Creative Thinking:Entrepreneurship in the Digital Age

STERNbusinessInformation Nation

S P R I N G / S U M M E R 2 0 0 3

Crossing Borders

CEO Interviews: How UPS Delivers How Bic Stays on the BallNiall Ferguson on Anglobalization India’s Software GiantWhy Major Economies Don't Move in Sync UnderstandingNew Consumer Markets Wal-Mart ’s Foreign TravelsR x C o v e r a g e : C u r i n g Te l e c o m a n d A r g e n t i n a

a l e t t e r f r o m t h e deanIt’s more than fit-

ting that this issue

focuses on the topic

of globalization and

crossing borders. In

recent months, Stern

has seen significant

milestones in our

international efforts. This past January the inaugu-

ral, 28-person class of executive MBA students from

TRIUM, the program Stern offers jointly with the

London School of Economics and the HEC School of

Management in Paris, completed their studies. The

second TRIUM class, with 35 members, completed

its first module at our campus in New York that

same month. This innovative program, geared

toward inculcating a global perspective in its stu-

dents, will continue throughout the year with

sessions in Paris, London, Brazil, and Hong Kong.

While many of our alumni remain in the New

York area, and hence can easily maintain connec-

tions to Stern, and with one another, Stern graduates

who live in 98 countries have fewer opportunities to

do so. In October, we held our second international

alumni conference at La Pietra, NYU’s conference

center in Florence, Italy.

At La Pietra, where nearly 160 people gathered

for a weekend of fine food, fine art, and fine discus-

sion, Stern’s approach toward business – and busi-

ness education – was on full display. Panels brought

together executives and scholars to discuss topics

ranging from corporate governance to the direction

of the global economy. A session on the business of

opera included the administrators of New York’s

Metropolitan Opera, Munich’s Bayerische Staatsoper,

and Milan’s La Scala.

Meeting in the heart of Europe, and with people

from different business cultures and scholarly

disciplines, added a great deal of context to all our

discussions. Of course, history is an important com-

ponent of context. Business history – long a strength

at Stern – has been augmented by the arrival in

January of Professor Niall Ferguson, who recently

joined us from Oxford University and is the author

of the definitive two-volume history of the

Rothschild banking empire. His most recent book,

Empire – which is partially excerpted in this issue –

is a significant contribution to the growing literature

on globalization.

As several articles in this issue argue,

understanding the historical development of

international markets, companies, and financial

systems is crucial for leaders grappling with

contemporary questions and challenges. After

all, locating our place and role in an increasingly

connected world is the fundamental task of all edu-

cational endeavors, but in particular of business

and management education.

We look back on recent accomplishments with

pride and a sense that we are affording all members

of the Stern community a greater understanding of

the world in which we live and work. And we look

forward eagerly to the future – and to this issue of

STERNbusiness.

Thomas F. CooleyDean

STERNbusinessA publication of the Stern School of Business, New York University

President, New York University � John E. SextonDean, Stern School of Business � Thomas F. CooleyChairman, Board of Overseers � William R. BerkleyChairman Emeritus, Board of Overseers � Henry KaufmanAssociate Dean, Marketing

and External Relations � Joanne HvalaEditor, STERNbusiness � Daniel GrossProject Manager � Rika NazemDesign � Esposite Graphics

Letters to the Editor may be sent to:NYU Stern School of BusinessOffice of Public Affairs44 West Fourth Street, Suite 10-83New York, NY 10012http://www.stern.nyu.edu

contents S P R I N G / S U M M E R 2 0 0 3 C r o s s i n g B o r d e r s

Illustrations byChris McAllister,Timothy Cook,Warren Gebert Gordon Studer,Robert O’Hair, and Michael Caswell

10A Passage From Indiaby Raghu Garud,Arun Kumaraswamy andMonica Malhotra

18The Market Next Doorby Peter Golder andDebanjan Mitra

24Anglobalizationby Niall Ferguson

30Don’t Cry For ArgentinaA Roundtable Discussion

34The Big Store GoesGlobalby David Liang

40It’s A Small WorldAfter All?by Jonathan Heathcote and Fabrizio Perri

44Telecommunications:Excess Capacityby Lawrence J. White

48 Endpaperby Daniel Gross

SternChiefExecutiveSeries

Interviews withBruno Bich, page 2Michael Eskew, page 4

8Crossing Bordersby Daniel Gross

ML: You certainly are thequintessential multi-national,multi-lingual executive. Tell uswhat's going on in the globaleconomy. Is it really as difficult,demanding, and daunting as itappears?BB: We are slightly affectedby the downturn in the econo-my. There are good reasons tobe careful right now. We creat-ed a bubble and we are payingthe price. There was a bubblein Asia, which corrected a cou-ple of years ago, and now istrying to recover. In Europe,there was an Internet bubble,but to a lesser extent than inthe U.S. It's just like a pendu-lum. We went too far one way,we go too far the other way.Short term, I'm concerned.Long term, I'm very optimistic.

In three years or so, businesswill come back to its normalpace.

ML: Do any of your majorproducts face specific chal-lenges now? For example,lighters. We see what's hap-pened with cigarette smokingin this country, and notably inthis city, and presumably thatwill spread. Or your White Outbusiness, when more andmore people are using com-puters?BB: Smoking is going downone to two percent per year inthe U.S. or world. That's a verysmall decline. In fact, we haveincreased our sales of lightersabout four percent a year overthe last five years. We keep ongaining market share despite

the tough market. Computershave not really done much toour White Out business. Thatmarket also grows two, threepercent a year. Our highlighterbusiness has actuallyincreased quite a bit. Peopleare highlighting a lot of com-puter reports.

ML: Shavers must be a chal-lenging market, especially witha goliath of a competitor likeGillette. How do you make thatbusiness grow?BB: Our company was startedright after World War II by myfather. In the U.S., we went inthe shaver business againstGillette. Gillette was strong inwhat I call the system andreplaceable blade. To gothrough the door and attack

that market head on wouldhave been extremely difficult.Instead, we went into the one-piece or disposable razor. Wewent through the side door.And today, if you look at thewestern world, 55 to 60 per-cent of the people shave witha disposable razor. There aremore people shaving with thedisposable razor than with thesystem razor. Now, the systemis bigger in value. But, in vol-ume, we are about equal withGillette, in the U.S. and inEurope.

ML: What is your strategy forexpanding in terms of new anddifferent products?BB: First of all, the consumergoes to the store, and has achoice. Consumers usually

Bruno Bich is the Chairman and CEO of Société Bich, a leadingmanufacturer of stationery products, lighters, and shavers thatwas founded by his father, Marcel Bich, in 1945. Based in Paris,France, Bich has subsidiaries in several different countries andsells products in more than 160 countries. The company’s U.S.subsidiary, Bic Corporation, based in Milford, CT, accounted forabout 53 percent of Bich’s 1.53 billion in 2001 sales. Bic man-ufactures three million ball point pens, 2.5 million shavers, and 1million lighters each day. Mr. Bich graduated from NYU Sternwith a Bachelor’s Degree in Marketing, and has worked atSociété Bich for more than three decades. After holding posi-tions including national sales manager, vice president of salesand marketing, and Chairman and CEO of Bic Corp., Mr. Bichwas elected to succeed Marcel Bich as Chairman and CEO ofSociété Bich in 1993.

sternChiefExecutiveseries

Bruno Bichchairman and chief executive officer

Société Bich

2 Sternbusiness

spend about 20 secondsdeciding which product to buy.The quality of the brand namein the subconscious of the con-sumer becomes very impor-tant, as does his recollection ofhow well he was served by theproduct in the past. That isreally where we concentrateour strategy.

The second thing is, wedevelop products with newtechnologies that offer differentservices to the consumer inrelation to their purchasingpower. Thirty years ago, youhad a ball point pen and youhad a mechanical pencil. Thencame the first felt products, thefirst flair pens. Instead of fourcolors, now there are 12 colorsof ink. And the point size,which dictates the width of aline of color on a piece ofpaper. There used to be only0.7 millimeter and 1 millimeter.Now we have 1.2, 1.0, 0.7,0.5, and even 0.3 in Japan. Soall those technologies offerchoices to consumers, whichthey like to indulge.

Then there are differenttypes of markets. In bothdeveloped markets and emerg-ing markets, but particularly inthe developed markets, youhave the need market and thepleasure market. People wanta basic ball pen that writeswell. On the other hand, peo-ple--particularly young people--want to find a little bit of pleas-ure in their everyday life. Andthat's where they really look atthe design of the product, andnew technologies with differentink colors. At the same time,

we can never forget that intoday’s world, approximately20 percent of the people earnless than $2 a day. So ourstrategy is serve the con-sumer, never forget the basicproduct, and work on the quali-ty all the time. If people wantto spend a bit more money,and they have the money incertain countries of the world,then we'll present a widerchoice, with newer technology.

ML: Where are you going tomake your major thrust forexpansion?BB: My father started the busi-ness in France. But France,today, represents only ninepercent of our sales. Overall,Europe is about 34 percent,North America about 56 per-cent, South America eight per-cent. We have the most oppor-tunity in Asia. We started doingbusiness two years ago inAsia, but building a businessthere will take 10 or 20 years. Ithink that in the 1970s, youcould not call yourself an inter-national company if you werenot strong in the United States.I think in 10 or 20 years youwill not call yourself a strongglobal company if you are notstrong in Asia.

ML: You have a managementteam that is stationed all overthe world. How do you managethat?BB: Well, I have two offices--one in Paris and one in NewYork. And I commute. I'm inNew York 50 percent of mytime, Europe 30 percent of the

time, and somewhere else 20percent of the time. We haveput together a group of man-agers who come from differentbackgrounds and different civi-lizations, because there is a lotof value to finding what are thecommon points between con-sumers in Europe and theUnited States, South Americaand Europe, and even Asia. Ithink too often, people start totalk about the differences.First, let's talk about the com-mon points. Ethics. Teamwork.Internationalism. When youlook at consumers, they writethe same way, they shave thesame way. We use English asour language of business,which is pretty advanced for aFrench company. Once amonth, we video-conferencewith top managers around theworld. We get together face toface every three months.

If there's one weakness inthe United States, it is thatAmerican companies callthemselves international whenin fact, there are very fewexecutives at American compa-nies who are multi-lingual andvery few people who comefrom foreign backgrounds.

ML: What are some of the dif-ferences between Americanmanagers and non-Americanmanagers?BB: The main difference isthat the American managersare very results oriented. Andthe French, who are moreintellectuals, love to discussand do more research. I thinkEuropeans are extremelyinventive in terms of technolo-gy. And when you put themtogether with Americans, whoare very good at process, youhave stupendous machinery.The idea is to use the strength

of each toward the same goal,versus focusing on the differ-ences. That's arduous work.But the payoff is great.

ML: You have some of theworld's best known brands.How do you develop a brand,and how important is that toyou?BB: Our brand name is myfamily name so I look at it as asignature. I think that a brandstands for an agreement or acontract, your signature to theconsumer that what you deliv-er to him is what he expects.You can build a brand, withadvertising, with a very goodproduct, and with consistentquality in your product. But youcan lose it very, very quickly. Idon't think that any brand inthe world can be number oneor number two by offering infe-rior quality. The strength of abrand is in the long-term faithof the consumer around theworld. The important ingredi-ents are quality, reliability, andvalue. After that, you're goingto add the pride of having theproduct. And this is whereadvertising comes in. Forexample, we used JohnMcEnroe in our shaver adver-tising. That campaign showedthe consumer that Bic has asimpatico side to it. When itcomes to the advertising or thedesign of the product, I per-sonally spend a lot of time onit, because it affects the longterm strength of the company.Our managers know exactlyhow to manage things like pric-ing. But they are not responsi-ble for the soul of the compa-ny, which is the brand name,or the design of the product.

ML: When you seek to hire

Marshall Loeb, the former managing editor of Moneyand Fortune, conducts a regular series of conversationswith today’s leading chief executives on the Stern campus.

"We can never forget that in today’sworld, approximately 20 percent of thepeople earn less than $2 a day."

continued, page 6

Sternbusiness 3

Michael Eskew is the Chairman and CEO of United ParcelService. UPS is the world's largest package distributioncompany and logistics provider. In 2001, the companyreported sales of $30.3 billion. After nearly a century inbusiness, the UPS name is synonymous with reliability andintegrity. Today UPS’ 360,000 employees deliver more than13 million packages and documents each day, servingnearly eight million customers. The company’s website han-dles more than six million tracking requests each day. Mr.Eskew, a graduate of Purdue University, joined UPS in 1972as an engineer. In his 30-year career with the company, hehas held a variety of posts in the U.S. and Germany, includ-ing Corporate Vice President for Industrial Engineering andVice Chairman. In January 2002, he was named Chairmanand CEO.

ML: What do you think isgoing on in this economy?What is really wrong, andwhat's going to pull us out?ME: We released our earningsin July and we concluded thatthe economy, at that time, wassluggish across all the differentsectors that we serve. Theonly area where we saw any-thing going on was in mort-gage refinancing. An awful lotof letters and documents weregoing back and forth betweenbanks. We used to think thatwe were a good leading indica-tor for Gross Domestic Product(GDP). But as inventory levelsover the last few years havecome down, we don't think wesee changes in GDP until theyhappen.

ML: What do you see as thegreatest spurs to innovation? ME: For our business, wethink about two dynamics thatare in place: globalization andwhat we call “consumer pull” -consumers being able to lookinto the supply chain and pullthrough what they want, whenthey want it. As far as global-ization goes, our internationalbusiness is strong. The lastquarter our exports fromEurope were up 13 percentand our exports from Asiawere up 17 percent. China wasup nearly 40 percent year onyear. We see an awful lot ofpower in that dynamic. Theother dynamic, consumer pull,is powerful as well. I'll giveyou an example. The first com-puter I bought was an IBM XT.

