brewing in the policy environment, this seems like a particularly inauspicious time to think that one can go global just by setting up a website or joining an online platform.
How to Compete
If you conclude that your company should continue to do business in a variety of markets, you still need to figure out whether to change the type or mix of strategies that you use in response to protectionist pressures. At a high level, globalization strategies have three components, as described in my 2007 book, Redefining Global Strategy.
Companies use adaptation when they want to adjust to cross-country differences in order to be locally responsive. They use aggregation to achieve economies of scale and scope that extend across national borders. And arbitrage strategies are used to exploit differences, such as low labor costs in one country or better tax incentives in another.
How companies should use these three strategies will change somewhat in a protectionist world—but perhaps less than you’d think. Take adaptation. Jeffrey Immelt isn’t alone when he talks of his company’s “bold pivot” away from aggregation and the importance of “localizing” in today’s environment. Firms should look for opportunities to amp up their adaptation efforts, because becoming more responsive to differences can help reduce the impact of protectionism.
The most obvious way for a company to adapt is to vary products, policies, market positioning, and so on to suit local markets. However, each variation increases costs and complexity. Therefore, smart adaptation typically involves limiting the amount of variation as well as finding ways to improve the effectiveness and efficiency of any changes that are introduced. For example, companies can design common platforms upon which local variants are offered. Or they can externalize some of the costs of adaptation via franchising, joint ventures, or other types of partnerships.
But while more adaptation may make sense, multinationals should not automatically put it above all else—doing so would only undercut their sources of competitive advantage relative to local competitors. Global companies—especially those from advanced economies—typically justify their cross-border strategies primarily on the basis of aggregation. In the most classic cases, they invest in intangible technological or marketing assets that they can scale across national borders. Those advantages normally have to be pretty large in order to overcome the home court advantage of local competitors. The economic rationale for aggregation won’t evaporate for multinationals that have built a healthy, profitable business in foreign markets—even if some countries make it more expensive to operate within their borders. Companies that have operations in markets where they’re only marginally successful, on the other hand, may need to retrench.
Turning to arbitrage, the opportunities for vertical multinationals to globalize on the supply side rather than on the demand side have narrowed somewhat in recent years, but they still remain large. Even with rising prosperity in large emerging markets, U.S. GDP per capita is still seven times that of China, and 33 times that of India. Differences in tax regimes across countries are not going away either, and will continue to provide arbitrage opportunities. According to the OECD, the dispersion of corporate tax rates across countries has barely changed since 2007, and progress at curbing tax havens has been slow. Furthermore, cross-country differences in safety, health, and environmental standards continue to persist as well—although exploitation of these differences raises ethical concerns.
Multinationals coming out of emerging markets tend to get their start from advantages rooted in arbitrage—competing abroad on the basis of low costs at home. This strategy continues to be the engine that drives the growth and profitability of India’s offshore IT services industry—which inspired Friedman’s The World Is Flat, kicking off a wave of interest in arbitrage strategies. More than a decade later, programmers’ salaries in India are still just a fraction of those in the United States, and cost reduction remains the top reason companies choose to outsource. The largest India-centric vendors have far outstripped their Western competitors in terms of both growth and profitability, and as of June 2016 the top four India-centric vendors enjoyed market valuations more than 50% larger than those of their top four Western competitors.
As companies from advanced and emerging countries joust for global leadership, each has to shore up its traditional weakness—for incumbents, that’s arbitrage; for insurgents, it’s aggregation. For example, developed-world incumbents in IT services, such as Accenture and IBM, have expanded their workforces in India, while Indian companies are trying to strengthen their brands and technological capabilities.
Returning to GE, Immelt’s pivot toward localization does imply a boost to its adaptation strategy. But GE—like most other multinationals—cannot give up on aggregation or arbitrage. GE’s aggregation-based advantages are what underpin its ability to compete across 170 countries. Its $5.5 billion R&D machine yields world-beating technological innovations, its $34 billion brand value opens doors everywhere, its famous management-training programs both attract and cultivate talent, and its scope across products, services, and geographies all contribute to GE’s immense cross-border aggregation potential. And while Immelt’s remarks shrewdly downplay wage arbitrage as “what GE did in the 1980s,” in contrast to its current focus on selling more abroad, arbitrage has become sufficiently ingrained at the company over the past few decades that it will probably not disappear and will continue to be part of its globalization strategy. In my view, GE’s “localization” strategy is best understood as one that retains a core strength in aggregation while toning down the company’s prior emphasis on arbitrage and becoming more adaptive.
Engaging with Society
Along with where and how to compete, questions about how to engage with society are becoming increasingly prominent on business leaders’ agendas. Except in highly regulated industries, companies have historically treated interactions with governments, media, and the public as an afterthought in setting strategy. But now, as Martin Reeves of BCG points out, “In many cases companies are seeing bigger impacts from political and macroeconomic factors than from competitive considerations.” Those factors, he says, include Brexit-driven exchange rate movements, share price fluctuations in response to policy pronouncements, and the cost of changing investment plans in light of anticipated shifts in trade policy. I would add to the list the rise of NGOs, the proliferation of social media, and increases in anti-globalization sentiment.