I went to a retail shop to buy it.All the computers looked alike.They were all configured thesame way. And they weredelivered by truckloads. TodayI can order one computer and Ican configure it exactly as Iwant. I can select the screensize and printer. And today,consumers can pull these cus-tom-made computers throughthe supply chain one-by-one.They come one-by-one in apackage delivered, I hope, bya brown package car. Thisdynamic is making the supplychain cheaper.

ML: Tell me about globaliza-tion and its effects upon yourcompany.ME: We have an awful lot ofcustomers who really do want

to expand their markets. Andit's not just the big companies,it's the smallest companies,companies that started with uswhen they were in a garage.The nice thing is, we can actlike each customer’s packageis the only package we have.We can tailor solutions on aone-by-one basis.

ML: UPS is engaged in whatseems to be a pretty basicbusiness. You deliver packagesby trucks. It doesn't sound likea very romantic or exciting orchallenging business, yet Isuspect that it is.ME: UPS has been in busi-ness for 95 years. It wasfounded in 1907 by a teenagerin Seattle named Jim Casey.He started out delivering mes-

sternChiefExecutiveseries

Michael Eskewchairman and chief executive officer

United Parcel Service

4 Sternbusiness

sages in Seattle. In about1911, a new technology putJim's company out of busi-ness: the telephone. The needto run messages all overSeattle went down dramatical-ly. So he changed his businessand started to deliver goods forstores. Jim had to go convincethe stores of Seattle that if acustomer came downtown onthe streetcar and didn't want tocarry his goods home, hiscompany could deliver thosegoods to the customer’s home.And he could put all the pack-ages together and createscope and scale and put themall in a clean car with a uni-formed driver and do it profes-sionally. That's how the wholething started. That businesswent on until after World WarII. Then people didn't go down-town to shop anymore. Theydrove to suburbs and shoppingcenters, bought things anddrove them home. So the busi-ness model was again threat-ened by technology. JimCasey had to go into the com-mon carriage business andcompete directly with the postoffice. The business spreadfrom there.

I joined UPS in 1972. Wewere in 37 states and had rev-enues of about a billion dollars.Since then, we've moved into200 countries and we'vemoved beyond just ground, toair, to ocean, to international.And we've moved beyond justsmall packages. We now serv-ice the whole supply chain. Allcommerce is all about threeflows. Goods flow, informationflows, and funds flow. Ourbusiness is the flow of goods.And today, thanks to technolo-gy, we facilitate the flow ofinformation and funds. Weknow exactly when a package

was picked up, when it wasdelivered, and whether it wassigned for.

Think about a camera or acomputer or an elevator or aprinter or an aircraft or a med-ical device, any high techdevice. Usually folks that buythose devices need two-to-four-hour part replacementwhen something breaks. Youcan't run a McDonald's if thecash register doesn't work.Satisfying the need for twohour part replacement any-where in the world requires thebest transportation company inthe world, which we've beenbuilding for 95 years. Itrequires a lot of technology. Itrequires central stocking,keeping those critical parts inone or two or three locations inthe world. It requires forwardstocking locations, placeswhere you can keep parts sothat they can be where theyare needed two hours afterthat phone call is made. Wecan put all those servicestogether anywhere in theworld.

We also have repair loca-tions. We do repairs on thoseparts also, because it all needsto come together at one timeand place. Those companiesin the U.S., and in Asia, and inSouth America, and in Europewant one throat to choke. Weare it. They want one entity tomanage the supply chain. Sowe do get excited about thismundane business. It's makingcustomers better.

ML: You have a very strongbrand. How would you defineit? How do you preserve andprotect it? ME: Our brand was just evalu-ated and we determined thatwe have the second best busi-

ness brand in the U.S., next toCoke. We've done a lot ofwork with our brand recently. Itused to be that our purposewas to satisfy the small pack-age needs of our customers.Now our purpose is to enableglobal commerce. We went tobrand consultants. They toldus that we don't use our colorsthe way we should use our col-ors. We need to call attentionto brown, the color we own.We also need to think aboutmore than just the package,how to make the brand aboutenabling global commerce.

When the brown campaigncame out, we did a lot of sur-veys and we felt that therewere two other colors thatcompanies owned. Blue wasone of them, that was IBM.And pink was the other one,and that was Owens-Corning.And so we felt like we reallycould stake brown.

ML: What is unique and dis-tinctive about the UPS cul-ture?ME: We have two strengths atUPS. One is the way we'reorganized. We have districtorganization so we can beclose to the customer. Thepeople that run our businessday-to-day are in the field. Theother strength is our culture.We have 360,000 employeesin 200 countries around theworld. And there are no super-stars. None of us are moreimportant than the other. Noneof us are sufficient by our-

selves. We are a team. Thereare no private jets. We driveourselves to the airport. Iparked my own car and carriedmy own bag today. And Ianswer my own phone. Ourculture is that we are onegroup. We try to treat eachother the same. For instance, Ieat in the cafeteria every dayand I don't bring coffee anddrinks to my desk because weask the drivers not to drinkcoffee and eat lunch in theircars. That driver is as impor-tant as I am. That's part of ourculture.

ML: Do your executives getout and actually drive thetrucks?ME: We all did, every one ofus. I started at UPS as anengineer. I did some basicengineering for about the firsttwo months. Then I went on todeliver packages for about twoor three months. And younever forget the look in thecustomer's eye, the things theylook for. If a package is late,you'll never, ever forget it. Andwhen you get it there on timeand it delights and they need-ed it, you'll never forget it.When I was a district managerin New Jersey I would rideonce a month. I would ask thestaff to ride once a month.That’s not uncommon.

ML: You have a lot of longtime, long-term employees.ME: We do. We have about

"Our business is the flow of goods. Andtoday, thanks to technology, we facili-tate the flow of information. We knowexactly when a package was picked up,when it was delivered, and whether itwas signed for."

continued, page 7

Sternbusiness 5

somebody, what do you lookfor?BB: Personal values. I don'tthink leopards change theirspots. We want to find peoplewho believe in the same val-ues that we do. Respect forthe consumer. Respect foryour fellow workers. That leadsyou to teamwork. Modesty.That leads you to the accept-ance that there are good ideasall over the world. Then youmove on to professionalism.Internationalism. There was atime when I used to say, atti-tude is more important thanaptitude. I don't say this to thehuman resources departmentanymore. I tell them, I wantboth. There are good peopleall over the world, people withthe right values, and the rightbrain. I also look for peoplewho are hungry.

ML: Yours is a family busi-ness. The family owns a littlemore than a third of the sharesand has a little more than 50percent of the voting power.What are some of the particu-lar advantages and the partic-ular challenges of being in afamily business?BB: Over all, being a familybusiness is a big plus. The bigplus is that you build the busi-ness for the long-term. InEurope, we don't report quar-terly earnings. We report semi-annually. Of course, when youare a public company in theU.S., you must report quarterlyearnings. That puts pressureon management to do thingsthat are not necessarily goodfor the long-term. But if you'rea family business, you canbuild for the long-term. Andthat means, in our view, that

you don't have debt in such away that you are under pres-sure to make short-term deci-sions in order to cover yourdebt. And you don't over prom-ise to Wall Street. I sense thatsome of the things that havehappened recently on WallStreet are the result of pres-sure to generate earnings,which frankly were not realisticin relation to the growth of themarket. Also, the people whowork in the company mustknow that they will be evaluat-ed and fairly promoted, eventhough they are not in the fam-ily. And we in the family mustdo an excellent job. When Icame to the U.S., and when Igot more and more responsi-bility, my father was testingme. If I had not succeeded inthe U.S., I would not have thejob I have today. I tell my chil-dren and nephews and nieces,first you'll have to ask to jointhe business and then you'llhave to prove yourself.

Student questionsQ: How do you create syner-gies between your managersof different nationalities aroundthe world and what kind of dif-ferent talents do you expectfrom them?BB: You create synergies bychoosing the right people.You've got to have people whodeliver on a regular basis. Andyou have to be very carefulabout communication. Whenyou have people from differentbackgrounds who speak differ-ent languages, you have to bevery, very attentive. One of ourphilosophies is, "It's notenough to explain. You have tobe understood."

Q: Do you sell the same razorat the same price in the U.S.

as you do in China, India, orSouth America? Many retailershave a terrible problem whenthey price discriminatebecause their merchandise issmuggled from third worldcountries into developed mar-kets and sold at below marketprices.BB: We do price to marketand we do have that issue. Ifyou want to grow in EasternEurope, you have to offer yourproduct at a price that is lowerthan in Western Europebecause people in EasternEurope don't have the money.But you need to know yourbusiness. You need to know anaccount well enough to seethat if you get an order from awholesaler four times biggerthan any order that you haveever got from that wholesalerbefore, there is somethingfishy about it.

Q: Failure is part of the grow-ing process to become a goodmanager. Could you share withus one of the most humblinglosses that you had whilegrowing up in your business?BB: My biggest failure was theacquisition of Shaeffer Pen. Ithasn't worked out yet. I thinkone of the reasons is that a lotof the Shaeffer business is inAsia. And shortly after webought the business, Asia wentstraight downhill. The secondthing is that people today,executives, do not have asense of pride in having a

Continued from page 3

high-quality, high-end writinginstruments. We need to revivethat part of the industry. We didnot thoroughly analyze thehigh-end of the business. Wedid not do enough homeworkbefore the acquisition.

Q: Would you please tell usabout your trajectory to the topof Bic?BB: When I was 16 or 17,instead of going to England tolearn English, I came here forthe summer. And I loved it.Later, I took a year off andtraveled all over the UnitedStates driving a car. It was1964 and we were a verysmall company. And I would goto retail stores and check onour distribution. I became veryinterested. After a year, myfather asked me what I wantedto do. I said, I want to go tobusiness school in America. In1964, there was no other placeto go to business school. AfterI graduated from NYU Stern, Iwent into investment banking. Iworked for White Weld in theU.S. and Europe for about fouryears, and then joined Bic. Ibecame president of the U.S.business in 1983. That's whenwe started to introduce newproducts which we didn't havein Europe. And that's howNorth America became 56 per-cent of our global business. Myfather gave me the chance toshow what I could do here inthe U.S.

"I think that in the 1970s, you could notcall yourself an international company ifyou were not strong in the United States.I think in ten or twenty years you will notcall yourself a strong global company ifyou are not strong in Asia."

6 Sternbusiness

four percent turnover, whichmeans that people last onaverage 25 years among thefull-time ranks. The loyalty thatthey have is terrific.

ML: What kind of characteris-tics and qualities do you lookfor when you are hiring some-one?ME: We really think aboutfolks that can work with peo-ple. This is a people business.It's not a place for everyone. Ifyou want private cars and pri-vate jets and country clubs andyou want to see your name upin lights, don't come to UPS.It's not that kind of place. But itis a place that you can workand know that you do some-thing that's honest and noble.Delivering a package is noble.We are enabling commerce,making our customers better,taking them places. It's anhonest job and it's a greatplace to work. And we think wemake a difference.

Student questionsQ: Can you give us an exam-ple of how you create highvalue, innovative solutions forcustomers? ME: We think about this interms of four dynamics. Wethink about things we do inter-nally and things we do exter-nally, things we do for existingbusinesses and things we do

Continued from page 5 for new businesses. In termsof things we do internally, welook at the product processwith our marketing group. Forexample, they take next dayair and second-day air andmake it 8:30 and 10:30, andthey replicate that model andintegrated delivery networkthroughout 200 countries. Theway we grow existing busi-nesses externally is throughmergers, acquisitions, partner-ships, and alliances. We'vedone several acquisitions.We've done hundreds of part-nerships and alliances, gener-ally in the high- tech space.We know that we have to go toexternal sources to be able togrow existing some businesses.

With new businesses, we

can try new things and we can

fail small fast, so we try to

innovate down there. For

example, we investigated web-

based grocery delivery. We

tried it and failed fast. But we

didn't fail with a lot of money.

We use a strategic enterprise

fund to examine new business

opportunities. We use that to

fund pre-IPO companies that

do things in spaces that we're

interested in. And we support

research at universities. One

of those companies was a

company named Savi, which

does radio frequency (RF)

transponders. We move 13

million packages across the

world every day and we want

to know where every one is at

every moment. Right now, we

do that by scanning every

package several times. That's

a lot of labor. What we'd like to

do is use RF transponders as

a way to track packages.

Q: What items are on your

capital expenditures wish list?

ME: We spend a billion dollars

every year on technology, and

we have for the last 15 years.

We've been described as a

technology company with

trucks and that's a fair descrip-

tion. We're going to continue to

spend money on technology.

We just opened our new air

sort in Louisville. It's the most

phenomenal sort you've ever

seen in your life. The pack-

ages sort themselves! The

packages move 400 feet a

minute but if you could make

time stand still, you could find

that package within 12 inches

in a building that is the size of

the Pentagon. It's a phenome-

nal thing. Also, we're going to

continue to add to the 300 air-

craft we own, to be able to

take our customers' packages

around the world.

Q: In your ongoing effort to

globalize your market, how has

it been different doing busi-

ness in other countries?

ME: We did our first interna-

tional expansion in Germany in

1976. We all thought that we

could do things there just like

we did them in the U.S. For

example, we called each other

by our first names in the U.S.

Well, Germans don't do that

because of the formality of the

language. We want to be able

to build our overall brand so

that folks all over the world

learn to think of UPS. Our

website is available in 19 dif-

ferent languages. It's tailored

to 109 different countries. So if

you're in a remote part of

Nigeria, you can find out how

long it takes to get a package

to Japan.

Q: UPS has invested very

heavily in aviation over the

past decade. I know that you

have experimented with using

that aviation equipment in

other ways. Can you tell us

about that?

ME: We do sometimes experi-

ment in that kind of new busi-

ness. We look at three differ-

ent dynamics. First, it has to

be an attractive market, a

growing market. Second, it has

to leverage our strengths, our

skills, our brand, our customer

base, our technology, our peo-

ple. Third, it has to fit our strat-

egy. Again, that strategy is to

enable global commerce. We

didn't think flying passengers

on the weekends to cruise

ships necessarily was an

attractive market. It almost dis-

tracted us. So we got out.

"We went through brand consultants.They told us that we don't use our colorsthe way we should use our colors. Weneed to call attention to brown, thecolor we own."

"We have 360,000 employees in 200countries around the world. And thereare no superstars. There are no privatejets. I parked my own car and carriedmy own bag today. And I answer myown phone."

Sternbusiness 7

rom the ability to communicate with friends inLondon via instant messaging to the presenceof canned okra from Lebanon in the aisles ofStop’n’Shop, there is evidence all around us

that the world is becoming a smaller place. So too, alas,are indicators that significant distances – political, cul-tural, and economic – stand between us and our fellowinhabitants of the earth.

In his 2000 best-seller, “The Lexus and the OliveTree,” New York Times columnist Thomas Friedmanrhapsodized about the positive implications of global-ization and the proliferation of the latest development ininformation technology. No two countries withMcDonald’s, he reported, had ever gone to war. His2002 best-seller, “Longitudes and Attitudes,” focusesmore on the downsides of globalization. It turns out, ofcourse, that in our global village, terrorists can use theInternet to organize, and that even isolated countrieslike North Korea can gain the expertise needed to pro-duce highly sophisticated weaponry.

Despite today’s uncertainties – many of which havebeen economically disruptive – the forces that spurredglobalization are still immensely powerful. The trade ingoods, services, and ideas is increasing, not decreasing.In a fascinating interview, Michael Eskew, the chairmanand chief executive officer of United Parcel Service(UPS), provides insight into one of the workhorses ofthe global economy (p. 4). UPS, which began life as amessenger operation in Seattle, now employees 370,000people in 200 countries. But while UPS’ fleet of browntrucks and brown-clad delivery people provide themuscle, the human element is only half the story. “Whatreally makes us the best is information,” Mr. Eskewsays. “Information that tells us where that package is,when it's late, what building it's been in, where it went,who sorted it in the wrong direction.”

Yes, information – and information technology (IT) –increasingly drive commerce. Unlike oil or bananas, bitsand bytes can move freely and cheaply from prettymuch any point on the globe to another at the click of amouse. That allows an enterprising company to provide

IT services to U.S.clients from alocation as seem-ingly remote asIndia. Today,Infosys, a soft-ware giant basedin India andlisted on theNasdaq, countsdozens of blue-chip U.S. compa-nies among itsclients. In theircase study (p. 10)Raghu Garud, ArunaKumaraswamy and MonicaMalhotra show how Infosysis creating a new paradigmthat can be emulated by compa-nies from Bangalore to Boston.“What most distinguishes Infosys is theway it systematically built up a post-modern,scalable enterprise for harnessing intellectual capital inthe new information economy,” they write.

The realization that gaping cultural, political, andeconomic gulfs exist in a world theoretically made smalleris just one of many apparent contemporary paradoxes.Here’s another: In recent years, the trade in internation-al financial assets has increased sharply. And yet at thesame time, the major economies have seen their pathsdiverge. We’re growing together while growing apart.These two phenomena – financial globalization and realregionalization – as Fabrizio Perri and JonathanHeathcote tell us, are directly related (p. 40). After all,when capital moves more freely, it can follow and pursuereturns, and react quickly to local shocks.

The recent experience of Argentina, whose decision todevalue the peso has caused massive economic disloca-tion, shows that discussions about capital flows are notsimply academic exercises. At a lively Stern forum last

F

8 Sternbusiness

C R O S S I N GBy Daniel Gross

fall (p. 30), Argentina’sformer economy min-

ister Domingo F.Cavallo (a HenryKaufman VisitingProfessor at NYUStern), Mario Blejer,a former governorof the Central Bankof Argentina, andNYU Stern profes-

sor Nouriel Roubinidebated the causes of –

and potential solutions to– the Argentina morass.

Surprisingly perhaps, theeconomists spent a good deal of

time talking politics. “For eco-nomic growth, you need strong insti-

tutions. And for that, you need a well-functioning political system,” Professor

Cavallo said. “The functioning of the constitu-tional system is more important than any question

related to the exchange rate system.”Niall Ferguson, the distinguished Oxford historian

who is a professor at NYU Stern, similarly argues thatinstitutions matter. In an elegant and provocative essay –drawn from his most recent book, “Empire” – Fergusonargues that the institutions and practices promulgated bythe British Empire in the 19th and early 20th centurymade it one of the original progenitors of globalization(p. 24). “A case can be made that the British Empire waseconomically beneficial, not only to Britain herself, butalso to her Empire – and perhaps even to the world econ-omy as a whole,” he writes.

History similarly informs Lawrence J. White’s pres-ent-minded discussion of the telecommunications melt-down (p. 44). Drawing parallels between the current tele-com glut and the overcapacity of railroads in the 1880sand 1890s, the savings and loan debacle of the late 1980s,and Japan’s rolling crises of the past decade, ProfessorWhite offers some advice for regulators and entrepreneurs:

declare bankruptcy, recognize and absorb losses, andmove on. And continue to use sound antitrust policy toencourage innovation. “Good public policy could steer usthrough the turmoil and allow us to emerge fairly rapid-ly with a more efficient telecommunications sector.”

ature companies must expand in order tocontinue growing. But the leap into a foreignmarket can be daunting. Many companiesgain initial knowledge from the experience

they build up at home. But, report Peter Golder andDebanjan Mitra, crucial knowledge “can also be gener-ated in foreign markets in which the firm already oper-ates that are similar to potential new markets.” Inexamining Wal-Mart’s mixed efforts to expand overseas(p. 34), David Liang concludes that the retailing giantscould have benefited from what Professors Golder andMitra call “near-market knowledge.” When it firstopened in Argentina, Wal-Mart stores stocked 110-voltappliances; the local standard was 220 volts. Wal-Marthas stumbled, Mr. Liang concludes, in part because ithas failed to replicate sufficiently the sources of com-petitive advantage – its brand, product mix, logisticsoperations, among them – that it has developed athome.

Increasingly, growth-seeking giants like Wal-Martare going to turn to Asia, says Bruno Bich, the secondgeneration chairman and CEO of the French consumerproducts company. “I think that in the 70s, you couldnot call yourself an international company if you werenot strong in the United States,” he said in a NYU Sterninterview (p. 2). “I think in 10 or 20 years you will notcall yourself a strong global company if you are notstrong in Asia.”

Today, globalization is a loaded term. It inspiresvisionary idealists and embittered protesters alike.There’s a tendency on both sides of the debate to inflatethe costs and benefits of this powerful and unstoppabletrend. But if you take the long view, and analyze trends,and place them in their proper context – as the authorsin this issue do – you can’t help but think that the way ofthe future lies more in crossing borders than in isolation.

D A N I E L G R O S S is editor of STERNbusiness.

M

Sternbusiness 9

B O R D E R S

A Passage From

I N D I AInfosys has emerged as a titan of the global software industry by carefullydesigning and constructing a unique corporate culture. Continued growthwi l l tes t the qua l i t y and soundness o f the company ’s a rch i tec tu re .

By Raghu Garud, Arun Kumaraswamy and Monica Malhotra

he software companyInfosys is one of India’sgreat business success sto-ries. Infosys was founded

in 1981, when seven professionalsled by N.R. Narayana Murthy, cur-rently the chairman and chief men-tor, collectively invested $1000.Now, Infosys is the third largestcompany in India, with a marketcapitalization of more than $10 bil-lion. Based in the emerging informa-tion technology (IT) center ofBangalore, Infosys in 1999 becamethe first Indian company to be listedon the Nasdaq. In a country wheremany companies have opaquefinancial statements, Infosys hasvoluntarily adopted stringentaccounting practices. In a country

where ownership and control ofbusinesses have been concentrated inthe hands of a few families, Infosyshas distributed ownership and con-trol broadly among its 10,000employees, known as “Infoscions.”

But what most distinguishesInfosys is the way it systematicallybuilt up a post-modern, scalableenterprise for harnessing intellectualcapital in the new information econ-omy. Nandan Nilekani, Infosys’sCEO and managing director, usesthe term “scalability” to refer toInfosys’s ability to grow from pastexperiences even while maintainingthe integrity of operations. In abroader sense, scalability meansInfosys can simultaneously increaserevenues and profitability while

growing across cultural valuesystems and value chains. Thisscalability is built into the compa-ny’s DNA, and it pervades the waythe company develops software,mentors employees, formulatesstrategy, and governs itself.

ndeed, this scalability hasallowed Infosys to evolve con-tinually. In particular, Infosyshas created a malleable andresponsive learning organiza-

tion that continually uses its experi-ence to replenish and transform itsstock of resources and capabilities.In other words, Infosys is an organi-zation that is perpetually in themaking – which is what it takes tosucceed in the fluid, global, rapidlyevolving IT industry.

T

I

10 Sternbusiness

ILLUS

TRATIO

NS

BY

CH

RIS

MC

ALLIS

TER

Sternbusiness 11

Scalable StrategyProfessor Marti G. Subrahmanyam

of NYU Stern School of Business,and an independent director ofInfosys, pointed out that “A key ele-ment of a strategy for survival andeven rejuvenation in a downturn isa flexible financial frameworkwithin which a company operates.”Infosys’s PSPD Model that empha-sizes predictability, sustainability,profitability, and “derisking,” is anintegral component of such a flexi-ble framework. These four strategicgoals are, in turn, accomplishedthrough a set of sub-models andguiding principles. For instance, theCustomer Relationship Model, whichemphasizes the creation of long-term relationships with each client,helps ensure the predictability andsustainability of revenues. More

For the years ended March 31,

RevenuesCost of revenues

Gross profit

Operating expenses:Selling, general and administrative expensesAmortization of deferred stock

compensation expenseCompensation arising from stock split

Total operating expenses

Operation income

Equity in loss of deconsolidated subsidiaryOther income, netIncome before income taxesProvision for income taxesSubsidiary preferred stock dividends

Net Income

Earnings per share:BasicDiluted

Cash dividend per equity share

Balance sheet data:Cash and cash equivalentTotal assetsTotal long-term debtTotal stockholders equity

$413,851 $203,444 $120,955 $68,330 $39,586 $26,607 $18,105 $9,534213,614 111,081 65,331 40,157 22,615 15,638 10,606 5,621

200,000 92,363 55,624 28,173 16,971 10,969 7,499 3,913

57,641 26,656 16,199 13,225 7,010 4,351 3,344 1,314

5,081 5,118 3,646 1,520 768 361 46 –– – 12,906 1,047 – – – –

62,722 31,864 32,751 15,792 7,778 4,712 3,390 1,314

137,515 60,499 22,873 12,381 9,193 6,258 4,109 2,598

– – (2,086) – – – –9,505 9,039 1,537 801 769 1,460 746 322

147,020 69,538 22,324 13,182 9,962 7,718 4,856 2,92015,072 8,193 4,878 770 1,320 895 893 251

– – – 68 – – – –

$131,948 $61,345 $17,446 $12,344 $8,642 $6,824 $3,963 $2,670

$2.01 $0.93 $0.28 $0.21 $0.15 N/A N/A N/A$1.98 $0.93 $0.28 $0.20 $0.15 N/A N/A N/A

$0.14 $0.11 $0.09 $0.04 $0.02 N/A N/A N/A

$124,084 $116,599 $98,875 $15,419 $8,320 $7,769 $8,046 $2,885342,348 219,283 153,658 48,782 32,923 27,261 23,051 9,400

– – – – – – – –311.792 198,137 139,610 41,146 30,640 23,925 19,668 8,852

2001 2000 1999 1998 1997 1996 1995 1994

$ in thousands (except per share data)

Source: Infosys Annual Reports

EXHIBIT 1INFOSYS AUDITED FINANCIAL INFORMATION, 1994-2001

Source: Infosys Annual Reports

EXHIBIT 3INFOSYS PSPD MODEL

Quality

PredictabilityMaintenance

Higher value services

Increase revenue productivity

Offshore model – Global delivery

Upsell to existing clients

Iterative model of development

Exposure limits for client concentration

Exposure limit for dotcom businesses

Exposure limit for opportunitybusinesses (like Y2K)

Geographical diversification

Translating clients to partners

Long-term Relationship

Offshore SoftwareDevelopment Center

Sustainability

Profitability

Growth

De-risking

People Transparency

12 Sternbusiness

A PASSAGE FROM INDIA

than 80 percent of Infosys’s businessis generated from repeat customers.The Global Delivery Model, underwhich a major portion of project exe-cution costs is shifted from costly“on-site” client locations to relativelycheaper locations in India, plays animportant role in ensuring profitabil-ity. Derisking is accomplished by, forexample, limiting exposure to anyspecific client, domain or type ofproject to less than 10 percent ofannual revenues, and by adopting aconservative financial policy thatlimits debt.

Of course, the PSPD model is notapplied without reflection to addressnew challenges that continuallyarise. Models cannot replace humanjudgment, which is why Infosys hascreated several processes to study,review, and coordinate strategic ini-tiatives and operational priorities.These processes unfold in severalforums, including the Board ofDirectors, and the 57-memberManagement Counci l , whichincludes the board and departmentheads, as well as nine representa-tives from the younger generation atInfosys. The Management Councilmeets frequently to discuss markettrends and any other issues of strate-gic/tactical relevance.