Companies are constrained in their responses to these developments by a range of factors. First of all, the backlash against globalization is also—in part—a backlash against big business. The general reputation of business is at an all-time low. In a recent survey, the Pew Research Center asked respondents in the U.S. how much people in 10 occupations contributed to the well-being of society. Business executives ranked next to last, ahead only of lawyers. Just 24% of respondents said they thought business leaders contributed “a lot.” The 2017 Edelman Trust Barometer also reports an all-time low for CEO credibility. And companies’ decisions about how to deploy the reputational capital that they do possess are complicated by tensions between a country’s citizens and its government—Uber CEO Travis Kalanick ran into problems with public perception when he joined Trump’s business advisory council, for example—as well as by uncertainties about how the broader environment will evolve.
In such a context, just speaking up more about social issues—as business leaders today are often instructed to do—is no panacea. While it is hard to offer simple instructions about how to cope with these complexities, the law of semi-globalization does suggest one injunction and one insight. First the injunction: Falling in line with what governments want wherever a company operates is unlikely to be a sustainable strategy. Multinational companies need to craft governmental and societal agendas that are both localized and linked across countries. Anti-globalization pressures require that multinationals deliver more local benefits—and communicate about them—in the countries where they operate. Such efforts must go well beyond compliance to include contributions in the form of jobs, technology, and so forth.
The backlash against globalization is also—in part—a backlash against big business.
Of course, there are dangers to shifting too far toward localization. Consider how IBM responded to the rise of the Nazi regime in Germany. Rather than pulling back—even as it became clear that the census IBM was supporting was being used to identify Jews for persecution—IBM sought to grow its business with the Nazi government. In 1937, then-CEO Thomas Watson was awarded—and accepted—a medal from Hitler for “service to the Reich.” One would hope that such a strategy would not even merit consideration today.
The law of semi-globalization affords an important insight as well: Addressing much of our current malaise—including but not confined to anti-globalization sentiment—requires domestic policy changes rather than the closing of borders. For example, one of the principal complaints about globalization today is the sense that it has contributed to rising income inequality and that a large swath of the population in advanced economies has been left behind. In the U.S., income inequality has recently risen to levels last seen in the 1920s, and other countries, especially developed ones, have registered similar, if less dramatic, increases. Meanwhile, corporate profits are running close to their highest historical levels.
The widespread perception that globalization is primarily to blame for this problem, however, is empirically implausible. Most research suggests that technological progress and (in the United States) the decline of unions have been bigger contributors to inequality than globalization. Corroboration is supplied by real-world examples: If the Netherlands can preserve a more reasonable income distribution despite having a trade-to-GDP ratio six times that of the United States, it seems odd to blame globalization for the much higher level of inequality in the U.S. economy. And even if one is inclined to point fingers at globalization, it is clear that protectionism is a much more expensive solution than government safety nets, increases in the minimum wage, changes in tax policy, job-training programs, and the like. Such policies are not typically favored by big business, so corporate voices advocating them make a powerful statement. Furthermore, closing borders does nothing to prepare a country to deal with the automation-related threats to jobs that dominate the debate about the future of work.
My research into the 2011 book, World 3.0: Global Prosperity and How to Achieve It, offers an in-depth evaluation of the various harms attributed to globalization. (I expected the present backlash to arrive several years before it did.) Some, such as the risks associated with international imbalances in trade and investment, are indeed real and significant. Most others, however, turn out to be overblown in relation to actual levels of international integration. For example, the contribution of international air transportation to energy-related greenhouse gas emissions is only one-tenth as large as British air travelers estimated in a survey. To deal with global warming, it would be far more effective to tackle bigger sources such as housing or driving. My research suggests that international openness should be coupled with targeted domestic policies in addressing such side effects as globalization does have.
That perspective is, of course, the opposite of President Trump’s apparent preference for domestic deregulation and international intervention, which brings me to my last point—which may seem politically partisan but is rooted in the common notion that a company’s market and nonmarket strategy should be in alignment. If your company is or may eventually be global, it’s not a good idea to actively support policies that build up barriers to trade and capital flows, make people less mobile, and delegitimize the idea that companies can contribute to the well-being of people in more than one country—even if all you care about is shareholder value. Over the long run, companies that rely heavily on sourcing from abroad (such as Walmart) and those that export far more than they import (such as GE) would benefit from joining forces to oppose protectionism.
CONCLUSION
In his classic 2006 Foreign Affairs article Samuel Palmisano, then chairman and CEO of IBM, pointed out that 150 years ago, companies that crossed borders engaged mostly in trade, but by the early 1900s, they had started to invest in localizing production. He also proclaimed the recent emergence of a new corporate form, the globally integrated enterprise, for which “state borders define less and less the boundaries of corporate thinking or practice.”
From today’s perspective, that seems too rosy by half. But there is some good news for those tasked with leading multinational companies. First, the global corporation never became nearly as integrated as Palmisano prophesied, so the amount of change required if globalization does go into reverse is less than people might think. Second, it’s still unclear whether a retreat from globalization will occur: International activity has stagnated in recent years but has not fallen off significantly. And third, even if globalization suffered a violent reversal similar to that experienced at the beginning of the 1930s, the world would still remain more globalized in terms of trade and foreign direct investment than it was in the 1920s, let alone in the 19th century. So reverting to the multinational structure of 100 years ago or the trade-based structures of 150 years ago strains plausibility. Globalization strategy and practice have advanced well beyond the prescriptions those historical models would imply, and leaders would be ill-served by going backward.