Even though Infosys departmentsenjoy considerable autonomy todevelop and implement strategicand operational initiatives, the coreimplementation process is essential-ly the same across the company.Infosys also takes a measuredapproach to implementation.“Usually, when we come up with apossible solution or a plan, we pilotit to see how it works,” observedS.D. Shibulal, director of customerdelivery: “Then, we go back to thesolution and correct it based on theresults. We institutionalize the solu-tion only after two or three suchcycles.” Infosys’s ability to learn andadapt as it evolves is implicit in thisapproach. Here, scalability is evi-dent in the ways Infosys encapsu-lates past experiences to shapefuture aspirations.

EXHIBIT 2 Infosys Timeline, 1981-2001

1981 • Year of incorporation in India

1987 • Opened first international office in the U.S.

1992 • IPO in India

1993 • Listed successfully in India• Obtained ISO 9001/TickIT Certification

1995 • Set up development centers across cities in India• Received best Annual Report Award from ICAI

(every year from '95)

1996 • Set up Infosys Foundation to focus on contributing back to the society

• Established e-Business practice• Set up first European office in Milton Keynes, U.K.

1997 • Attained SEI-CMM Level 4• Set up office in Toronto, Canada• Set up Engineering Services practice

1998 • Rated first in Economic Times India’s "Award for Corporate Excellence"

• Established Enterprise Solutions practice

1999 • Listed on Nasdaq• Crossed $100 mm in annual revenues• Attained SEI-CMM Level 5• Rated India's most admired company by

The Economic Times Survey• Opened offices in Germany, Sweden, Belgium and Australia• Established two development centers in U.S.• Established Infosys Business Consulting Services• Reorganization for competence building - DCG,

SETLABS,CAPS

2000 • Became first company to be awarded the "National Awardfor Excellence in Corporate Governance" conferred bythe Government of India

• Crossed $200 Million in annual revenue• Set up offices in France and Hong Kong• Set up Global Development Centers in Canada and U.K.;

Set up third Development Center in the U.S.• Combined dedicated e-Business practice with rest of the

organization

2001 • Crossed $400 mm in revenues• Rated Best Employer of India in a study by

Business Today-Hewitt Associates• Opened new offices in Singapore, UAE, and Argentina• Set up new development center in Japan

Source: www.infy.com

Sternbusiness 13

A PASSAGE FROM INDIA

Developing IntellectualCapital

o company can executestrategies without theright personnel in place.And Infosys has takengreat pains to recruit,

train, and mold a scalable work-force. In the middle of Infosys’ssprawling ‘Infosys City’ universitycampus sits an imposing structurewhere Infoscions regularly receivetraining. New employees enter a 14-week educational program. Afterthis rigorous initial training, eachInfoscion must undergo 15 days offormal training annually to upgradetechnical and managerial skills. Inaddition to training Infoscions,the company’s 50-faculty strongEducation and Research Center(E&R) conducts research on newtechnologies and pilots them as theyemerge. For example, E&R enabledInfosys to leverage the late 1990scorporate “mind-shift” towards e-commerce. Infosys’s revenues frome-commerce related projects rosefrom a mere 1.7 percent of revenuesin the first quarter of 1999 to18.8 percent of revenues in thefirst quarter of 2000.

Intellectual growth is all-perva-sive at Infosys. People learn fromone another as they rotate from oneproject group or from one knowl-edge domain to another. Whenrecruiting, Infosys looks for peoplewith “learnability” – the ability toderive generic conclusions from spe-cific situations and then apply themto a general class of unstructuredsituations. Learnability is crucial tomanage the rapid career progres-sion. “By 28, an Infoscion could wellbe a general manager, and by mid-30s, a director of the company,” saidNandita Gurjar, associate vice presi-dent of Learning and Development.“Those who have been rewarded arethose who have been able to jumpfrom one paradigm to the next.”

Under the company’s intensivementoring process, Infoscions atevery level groom and teach thoseunder them. Top executives coachnewly minted middle managerson the need to spend ample time

on networking, interdepartmentalsocializing and meetings, fire-fighting and logistics administration.To design an effective leadershipprogram, Infosys has established theLeadership Institute at Mysore,India.

Knowledge ManagementFor an entire company to be scal-

able, it must be able to leverageknowledge across all its employees.“Learn once, use anywhere,” as akey Infosys motto puts it. Infosyshas now instituted an integratedapproach to the management of

knowledge. “The vision is thatevery instance of learning withinInfosys should be available to everyInfosys employee,” said MaheshVenugopalan, a member of Infosys’sKnowledge Management (KM)Group.

The four pillars of Infosys’s KMsystem – people, content, process,and technology – comprise thearchitecture that guides the creation,transfer, and reuse of knowledge atInfosys. Its origins can be traced tocompany efforts starting around1992 to create Bodies Of Knowledge(BOK), which are nuggets of experi-ential knowledge on topics rangingfrom technologies and applicationsoftware to adapting to new cul-tures. Dr. J. K. Suresh, principalknowledge manager, pointed outthat such BOKs, and other reusablecontent, were created and reused inisolation within any given projectcontext. But they lacked visibility aswell as extensive use across theorganization till the developmentand deployment of a formal, enter-

prise-wide KM system during 1999-2000.

Besides creating and recordinginternal knowledge, white papers,and re-usable code, the KM systemaffords Infoscions access to externalcontent like websites and technologyand business news. Eighteen differ-ent content types have been identi-fied (BOK being one of them). Everyitem in the central KM repository isassociated with one or more nodes(representing areas of discourse) ina ‘knowledge hierarchy’ and taggedto facilitate ease of submission, clas-sification, and retrieval. Currently,approximately one fifth of allInfoscions have contributed atleast one knowledge artifact to thecentral KM repository, and morethan a thousand knowledge artifactsget downloaded by Infoscions forserious use every day.

Since practice units lack the timeand resources to create domain ortechnology specific knowledge,Infosys created two internal consult-ing groups: the Domain CompetencyGroup (DCG) and the SoftwareEngineering & Technology Labs(SETLabs). The DCG coversindustry dynamics and trends, keyplayers, regulatory and accountingpractices. SETLabs focuses ontechnology architectures to createframeworks that can be used byproject teams and business units.

o sow the seeds for theemergence of newknowledge and compe-tencies, Infosys createdthree new business units

to focus on the emerging e-business,ERP solutions, and telecommunica-tions sectors, and an engineeringservices group to offer engineeringservices focused on quantitativemodeling. S. Sukumar, head of cor-porate planning, explained: “Overtime, people from these businessunits are moved around to otherunits to transfer competencies.”

To facilitate the transfer ofknowledge and a culture of sharing,Infosys developed an Intranet portal– the K-Shop. If a question is postedon an electronic bulletin board thatis part of the knowledge manage-

"What most distinguishesInfosys is the way it

systematically built up apost-modern, scalableenterprise for harness-ing intellectual capitalin the new information

economy."

14 Sternbusiness

N

T

ment system, it is not surprising toget several responses from employ-ees across the organization within afew minutes. The KM group has cre-ated an application called the“expert locator,” which allowsInfoscions to declare their specificexpertise so colleagues may consultthem when necessary. The KMgroup has also instituted formalmechanisms for the sharing of bestpractices across the company –quarterly meetings of business man-agers, for example.

To encourage knowledge sharing,the KM group has instituted variousrewards, recognition, and incentiveprograms. Specifically, Infoscionscan earn Knowledge Currency Units(KCUs) for contributing, reviewingor using the BOKs or other knowl-edge assets. Another form of KCUs(termed the composite KCUs) also

serves as a metric to assess contentquality (as determined by the vari-ous attributes related to contentusage, and ratings by users acrossthe organization) and measure theeffectiveness or benefits of theknowledge management program.“Overall, the number of KCUs gen-erated and distributed to employees– currently more than 160,000 –provides a clear indicator of theincreasing level of knowledge shar-ing within Infosys,” said C.S.Mahind, a member of the KM group.

Organizing for GlobalDelivery

Infosys thrives on its ability tosolve clients' problems that lie dis-tributed across the globe with soft-ware solutions created in India. In1998, Infosys decided to abandon its

traditional strategic business unitstructure in favor of a combinationof geography and focused servicesbased business units (also known asPractice Units (PU)). The threelargest delivery units are located inthe U.S., Infosys’s largest market,which accounts for nearly 75 per-cent of its business. In keeping withInfosys’s Customer Relationship

Sternbusiness 15

"In 1998, Infosys decided to abandon its

traditional strategicbusiness unit structurein favor of a combina-tion of geography and

focused services basedbusiness units."

Corporate Organization Structure - Infosys Corporate Organization Structure - Infosys

CHIEF MENTOR

CEO & PRESIDENT

COO & CUSTOMER SERVICE& TECHNOLOGY

CEO & President CEO & President

Nandan M. Nilekani, (Managing Director)

Gopalakrishnan S.(Deputy Managing Director)

Shibulal S.D.(Director)

HRD, IS, QUALITY &PRODUCTIVITY AND CDG

Dinesh K. (Director)

CFO, ADMINISTRATION& FACILITIES

Mohandas Pai T. V.(Director)

DELIVERY - APAC

EDUCATION & RESEARCH

COMPUTERS &COMMUNICATIONS

HUMAN RESOURCESDEVELOPMENT

FINANCE & COMPANYSECRETARY

SECURITY AUDIT &ARCHITECTURE GROUP

SALES - CENA

SALES - ES

SALES - EURP

SALES - IBCS

SALES - SONA

SALES - WENA

DC - MOHALI

DELIVERY - CAPS

SALES - CAPS

CORPORATE MARKETING

SALES - IT OUTSOURCING

QUALITY & PRODUCTIVITY

COMMERCIAL & FACILITIES

INFORMATION SYSTEMS

COMMUNICATIONDESIGN GROUP

SALES - SYSTEMSINTEGRATION

DELIVERY - CENA

CHINA INITIATIVE

PDC - BOSTON

ESCP

SALES - ESCP

DELIVERY - ES

DC - HYDERABAD

GDC - CANADA

IT OUTSOURCING

DC - MYSORE

PDC-NEW JERSEY

DC - PUNE

SET LABS

DELIVERY - QUALITY

IBCS

SPECIAL INITIATIVES

DCG

LIFE SCIENCES INITIATIVE

PDC - UK

DC - CHENNAI

DC - BHUBANESWAR

PDC - FREMONT

DC - MANGALORE

PDC - CHICAGO &SYSTEMS INTEGRATION

DELIVERY - EURP

DELIVERY - SONA

DELIVERY - WENA

BANKING BUSINESS UNIT

Girish Vaidya (SVP)

INFOSYS LEADERSHIPINSTITUTE

Jayaram G. K. (Head ILI)

CORPORATE PLANNING

Sukumar S.(Manager Acting Head)

Narayana Murthy N. R., (Chairman)

Legend:APAC = Asia PacificBPO = Business Process OutsourcingCAPS = Communication and Product Services CENA = Canada & East North AmericaDC = Development CenterDCG = Domain Competency GroupES = Enterprise SolutionsESCP = Engineering Services & Consultancy PracticeEURP = EuropeGDC = Global Development CenterPCC = Product Competency Center PDC = Proximity Development CenterIBCS = Infosys Business Consulting ServicesSONA = South North AmericaSETLabs= Software Engineering and Technology LabsWENA = West North America

Designations:AVP = Associate Vice PresidentBDM = Business Development ManagerBM = Business ManagerCMO = Chief Marketing OfficerPM = Project ManagerRM = Regional ManagerSPM = Senior Project ManagerSVP = Senior Vice PresidentVP = Vice President

SALES & MARKETING

SALES - APAC

CUSTOMER DELIVERY

INFRASTRUCTURE & SECURITY

ACCOUNTS &ADMINISTRATION

EXHIBIT 4

model, a PU is responsible for itsclients globally, even if the clients’operations are spread across regionsin other PUs. In addition to buildingclose relationships with clients, thisstructure generates scale economieswith support functions such ashuman resources and finance locat-ed in India.

Organizing for economies of scaledoes not necessarily result in scala-bility along the value chain,because PUs are purely orientedtoward execution. Infosys has creat-ed structures and processes toaddress this challenge. The domainand technology specific knowledgethat the DCG and SETLabs offer,combined with the relationshipspecific knowledge that PUs offer,generates value that is scalableacross geographical contexts. Projectteams are cross-functional withmembers possessing multiple, over-lapping skills.

ventually, whether or nota company is scalable isdetermined not just byhow its activities are par-titioned, but also by the

processes that integrate these vari-ous parts. If processes are static,the corporation may settle into anefficient structure that lacks evolu-tionary capabilities. But there isnothing static about the organiza-tional routines that governInfosys’s operations. The best wayto understand these routines is byexamining the software develop-ment and deployment process. TheCapability Maturity Model (CMM),developed by the SoftwareEngineering Institute at CarnegieMellon University, forms the back-bone of Infosys’s processes. CMMassesses the maturity level of asoftware development company’sprocesses and methodologies on ascale of one to five. Each maturitylevel requires the organization todevelop specific capabilities in cer-tain key process areas. And Infosysis one of the few organizations in theworld to be assessed at Level 5.

An important component ofCMM is the capability to learn,which ensures continuous improve-

ment in processes. CMM generallyemphasizes learning from experi-ence and feedback. But Infosyslearns not only from its own experi-ences, but also actively seeks toimport relevant external knowledge.“If there is something better, weare willing to learn,” said S.Gopalakrishnan, COO and deputymanaging director. “We look atother organizations, study them,

and then do it our own way.”The continuous improvement

philosophy inherent in CMM hasbeen institutionalized for the rest ofthe company in the InfosysExcellence Initiative. Using theseven criteria of the MalcolmBaldrige National Quality Award(MBNQA) framework, Infosysassesses its entire cross-functionalsupply chain to identify areas thatneed attention. In these areas,Infosys has enacted changes toimprove quality and productivityusing the 6-Sigma technique and theISO 9001 initiative.

Inverting TraditionalHierarchies

Managing intellectual capital ischallenging. Employees can influ-ence a company’s value propositionby determining the extent andquality of their intellectual contri-butions. As Chairman NarayanaMurthy observed, Infosys’s employ-ees walk out of the door every dayand it is the management’s task tomake sure that they come back.

The need to maintain employeeloyalty has imposed demandsupon Infosys’s management.“Bright, young people want to workin smaller companies. They don’t

want to be part of a team or workfor a large company,” said ChiefFinancial Officer T.V. MohandasPai. “So, Infosys needs to retain theflexibility, speed, collegiality, andopenness of a small company.”Infosys attempts to do so by ensur-ing that decision rights remain withthose who possess relevant knowl-edge – its front-line workers.

Such an inversion of the tradi-tional hierarchy is only possible ifpeople assume the responsibility touse information to arrive at superiordecisions. K. Dinesh, director of HR,Quality and Productivity, offered thefollowing maxim as a guiding prin-ciple for decision making: “In onlyGod we trust. The rest of you bringfacts.” Infoscions are encouraged tochallenge one another based on thefacts they can marshal. As a result,the company culture itself is builtaround a dialectic tension whereemployees agree to disagree, therebygenerating informed consensus.

What role can top managementplay if front line knowledge workersmake most decisions? At Infosys,managers are part of a largerprocess of mutual mentorship, aprocess that the founders hope willcreate an institution that survivesthem. “As we go up the corporateladder, our role becomes direction-al,” said Pai. “Our philosophy andduty is to recruit people who arebrighter than us and to mentorthem.” This paradox speaks to adeep sense of security among man-agers. On the one hand, Infosysmanagers deploy their considerableexperience to guide those underthem. On the other, they learn fromthe very employees they teach.

TransparencyBecause investors are naturally

wary of new economy companies,Infosys has proactively adopted thehighest international financial stan-dards. In 1994-95, it was the firstIndian company to adopt stringentU.S. Generally Accepted AccountingPrinciples (GAAP) for financialaccounting and to include completeand detailed disclosures of accountsand activities in annual statements.

"Infosys reports itsfinancial performance

in compliance with the generally

accepted accountingpractices of seven

countries."

16 Sternbusiness

E

A PASSAGE FROM INDIA

Also, it was the first Indian compa-ny to publish audited quarterly state-ments and release annual statementspromptly after the end of its financialyear. Now, Infosys reports its financialperformance in compliance with thegenerally accepted accounting prac-tices of seven countries.

By embracing transparent prac-tices, Infosys is compelling otherlarge businesses in India to followsuit. As V. Balakrishnan, vice presi-dent of Finance, pointed out: “Wefeel that transparency is a competi-tive advantage. Investors have morefaith in a company that is moretransparent.” Infosys has leveragedits pursuit of transparency into aninternational brand. After embrac-ing GAAP financial reporting stan-dards, Infosys listed on the Nasdaq –a strategic move that created a cur-rency to be used for stock optionsand potential acquisitions.

To date, Infosys has grown contin-ually by employing its resources asplatforms for improving existing ini-tiatives and launching new ones. Inthis sense, Infosys has demonstratedwhat it means to be a scalable corpo-ration. However, this process willsurely be put to the test as Infosys con-tinues scaling across value creationactivities and cultural value spaces. AsMr. Nilekani observed, “The chal-lenge now is to ensure that we areable to scale on all fronts – thephysical front, the global front aswell as on the soft issues front. All

this, while we are still able to retainthe quality and effectiveness we hadas a small company.”

For example, Infosys would liketo move up the value chain in thesoftware services industry – fromlow-cost project execution tohigh-margin end-to-end solutions.According to Balakrishnan, Infosys’sdream is “to get U.S. revenues atIndian costs.” But doing so meansthat the iterative model of softwaredevelopment and close contact withclients will increase. Infosys willthus lose some of its flexibility tomove higher-margin consulting proj-ects off-shore. And as competition forprogramming talent increases in theglobal IT sector, salaries in India arealso rising. That will pressureInfosys to raise its incentive andcompensation packages, which willmake it difficult for Infosys to main-tain its profit margins.

nfosys executives believe thatorganic growth may be too slow inaccomplishing the desired trans-formation. Therefore, Infosys is

evaluating acquisition opportunities.But unless the potential target has acompatible culture, it would be diffi-cult for Infosys to integrate the alienculture without disrupting its well-oiled processes and well-defined val-ues. After all, any effort at integrationwould be Infosys’s first.

Growth, coupled with geographicdispersion of employees, may alsomake it more difficult for Infosys to

leverage its collective knowledgeeffectively. Given that more than 90percent of Infosys’s revenues accruefrom outside India, any growth mustbe global in scope. As a result,employees may have to spend moretime removed from their base inIndia. Not only does this imposeenormous lifestyle and psychologicalburdens on remote employees, italso complicates the task of manag-ing and monitoring them. Infosys istrying to tackle this problem byrolling out company-wide e-mails,newsletters, and magazines.Furthermore, Infosys trains its man-agers to manage and monitor theirteams more effectively over distances.

However, as Infosys moves up thevalue chain and grows globally, thelength of time spent by employees atcustomer premises will increase. Ms.Hema Ravichander, senior vice pres-ident of Human Resources, worriedthat this may dilute the Infoscionculture, values and processes, whichmay make it difficult for an increas-ingly global organization to configureand integrate its systems, processes,and business units effectively. Suchgeographic dispersal and loss of iden-tity may also make it difficult forInfosys to develop leaders with a com-mon purpose to manage for the future.

The two faces of the Greek GodJanus symbolize an end as well as abeginning. If one were to apply thisimage to Infosys, the promise ofscalability lies in Infosys's ability tocontinually evolve from the veryplatforms it creates. Outcomes andprocesses are so intertwined that anyend state is but a new beginning. Itremains to be seen whether thispromise will continue to hold asInfosys becomes a legitimate playerin the global market.

RAGHU GARUD is an associate profes-sor of management at NYU Stern.

ARUN KUMARASWAMY , Stern Ph.D.1996, is assistant professor of manage-ment at the Rutgers University School ofBusiness, Camden.

MONICA MALHOTRA is a Stern MBA2001.

Sternbusiness 17

I

18 Sternbusiness

THE MARKET NEXT D R

arket entry decisionsare among the mostimportant strategicchoices companiesmake. Entering anymarket requires a

major commitment of financial andmanagerial resources, but foreignmarkets can be especially demand-ing. Even though many companiesestablished multinational operationslong ago, some of today’s leadingcompanies are currently making thedecisions to go global. Half ofBusiness Week’s top 50 companieswere established within the last 20years and began to internationalizeonly within the past decade – thinkof blue-chips like Dell Computer,Cisco Systems, Home Depot, andBest Buy. And many companies have

found decidedly mixed successexpanding in foreign markets. Wal-Mart, for example, did not initiallyadapt its retail format in Argentinato the local culture. Nonetheless, thegiant retailer’s experience inArgentina provided it with valuableinsights that it applied to subsequentoperations in similar countries.

Most of the research on theinternationalization process focuseson two factors as the primary deter-minants of foreign market entry:cultural similarity and economicattractiveness. Many researchersfind that cultural similarity withrespect to the domestic market is animportant determinant of entry,while others have found that marketentry decisions are positively relatedto country size and the levels of

development, trade, and infra-structure. But no current study hasconsidered the role of knowledgedeveloped by a firm’s subsidiariesin similar markets on subsequentforeign market entries.

Intuitively, it makes sense thatthe knowledge of the economic andcultural environment of a foreignmarket will affect the probability ofentering that market. Theories oforganizational learning argue thatfirms develop knowledge based ontheir experiences. This store ofknowledge constitutes an importantresource and is a source of competi-tive advantage. At first, of course,knowledge comes entirely from thehome market, and companies makecomparisons between the character-istics of the home market and those

M

Sternbusiness 19

Too frequently, companies with global ambitions simply try to export a business modelthat works well in their home markets. But international expansion is not always sosimple. Smart managers can gain valuable knowledge and experience by operatingin markets that are culturally and economically similar to their ultimate targets.

By Peter N. Golder and Debanjan Mitra

ILLU

STR

ATIO

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BY

CH

RIS

MC

ALL

ISTE

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THE MARKET NEXT DOOR

of potential new markets. But suchknowledge can also be generated inforeign markets in which the firmalready operates that are similar topotential new markets. Operating inArgentina, for example, may haveprovided Wal-Mart with someinsights as to how to run a store inChile.

We have dubbed this phenome-non near-market knowledge. But theterm does not refer to markets thatare geographically close. Rather, itrefers to markets that are economi-cally and culturally similar. Suchknowledge can be broken down intonear-market cultural knowledge,and near-market economic knowl-edge. These terms refer to a firm’sunderstanding of the culture andeconomy, respectively, of potentialnew markets based on knowledgegenerated from operating in similarmarkets. When multinational corpo-rations (MNCs) internationalize,they can use such near-marketknowledge to select other foreignmarkets where the firm is more like-ly to succeed.

We set out to gauge the influenceand relative importance of near-market cultural and economicknowledge by gathering extensivedata and using it to test the validityof several widely accepted assump-tions about foreign-market entry.

Prevailing AssumptionsFirst, we assume that cultural

distance is negatively related to for-eign market entry timing. In otherwords, companies will hesitate toenter markets that are culturallyunfamiliar to them. Nearly allresearch on the impact of culture onforeign market entry has consideredthe distance between a firm’sdomestic culture and the culture ofeach potential market. Differencesin culture have been found to affectbrand image strategies, consumerinnovativeness, negotiations, andmarketing decision-making. Whencompanies operate in countries withdifferent cultures, they need to mod-ify their operations in these areas aswell as other elements of the mar-keting mix. Since such modifications

increase costs and risks, companiesare likely to enter countries with cul-tures similar to the domestic marketbefore entering countries with lesssimilar cultures.

Likewise, most people assumethat economic distance is negatively

related to foreign market entry tim-ing. Why? Firms seem more likely tobe successful operating in countrieswith economic characteristics thatare similar to the firm’s home mar-ket. Similar economic characteris-tics may reflect potentially impor-tant similarities between countrieswhere knowledge transfer is valu-able. For example, similar economicconditions might be associated withsimilarities in consumer demandand business institutions like distri-bution channels and media. Sinceknowledge of these factors can helpfirms succeed in foreign markets,companies are likely to enter coun-tries whose economies are compara-tively similar to the familiar domes-tic market.

The same set of assumptions per-tains when dealing with near-mar-ket knowledge. Since companies canacquire and share knowledgethroughout their organizations, theywill likely make some effort totransfer knowledge generated fromoperating in foreign markets toother similar markets. The knowl-edge generated in successful mar-kets should increase the probability

of entering similar markets. Whencompanies have positive experiencesin foreign markets, the cultural andeconomic knowledge generated inthose markets will lead to earlierentry in similar markets. Both con-cepts – cultural and economicknowledge – are dynamic andchange over time, with companies’experience.

Perhaps the most important fac-tor in foreign market entry decisionsis the economic attractiveness of acountry. All things being equal,firms are likely to choose more pros-perous and accessible economies.The extensive literature on foreigndirect investment (FDI) supportsthis view. FDI theory argues thatfirms face various disadvantages inforeign markets and invest onlywhen expected benefits exceed thosecosts. These benefits depend on theeconomic characteristics of eachcountry. Finally, in general,researchers have regarded economicfactors as playing a larger role incompanies’ foreign market entrytiming decisions than cultural deci-sions. Companies can mitigate thenegative impact of cultural distanceby gaining experience in similar for-eign markets and by hiring man-agers with knowledge of the localculture. But while companies canlearn about consumer demand andeconomic institutions, they havepractically no influence on the eco-nomic prosperity, size, and infra-structure of a country.

Identifying FrequentEntrants

As we set out to test theseassumptions, we conducted anextensive search for the completeentry data of many multinationalfirms. We focused on consumerproducts companies, based in a vari-ety of domestic markets, that havesuccessfully entered many countries.(The companies in our final samplegenerate more than half of their rev-enue outside their domestic mar-kets). All these firms have survivedfor at least several decades, holdleading market share positions, andhave not withdrawn from any for-

"Knowledge can also begenerated in foreignmarkets in which thefirm already operates

that are similar topotential new markets.Operating in Argentina,for example, may haveprovided Wal-Mart with

some insights as to howto run a store in Chile."

20 Sternbusiness

eign market entered. Using largelypublic sources, we were able to iden-tify foreign market entry data for 19of the 35 firms that satisfied thesecriteria. The average year of themost recent entry across these firmswas 1992. We contacted all 19 com-panies and corroborated 292 of ourentry events, finding only negligibledifferences for less than 1.5 percentof these observations. The final dataset includes 12 firms from theUnited States, two from the UnitedKingdom, two from Japan, and oneeach from the Netherlands, France,and Switzerland.

Next, we collected data on cultur-

al and economic factors. As mostother researchers of cultural dis-tance do, we rely upon the measuresof the four dimensions of cultureidentified by Dutch social scientistGeert Hofstede: individualism,uncertainty avoidance, power dis-tance, and masculinity. By calculat-ing the variance of these measuresacross different countries, wederived a quantitative measure ofcultural distance. We based ourmeasure of near-market culturalknowledge on two key criteria. First,every market in which a firm oper-ates that is more similar to a poten-tial market than the domestic mar-ket is to that potential market willincrease the cultural knowledge ofthe potential market. Second, theduration of experience in each of

these markets will increase culturalknowledge, albeit with diminishingreturns. Thus, each potential marketwill have its own measure of near-market cultural knowledge, and itwill change over time.

The factors we used to measurenear-market economic knowledgewere somewhat more straightfor-ward. Essentially, we used three setsof variables: measures of economicattractiveness, economic distancebetween the home market andpotential markets, and near-marketeconomic knowledge. Economicattractiveness can be calculated bythe measurement of four variables:

consumer prosperity, as measuredby Gross National Product per capi-ta; economic size, as measured byGross National Product; populationdensity; and the development ofinfrastructure, as measured by thedensity of railroad networks.Economic distance is calculated asthe difference of such measuresacross countries. Our measures ofnear-market economic knowledgecapture the economic similaritybetween each foreign market andthe similar foreign markets in whichthe firm already operates, based onthe four economic attractivenessmeasures for each country. Just as isthe case with near-market culturalknowledge, near-market economicknowledge will change over time asfirms enter additional similar mar-

kets, operate for more years in thosemarkets, and as the basic economicattractiveness variables change overtime.

We then ran all the data througha hazard model, which models therate at which market entry occursbased on dependent and independ-ent variables. In this instance, thedependent variable is the time, inyears, between the year of incorpo-ration and the year each country isentered – through the initial estab-lishment of a sales or manufacturingsubsidiary in that country. Our inde-pendent variables are the measuresof cultural distance, near-marketcultural knowledge, economicattractiveness, economic distance,and near-market economic knowl-edge. When we finished the tests, wepolled senior executives at the firmsdirectly to gauge their opinions.

Examining the ResultsWhat did we find? Table 2 shows

that on average, it took 24 years forthese firms to enter their first foreignmarkets. However, this time hasdecreased significantly to nine yearsfor newer companies. This suggeststhat firms have sought internationalopportunities more quickly overtime. There was no significant dif-ference in time to first entry amongfirms based in different countries.

Table 2 also shows that, on aver-age, firms have entered 37 coun-tries. Therefore, the typical firm inour sample has yet to enter manycountries. We did find that thenewest firms were significantly morelikely to have entered more foreignmarkets than the middle-aged firmsin our sample. However, there wasno significant difference between thenewest and the oldest firms. Overall,we believe that Table 2 shows acommon number of countriesentered over time and across firmsfrom different countries. These find-ings suggest that newer firms movethrough the internationalizationprocess more quickly. It also sug-gests that there is some central ten-dency for the number of countries inwhich firms choose to operate.

TABLE 1SAMPLE OF COMPANIES

Company Age of Company(Years)

Number of CountriesEntered

End ofObservation Period

Burger King 45 44 1999Cadbury 100 28 1995Campbell Soup 98 20 1997Danone 33 40 1998General Foods 70 28 1984General Mills 71 28 1995Gillette 98 38 1998Johnson & Johnson 112 48 1990Kellogg 93 24 1981Kimberly Clark 127 29 1995Matsushita 81 46 1990McDonald’s 44 41 1990Nabisco 123 37 1994Nestle 132 60 1990Philips 108 59 1995Pillsbury 130 25 1997Procter & Gamble 109 26 1981Sony 53 36 1997Unilever 109 45 1974

Sternbusiness 21

THE MARKET NEXT DOOR

We analyzed the results further todetermine which factors seem tohave an impact on foreign-marketentry. And here the results weresomewhat surprising.

In a conclusion that differs fromthat of much research on interna-tionalization, we found that, aftercontrolling for other variables cul-tural distance had no impact onforeign market entry timing. Evenwhen we estimate a model with onlycultural distance and economicattractiveness variables, culturaldistance was not significant. Thissuggests that previous studies mayhave overstated the importance ofcultural distance by not controllingfor economic attractiveness.

In addition, one of our assump-tions was that companies will bemore likely to enter countries withmarket conditions that are similar totheir domestic market. But ourresults did not find that the measureof economic distance, overall, boreany particular relation to marketentry. However, we did find that oneof the variables – economic prosper-ity distance – had a significant bear-ing on market entry. This variablemay be more likely than the othereconomic distance variables toreflect knowledge that might bevaluable in other markets. Forexample, consumers in foreign mar-kets with GNP per capita similar tothe domestic market are more likelyto buy similar types of products and

have access to similar types ofmedia.

In contrast with our results oncultural distance, we find that high-er near-market cultural knowledgeis associated with higher probabilityof entry. That suggests that culturestill has an important impact onentry decisions. However, culturalknowledge generated in similarmarkets seems to be more importantthan cultural knowledge from thehome market. This result seems log-ical because companies should bemore successful when they transferknowledge from countries that aremore similar. Therefore, our resultssuggest that near-market cultural

knowledge may be a better measurethan cultural distance for the impactof culture on foreign market entrytiming.

With respect to the economicquestions, we found that highernear-market economic knowledge isassociated with higher probability ofentry. And we found that all foureconomic attractiveness variablesare positively associated with for-eign market entry timing. Not sur-prisingly, firms tend to enter thesehigh-potential markets earlier.Finally, the weight of our findingssuggests that even though near-mar-ket cultural knowledge is signifi-cant, as we suspected, economic fac-tors are relatively more importantdeterminants of foreign marketentry timing.

Asking the CEOsTo validate our model results, we

sought input from executives at suc-cessful multinational firms. Sincetop executives are responsible forinternational entry decisions, wecontacted only the Chief ExecutiveOfficer and the other top executivemost directly responsible for inter-national operations at each firm.Nine of these executives agreed toanswer questions about how eco-nomic and cultural factors influencetheir foreign market entry decisions.

In Table 3 we present the survey

Questions

* responses on 7 point scale where 1=strongly disagree and 7=strongly agree

Mean Response*

Table 3Survey of Senior Executives on Foreign Market Entry

1. I prefer to enter a country that is similar to the home market of my company in terms of economic factors like market size, income, infrastructure, etc.

2. I prefer to enter a country that is similar to the home market of my company in termsof cultural factors like attitudes, beliefs, customs, etc.

3. In selecting foreign markets, I place more importance on economic factors than cultural factors.

4. In selecting foreign markets, I value experience gained in other foreign markets thatare economically similar.

5. In selecting foreign markets, I value experience gained in other foreign markets thatare culturally similar.

6. When entering a new country, I transfer knowledge developed in the most similarcountries.

7. When entering a new country, I prefer to use managers with experience in other foreign countries that are most similar.

2.6

2.2

5.1

5.4

4.9

5.0

4.7

TABLE 2Characteristics of Foreign Market Entry

Average Number ofForeign Countries Entered(Standard Deviation)

Criteria Sample Numberof Firms

Average Years to FirstForeign Market Entry(Standard Deviation)

All Firms 19 24 (15) 37 (12)

Age of Firms <50 years 3 9.0 (4.4)1, 2 42 (2.8) 1

51 to 100 years 8 22 (13)1 32 (9.0) 1

>100 years 8 32 (16)2 37 (15)

Home Country United States 12 27 (16) 33 (9.0)

Europe 5 18 (12) 47 (14)

Japan 2 25 (23) 44 (4.9)

1 significantly different at p < 0.052 significantly different at p < 0.01

22 Sternbusiness

questions along with the meanresponse for each question. Theseresponses support our model results.In particular, knowledge generatedin similar markets is important tothese executives. When selecting for-eign markets, they highly valueexperience gained in markets thatare economically and culturally sim-ilar. Moreover, once they haveentered countries, they transferknowledge and managers from sim-ilar countries. The survey also con-firmed that executives place moreimportance on economic factorsthan cultural factors. Finally, theseresponses support our finding thatcultural distance from the home

market is not an important determi-nant of foreign market entry.However, an alternative explanationfor this result may be that most ofthe executives who participatedwork at companies that havealready entered many countries sim-ilar to their home market. Theseresponses support our thesis aboutnear-market knowledge and theimportance of including our newmeasures of near-market culturaland economic knowledge.

What it All MeansOur new measure of near-market

cultural knowledge is one steptoward a broader consideration of

the role of culture on foreign marketentry. We find that this new measurecaptures a more significant impactof culture than the traditional meas-ure of cultural distance. This findingprovides support for the importanceof being market-oriented by collect-ing and disseminating relevantknowledge throughout the organiza-tion. The firms in our sample seemto have based their entry decisionson knowledge generated in similarforeign markets.

Companies making foreign mar-ket entry decisions today can learnfrom the successful multinationalsin our data. Today’s internationaliz-ing firms may be wise to place lessemphasis on cultural differences andmore on economic factors. However,the successful multinationals in ourdata may have been able to over-come some of the negative effects ofcultural distance by hiring localmanagers and transferring knowl-edge from similar markets. Indeed,our results confirm the importanceof considering both economic andcultural factors in modeling foreignmarket entry timing. And since bothsets of factors play some role, it isnot surprising that small culturaldistances do not always lead tostrong performance.

Finally, the primary implicationof our findings for today’s expand-ing companies is to consider devel-oping experience in foreign marketsthat will provide the best basis forentering other similar markets. Byinvesting in a small country first andlearning about the cultural and eco-nomic characteristics of its con-sumers and business institutions, afirm may be more successful whenentering a larger country with simi-lar characteristics.

P E T E R N . G O L D E R is associateprofessor of marketing at NYU Stern.

D E B A N J A N M I T R A is an assistantprofessor at the University of Floridaand an alumnus of the NYU Stern Ph.D.program.

A longer version of this article was pub-lished in the Journal of MarketingResearch in August 2002.

Sternbusiness 23

"In a conclusion that differs from that ofmuch research on internationalization, we

found that. . . cultural distance had noimpact on foreign market entry timing."

24 Sternbusiness

ecent economic historyhas not been kind to theBritish Empire. Accordingto one influential school

of thought, late 19th centurycapital exports to the country’snumerous colonies divertedresources away from the moderniza-tion of British industry. It’s evenbeen claimed that the Victorianscould have withdrawn from Empirewith impunity, and reaped a ‘decol-onization dividend’ in the form of a25 percent tax cut.

But a case can be made that theBritish Empire was economicallybeneficial, not only to Britain her-self, but also to her Empire – andperhaps even to the entire worldeconomy. In fact, when we considerits influence on capital and laborflows, on creating and promulgatingthe infrastructure that supports eco-nomic development, it is clear thatthe British Empire was a majorforce for global integration. Call itAnglobalization.

It’s now widely accepted thatprotectionism in less developedeconomies was one of the principlereasons for widening internationalinequality in the 1970s and 1980s.When they compared per capita

(GDP) growth among developingcountries, economists Jeffrey Sachsand A.M. Warner found that “theopen economies grew at 4.49 per-cent per year, and the closed coun-tries grew at 0.69 percent per year.”In the previous era of globalization –the period from the mid-19th centu-ry until the First World War – eco-nomic openness was imposed byBritain (and the other colonial pow-ers) not only on Asian and Africancolonies, but also on South Americaand even Japan.

A similar point can be made withrespect to flows of labor. The morefree movement there is of labor, themore international income levelswill tend to converge. One reasonthat modern globalization is associ-ated with high levels of inequality isthat there are so many restrictionson the free movement of labor. Butthe British Empire actively promot-ed emigration.

Consider also the evidence oninternational capital flows, anotherkey component of globalization.According to the simple classicalmodel of the world economy, capitalshould flow naturally from devel-oped to less developed economies,where returns are likely to be higher.

But as Robert Lucas, the NobelPrize winning economist, has point-ed out with respect to the UnitedStates and India in the 1970s, thisdoes not seem to happen.

Although some measures of inter-national financial integration seemto suggest that the 1990s saw biggercross-border capital flows than the1890s, in reality most of today’soverseas investment takes placewithin the developed world. In 1996only 28 percent of foreign directinvestment went to developingcountries; by 2000 their share wasless than a fifth. The overwhelmingmajority takes place between theUnited States, the European Union,and Japan. Investors in the devel-oped world prefer to invest incountries with high levels of percapita GDP.

Did Empire EncourageInvestment?

In the first era of globalizationthe share of cross-border capitalgoing to poorer countries was signif-icantly larger then than it is today.In 1997 only around five percent ofthe world stock of capital wasinvested in countries with per capitaincomes of 20 percent or less of U.S.

A N G L O B A L Z A T I O N

The great British Empire of the 19th century isn’t merely a quaint historical relic. It stands as one of the first great examples of globalization.

By Niall Ferguson

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Sternbusiness 25ILLUSTRATIONS BY CHRIS MCALLISTER

per capita GDP. In 1913 the figurewas 25 percent. In 1995 the share ofdeveloping countries in total inter-national liabilities was 11 percent,compared with 33 percent in 1900and 47 percent in 1938. Those fig-ures suggest the possibility that theexistence of formal empire encour-aged investors to put their money inless developed economies.

Finally, we need to considerrecent empirical work on the insti-tutional and political preconditionsfor growth. The historian DavidLandes has argued that “the idealgrowth-and-development” govern-ment would secure rights of privateproperty (the better to encouragesaving and investment) and enforcerights of contract. Such a govern-ment would be stable, honest,responsive, governed by publiclyknown rules, and hold taxes down.

hile British colonialrule was not dem-ocratic (outsideCanada, Australia,and New Zealand),

many of these criteria were amongthe British colonial administration’sdefining characteristics. Indeed, astriking number of the things cur-rently recommended by economiststo developing countries were in factimposed by British rule.

In an ideal world, of course, freetrade would occur naturally. Buthistory and political economy tell usthat it does not. For most of the 19thcentury, free trade spread morebecause of Britain’s power thanbecause of Britain’s example. Fromthe 1840s until the 1930s, theBritish political elite and electorateremained wedded to the principle oflaissez faire – and the practice of“cheap bread.” That meant that –certainly from the 1870s – Britishtariffs were significantly lower thanthose of her European neighbors,and that tariffs in much of the

British Empire were also kept low.Abandoning formal control overBritain’s colonies would almost cer-tainly have led to higher tariffsbeing erected against British exportsin their markets. After they securedindependence, for example, theUnited States and India pursuedhighly protectionist policies. Britain’simperial rivals, France, Germany,and Russia also maintained hightariff regimes after the late 1870s.

According to one estimate, theeconomic benefit to Britain ofenforcing free trade could have beenanywhere between 1.8 and 6.5 per-cent of GNP. But what about thebenefit to the rest of the world? Asone eminent Victorian put it, Britainwas “the great Emporium of thecommerce of the World.” Between1871-5 and 1925-9, the colonies’share of Britain’s imports rose froma quarter to a third. More generally,as Jeffrey Williamson has argued, itwas (mainly British) colonialauthorities that resisted protectionistbacklashes to the dramatic falls infactor prices caused by late 19th-century globalization.

In the same way, there would nothave been so much internationalmobility of labor – and hence somuch global convergence of incomes

before 1914 – without the BritishEmpire. True, the independentUnited States was always themost attractive destination for19th-century emigrants. But asAmerican restrictions on immigra-tion increased, the significance ofthe white “Dominions” as a destina-tion for British emigrants grewmarkedly (see Chart 1). Theyattracted around 59 percent of allBritish emigrants between 1900 and1914, 75 percent between 1915 and1949, and 82 percent between 1949and 1963. Nor should we lose sightof the vast numbers of Asians wholeft India and China to work asindentured laborers, many of themon British plantations and mines, inthe course of the 19th century.Perhaps as many as 1.6 millionIndians emigrated under this sys-tem. There is no question that themajority of them suffered greathardship. But we cannot pretendthat this mobilization of cheap andprobably underemployed Asians togrow rubber or dig gold had no eco-nomic significance.

Capital ExportsFrom the mid-19th until the

mid-20th centuries, Britain acted asthe world’s banker, channeling

90

80

70

60

50

40

30

20

10

0

1900-4 1905-9 1910-12 1913-14 1915-19 1920-24 1925-29 1930-34 1935-38 1946-49 1949-63

CHART 1PERCENTAGE OF ALL UK OVERSEAS EMIGRANTS GOING TO EMPIRE, 1900-1963

26 Sternbusiness

W

colossal sums of British (and otherEuropean) savings overseas. By1914 total British assets overseasamounted to somewhere between£3.1 and £4.5 billion, comparedwith a British GDP of £2.5 billion.True, around 45 percent of Britishinvestment went to the United Statesand the Dominions. But 16 percentof British foreign investment went toAsia and 13 percent to Africa, com-pared with just six percent to therest of Europe. As late as 1938,around 18 percent of British over-seas assets were in Asia, and 11 per-cent in Africa. British investment indeveloping economies principallytook the form of portfolio invest-ment in infrastructure, especiallyrailways. But the British also sankconsiderable sums directly intoplantations to produce new cashcrops like tea, cotton, indigo, andrubber.

Why were British investors will-ing to risk such an exceptionallyhigh proportion of their savings bypurchasing securities or otherassets overseas? One possibleanswer is that the adoption of thegold standard by developingeconomies offered investors a “GoodHousekeeping seal of approval.”

Yet there is a need to distinguishhere between anticipated and actualreturns on overseas investments. Forthe period 1850 to 1914, anticipat-ed returns were not significantlylower on colonial bonds than theywere on other foreign bonds. But thesame cannot be said of the actualreturns. In a sample of 11 majorcapital-importing economies, if onetakes an average of the three colo-nial countries – Australia, Canada,and Egypt – the anticipated yieldwas 5.3 percent, compared with4.7 percent for the three SouthAmerican countries in the group.But the actual returns were signifi-cantly different: 4.7 percent as

against 2.9 percent. So when thesame countries returned to the bondmarket in the inter-war years, theypaid significantly different risk pre-mia. On average, the returns LatinAmerican borrowers had to offerinvestors were 270 basis pointshigher than those on new colonialissues. Even so, actual returns onLatin American bonds were onceagain worse than expected andworse than those on colonial bonds.

n other words, money invest-ed in a de jure British colonysuch as India, or in a colonyin all but name like Egypt,was more secure than money

invested in an independent countrysuch as Argentina. This was becausethe commitment to the gold stan-dard was essentially voluntary. Goldstandard members who were sover-eign states could not only suspendgold convertibility in an emergency,they could also default on debts. To

varying degrees and at varioustimes, Argentina, Brazil, Chile,Mexico, Japan, Russia, and Turkeyall did. But British colonies wereunlikely to suspend convertibilityand not much more likely to defaultthan Britain herself.

In addition to the cast-iron com-mitment of colonial governors andadministrators, a variety of explicitlegal guarantees offered by theColonial Loans Act (1899) and theColonial Stock Act (1900) gavecolonial bonds the same “trusteestatus” as the benchmark Britishgovernment perpetual bond, theconsol. It was inconceivable,declared the Governor of the GoldCoast in 1933, that the interest dueon Gold Coast bonds should be com-pulsorily reduced: why shouldBritish investors “accept yet anotherburden for the relief of persons inanother country who have enjoyedall the benefits but will not accepttheir obligation”?

This sentiment explains why anincreasing share of British overseasinvestment ended up going to theEmpire after the First World War(see Chart 2). Between 1856 and1914, approximately two-fifths of

Sternbusiness 27

100

90

80

70

60

50

40

30

20

10

01900-14 1919-23 1924-28 1929-33 1934-38

39

66

59

70

86

CHART 2

IMPERIAL SHARE OF NEW CAPITAL ISSUES IN LONDON, 1900-1938 (AVERAGE PER YEAR)

I

“A striking number of the things currently recommended by

economists to developingcountries were in fact

imposed by British rule.”

British overseas capital went to theEmpire. But between 1919 and1938, the Empire received two-thirds of such investment while therest of the world got one third. Noris it surprising that more than three-quarters of all foreign capital invest-ed in sub-Saharan Africa wasinvested in British colonies.

Encouraging ImportsFor much of the 19th and 20th

centuries, British economic policywas heavily influenced by the finan-ciers of the City of London, withtheir ethos of “gentlemanly capital-ism.” International finance came firstand British export industries a poorsecond. In order to ensure that loansto developing economies were repaid,British policy-makers were preparedto go to considerable lengths, ulti-mately allowing a system of differen-tial tariffs to evolve that gave colo-nial manufacturers easier access tothe British home market than British

manufacturers enjoyed to colonialmarkets.

The British did not see the eco-nomic development of Asia andAfrica as their primary concern.Nevertheless, the intended policy offinancial rather than industrialdomination of the world economyhad secondary positive outcomes.Under the right circumstances, thispolicy was conducive to rapid eco-nomic growth on the periphery.

The results of Anglobalization

were in many ways astounding. Thecombination of free trade, massmigration and unprecedented over-seas investment propelled largeparts of the Empire to the forefrontof world economic development.Canada, Australia, and New Zealandproduced more manufactured goodsper capita than Germany in 1913.Between 1820 and 1950, theireconomies were the fastest growingin the world. Indeed, per capitaGDP grew more rapidly in Canadathan in the United States between1820 and 1913 (see Chart 3).

The Asian ExceptionBut the performance of the

Dominions was not matched in therest of the Empire, least of all inAsia. India attracted £286 million ofcapital raised in London between1865 and 1914 – 18 percent of thetotal placed in the Empire, secondonly to Canada. But between 1857and 1947, Indian per capita GDPgrew by just 19 percent, comparedwith an increase in Britain of 134percent. Chart 3 shows thatbetween 1820 and 1950, it grew ata mere 0.12 percent per annum.

The nationalist explanation forIndian “underdevelopment” underBritish rule has four essential com-

ponents. First, the British de-industrialized India by opening itto factory-produced textiles fromLancashire, whose manufacturerswere initially protected from Indiancompetition. Secondly, they imposedexcessive and regressive taxation.Thirdly, they drained capital fromIndia, even manipulating the rupee-sterling exchange rate to their ownadvantage. Finally, they did next tonothing to alleviate the famines thatthese policies caused. This negativeview of the British role in India con-tinues to enjoy wide currency.

Yet recent research casts doubt onkey aspects of the nationalist cri-tique. Economic historian TirthankarRoy has shown that the destructionof jobs in the Indian textile industrywas probably inevitable, regardlessof who ruled India, and that an equalif not greater number of new jobswere created in new economic sectorsbuilt up by the British. Even in thecase of textiles, by the 1920s theGovernment of India was clearly giv-ing preference to Indian manufactur-ers over Lancashire’s mills. Roy alsocasts doubt on the idea that taxationunder the British was excessive. Andthe supposed drain of capital fromIndia to Britain turns out to havebeen comparatively modest: only

2.0

1.5

1.0

0.5

0.0

-0.5

1.79

Dominions USA UK Africa Other Asia India

1.57

1.08

0.55

0.38

0.12

-0.24

CHART 3THE AVERAGE ANNUAL GROWTH RATE OF PER CAPITA GDP, 1820-1950

China

28 Sternbusiness

“Money invested in a dejure British colony suchas India, or in a colony

in all but name likeEgypt, was more securethan money invested inan independent country

such as Argentina.”

“about 0.9 to 1.3 percent of Indiannational income from 1868 to the1930s,” according to one recent esti-mate of the export surplus.

oreover, British rulehad some distinctlypositive effects. Itgreatly increased theimportance of trade

to India, from between 1-2 percentof national income to over 20 per-cent by 1913. The British created anintegrated Indian market: they uni-fied weights, measures and the cur-rency, abolished transit duties and,in Roy’s words, introduced a “legalframework [which] promoted pri-vate property rights and contractlaw more explicitly.” Between 1891and 1938, the acreage under irriga-tion more than doubled. The Britishintroduced a postal and telegraphsystem, deployed steamships oninternal waterways, and built morethan 40,000 miles of railway track(roughly five times the amount con-structed in China in the same peri-od). The railway network aloneemployed more than a million peo-ple by the last decade of British rule.Finally, there was a significantincrease in financial intermediation.By comparison with the other majorAsian empire – China, whichremained under Asian political con-trol – India fared well.

The explanation for the disap-pointing impact of these improve-ments in per capita incomes lies notin British exploitation, but rather inthe insufficient scale of British inter-ference in the Indian economy. TheBritish expanded Indian education –but not enough to make a realimpact on the quality of human cap-ital. The British invested in India –but not enough to pull most Indianfarmers up off the base line of sub-sistence. The British built hospitalsand banks – but not enough to makesignificant improvements in publichealth and credit networks. These

were sins of omission more thancommission. Unfortunately forIndians, the nationalists who cameto power in 1947 drew almost com-pletely the wrong conclusions aboutwhat had gone wrong under Britishrule, embarking instead on a pro-gram of sub-Soviet state-led autarkywhose achievement was to widenstill further the gap between Indianand British incomes, which reachedits widest historic extent in 1973.

Economic historians continue todebate the causes of the “great diver-

gence” of economic fortunes whichhas characterized the last half millen-nium. In this debate, the role of colo-nialism – and specifically the BritishEmpire – has a crucial role to play. Ifgeography, climate, and disease pro-vide a sufficient explanation for thewidening of global inequalities, thenthe policies and institutions exportedby British imperialism were of mar-ginal importance. However, if the keyto economic success lies in the adop-tion of legal, financial, and politicalinstitutions favorable to technicalinnovation and capital accumulation,then it matters a great deal thatbetween around 1880 and 1940 aquarter of the world was underBritish rule.

In all likelihood, the dichotomybetween geography and institutions isa false one. The British settled inlarge numbers in temperate zones,taking their institutions with them; inthe tropics, they preferred to rely onmonopoly companies and plantationsrun in (unequal) partnership withindigenous elites. But by the last third

of the 19th century this distinctionhad faded somewhat. Even in thetropics, the British endeavored tointroduce the institutions that theyregarded as essential to prosperity:free trade, free (and indeed forced)migration, infrastructural invest-ment, balanced budgets, soundmoney, and the rule of law and incor-rupt administration. If the resultswere much less impressive in Africaand India than they were in thecolonies of British settlement, thatwas because even the best institu-tions work less well in landlocked,excessively hot, or disease-riddenplaces. There, the investmentswhich would have been needed toovercome geography, climate, and itsattendant deleterious effects onhuman capital were beyond theimaginings of colonial rulers.

Yet it is far from clear that the verydifferent policies adopted by post-independence governments and inter-national agencies have been moresuccessful. A simple calculation of theratio of British per capita GDP to thatof 41 former colonies is instructive.Between 1960 and 1990 the gapbetween the British and their formersubjects narrowed in just 14 cases.While it is convenient for contempo-rary rulers in countries like Zimbabweto blame their problems on the “lega-cy of British rule,” the reality is thatBritish rule was on balance conduciveto economic growth. Tragically, mostpost-independence governments havefailed to improve on it.

NIALL FERGUSON is Herzog professorof financial history at NYU Stern andvisiting professor of history at OxfordUniversity.

His most recent book is Empire: TheRise and Demise of the British WorldOrder and its Lessons for Global Power(Basic Books), from which this article isadapted.

© Niall Ferguson 2003. Sternbusiness 29

M“The combination of free

trade, mass migration andunprecedented overseas

investment propelledlarge parts of the Empireto the forefront of worldeconomic development.”

30 SternbusinessILLUSTRATIONS BY CHRIS MCALLISTER

DON’T CRY FORA R G E N T I N A

PAUL WACHTEL: Should Argentina have

left the currency board?

DOMINGO CAVALLO: When a domestic

currency has to compete with foreign cur-

rencies you have to create some credibility

so you need a tutor. Most modern curren-

cies had gold as a tutor during the gold

standard period. More recently, it’s been

the dollar. And we thought that using a tutor

for a while would be important. The time to

exit the currency board and abandon the

tutor is when your currency has become

credible. Argentina could have exited the

currency board in 1997 after having avert-

ed the devaluation forecasted at the time.

The currency was growing very fast and

there was a significant inflow of capital. If

the Central Bank had let the peso float,

it would have appreciated vis-a-vis the

dollar. That’s what happened with

Singapore in the 1970s, and they start-

ed to have a strong currency.

But Argentina didn’t abandon the cur-

The continuing crisis in Latin America’s third largest economy is a matter of globalconcern. At a Stern event, Argentina’s former Economic Minister and a former governorof its Central Bank dissect the roots of the nation’s problems – and point toward solutions.

Sternbusiness 31

he collapse of the Argentinian economy has been one of the most hotly

debated economic events of the past year. Fiscal and monetary reforms

enacted in the late 1980s seemed to tame the country’s cycle of hyper-

inflation and devaluation. In 1991, Argentina established a currency

board, under which the value of the peso was pegged directly to that of

the U.S. dollar. After several years of growth in the mid-1990s, the Argentine economy

began to slip into recession. And as government deficits rose and the solvency of the

banking system came into question, depositors began to withdraw their funds. Amid social

unrest, Argentina announced in late 2001 that it would stop paying interest on its $155 bil-

lion in foreign debt – the largest such default in history. In January 2002, it abandoned

the currency board and let the peso float against the dollar. Within a month, the peso had

lost half its value, destroying savings and rendering borrowers unable to repay debts.

At NYU Stern on November 26, 2002, a distinguished panel gathered to discuss the

Argentinian crisis and its implications. It included: Domingo F. Cavallo, the Henry Kaufman

Visiting Professor at NYU Stern, who served as Minister of Finance for Argentina from 1989

to 1996 and was the architect of the currency board; Mario Blejer, a former governor of the

Central Bank of Argentina and currently Director, Bank of England Centre for Central

Banking Studies; and Nouriel Roubini, associate professor of economics at NYU Stern, and

a former senior economist for international affairs at the White House Council of Economic

Advisers. NYU Stern Economics Professor Paul Wachtel moderated the discussion.

T

rency board for a very simple reason. As

part of the competition for the presidency in

1999, the government was trying to finance

very large deficits of the provincial govern-

ments. [Then-President] Carlos Menem

would call the private banks and get them to

provide financing to the provinces. This fis-

cal management, which stemmed from the

political competition, prevented the govern-

ment from taking the natural opportunity to

exit the currency board.

WACHTEL: Let me ask Mario about that,

and more generally, whether emerging

economies should maintain currency

boards?

MARIO BLEJER: I’d distinguish between

the currency crisis and the crisis in confi-

dence. Governments were clearly afraid of

abandoning the one-to-one peso to dollar

peg. In 1997, the main constraint was the

cost. They didn’t want to have the risk of

having the currency first appreciate and

then depreciate. The IMF put out a paper

that concluded you should exit currency

boards when things are good. This is

appealing academically, but it’s not practi-

cal advice. It’s like saying you should have

a divorce when the marriage is going well.

The crisis really stems from the incon-

sistency between fiscal policies and the

saving investment balances. The sharp

increase in the government’s fiscal deficit

brought a very high increase in the interest

rate spreads. The convertibility of the peso

to the dollar helped bring down hyper-infla-

tion in Argentina, but this rigidity imposed

certain constraints on the conduct of

macro-economic policy that were not

respected.

NOURIEL ROUBINI: I'd like to put

Argentina in the context of other emerging

market crises we’ve seen in the last

decade in Mexico, Thailand, Korea,

Malaysia, Indonesia, Russia, Brazil, and

most recently in Turkey. One of the lessons

we've learned from all these episodes is

that capital markets tend to collapse. And

when this happens, emerging markets

tend to move either toward flexible

exchange rates or toward hard pegs. Until

recently I think people categorized dollar-

ization and currency boards as among the

hard pegs. But after what happened in

Turkey and Argentina, we realize that if

your policies are not consistent, even a

currency board can collapse.

In each crisis, fixed exchange regimes

collapsed and there was some overvalua-

tion of the currency. That led to current

account deficits, which led to an accumu-

lation of foreign debt or foreign liabilities.

When you have a current account deficit,

you can finance it either by equity inflows,

or in the form of debt. These countries all

had too much debt and too little equity.

And eventually that means the banks are

going to be in trouble. Argentina met most

of these conditions. Two thirds of

Argentinian bank assets were in debt to

households or to the government, which

was borderline insolvent.

How can countries be less vulnerable

to financial crisis? First of all, you need

sound macroeconomic and fiscal policy.

And if you're an emerging market, you

have to overachieve. Countries like this

should have debt ratios that are lower than

those of developed countries. Having

a sustainable exchange regime means

either you pay the cost of dollarization –

and few countries are truly willing to do so

– or otherwise go to a floating regime and

maybe use inflation targeting or some other

anchor as a way to stabilize inflation. You

can use regulation to reduce the currency

mismatch by encouraging more equity

investment. And if you have periods in

which hot money is flowing in, some con-

trols on inflows of capital may be useful.

WACHTEL: So, Domingo views the dollar

as a tutor, Mario views the dollar as not

being responsible, and Nouriel views the

dollar as being a monster that helped cre-

ate the crisis. Perhaps we can turn our

attention back to the present situation in

Argentina, and ask what are the prospects

for policy and economic reform in

Argentina?

BLEJER: To restore and start rebuilding

confidence you need to pacify some sec-

tors, like the foreign exchange market. I'm

not talking about the need to fix the

exchange rate, but the need to stop chaos.

Certain types of capital control may restore

that sort of confidence. The situation in

January 2002 was very chaotic in

Argentina: a lack of confidence in the peso,

the abolition of convertibility, and a lack of

confidence in the government.

The supposed outcome at that point

would have been hyper-inflation, and the

total collapse of the financial sector. We’ve

avoided that so far. You have to intervene in

the foreign exchange markets, provide liq-

uidity to the banking sector, and have a

very active and aggressive monetary

policy with very high interest rates.

These are the preconditions for a turn-

around. The question is if the turnaround

can be sustained. The problems are daunt-

ing, because the foreign and domestic

debt has not been negotiated, wages are

frozen, and inflation is 40 percent.

CAVALLO: For economic growth, you

need strong institutions. And for that, you

need a well-functioning political system.

The historical problem was that

Argentinians in general did not consider

paying debts as something that you had to

do. In a sense inflation was a reflection of

that attitude. The government would print32 Sternbusiness

"The convertibility ofthe peso to the dollar

helped bring downhyper-inflation in

Argentina, but thisrigidity imposed certain

constraints on theconduction of macro-economic policy thatwere not respected."

money to finance its deficit, and would per-

manently devalue the currency to soften its

domestic debt. Of course in a country in

which nobody honors their debt, there is no

credit.

In the 1990s, the convertibility law – not

the currency board – but the convertibility

law, made the difference. So did the deci-

sions to have savings protected by dollars

and the emphasis we put in legislation on

honoring obligations and fighting tax eva-

sion. Our development in the 1990s was

really financed from domestic savings. And

that permitted the incredible expansion of

the banking system, from $10 billion up to

$80 billion, and the creation of the pension

funds. This modernized much of the econ-

omy and created an increase in productiv-

ity, particularly in traditional export sectors

like agriculture.

As for the next decade? If the old ideol-

ogy that destroyed savings, prevented

investment, and generated inflation in the

past, rules the day, then the first decade of

the new century will be a lot like the 1980s.

The 1980s started with a default, and we

struggled with foreign creditors. Eventually,

it will wind up in the complete collapse of

the monetary and financial system through

inflation.

Argentina has realized that the rules of

the game of the 1990s were much superior

to the previous rules. The recent rule

changes did not come about because the

markets forced them. They were created

by big private sector debtors associated

with the governors and with some politi-

cians.

Building institutions is a very difficult

political task. But I think these problems will

be fixed, because fortunately we have a

republic. I think the judiciary will force the

executive and the legislative power to

reverse many of the decisions that were

adopted. The functioning of the constitutional

system is more important than any question

related to the exchange rate system.

ROUBINI: There's no disagreement thatinstitutions matter. But compare HongKong and Argentina. They both had a cur-rency board. Hong Kong in 1998 had amajor shock. But there was no budgetdeficit, no public debt problem, a verydynamic economy, and high productivitygrowth. They cut wages by 15 percent andthat's how you achieve the real devalua-tion. In Argentina, you have a large publicdebt, a large budget deficit, a currentaccount deficit, and rigid labor markets.When you have a bunch of shocks, eventu-ally the regime collapses. So institutionsmattered, but having also some policiesmattered as well.

On convertibility, I'll be really blunt. Ithink they lived under the delusion that onepeso was one dollar. You know these cur-rencies tend to collapse, so one peso isworth much less than a dollar. What’s more,the peso-based assets were loans made toa government that was bankrupt. So theidea that a dollar in a Buenos Aires bank isthe same thing as a dollar in Miami or NewYork was a false idea.

CAVALLO: I’d argue that the illusion thatArgentina had that we were saving dollarsis exactly the same illusion that people inTexas had that they were saving in dollarsafter the collapse of the price of oil in thelate 1980s.

ROUBINI: But that's why all those savingsand loans and oil companies went bank-rupt in Texas.

CAVALLO: But they went bankrupt in spiteof the fact that the dollar was the Americancurrency. If relative prices go down – like ifthe price of oil plummets – of course all thesectors whose income is tied to thoseprices will have a problem. You can’t solve

that with any monetary regime.

BLEJER: Saved in pesos, in dollars, or inchewing gum, the banking crisis wouldhave happened because the governmentwas crowding out the private sector. Thegovernment was pushing bonds into thebanking sector. And this has nothing to dowith the exchange rate.

CAVALLO: He’s right. We created the cli-mate for getting a lot of financing from ourcitizens, because they were convinced thatthey were saving dollars and that their sav-ings were protected. They left their savingsin the country and that generated credit.But if this facility for credit simply allows thegovernment to raise funds, and thegovernment wastes those resources andaccumulates debt, of course it’s bad. Thequestion is how to keep the savings andcreate credit while also protecting propertyrights of the people. The answer is toimpose discipline on the fiscal sector toprevent the misuse of those savings.

BLEJER: Without macro-economic stabil-ity you are not going to have investmentand growth. Argentina has paid a tremen-dous high price for this crisis, no doubt.Today more than 50 percent of the popula-tion lives below the poverty line, 25 percentare below what's called extreme poverty.Unemployment is 22 percent. I think thatthere is basic agreement in the fact that oneneeds to rebuild a different framework, butat the same time one has to be very carefulto implement macro-economic policies thatare conducive to the recuperation of confi-dence of credibility.

Sternbusiness 33

"Two thirds ofArgentinian bank

assets were in debtto households or to

the government,which was borderline

insolvent."

"The idea that a dollar in a BuenosAires bank is thesame thing as a

dollar in Miami orNew York was a

false idea."

34 Sternbusiness

al-Mart bestrides the mammoth U.S. retail market like a colossus. The original category-

killer, it has branched out from hard goods into groceries and electronics. Even amid the

recent economic slowdown, Wal-Mart has seen its sales grow at a rate far faster than that

of its customers. Through the first 11 months of 2002, the store tallied a stunning $227 billion in sales.

But outside the U.S. borders, Wal-Mart’s performance has not been quite as impressive. Through

November of 2002, the company’s 1,227 stores outside the U.S. counted $38 billion in sales. While the

number is certainly impressive, Wal-Mart has occasionally found it difficult to export its successful retail

paradigm.

Wal-Mart has been highly profitable in markets that are geographically close to the U.S., such as

Canada, and Mexico, and that are culturally similar to the domestic market, such as the United Kingdom.

But it has struggled in significant markets, such as Argentina, Brazil, and Germany. In these latter

countries, Wal-Mart has incurred huge losses and tallied consistently poor same-store sales comparisons.

And it is too early to say whether its efforts to expand into China have borne fruit.

THE BIG STORE GOES

GLOBALWhat retailers can learn from Wal-Mart's international expansion

By David Liang

Sternbusiness 35

W

ILLU

STR

ATIO

NS

BY

CH

RIS

MC

ALL

ISTE

R

resolve is how to get the right prod-ucts from suppliers at the right priceand at the right time. In the U.S.,established retailers have powerfulleverage over suppliers that they canuse to obtain products at the lowestcosts. And because Wal-Mart is sucha large customer of so many suppli-ers, it can demand and receive thebest prices. This ability is whataccounts for Wal-Mart’s higherprofit margins and its ability to passalong value to customers in the formof low prices. But in overseas mar-kets, in which a new retailer’s pres-ence is still relatively miniscule, it isa different story. Overseas suppliersmay know of Wal-Mart, but theymay not have a record of doing busi-ness with the company. As a result, arecent arrival usually does not startwith significant leverage power oversuppliers.

Because local suppliers may notbe familiar with the new entrant,they may refuse to comply with itsdemands on product quality anddelivery speed. Local suppliers maysee little reasons to change theiroperations to accommodate a newentrant with low order volume.Wal-Mart’s operation in Brazil andArgentina provides a perfect exam-ple. After eight years in these largeSouth American countries, Wal-Mart is the sixth-largest player, with11 stores in Argentina and 22 inBrazil. As such, Wal-Mart has farless leverage over local supplierscompared with that enjoyed by themarket leader, Carrefour, which hasbeen operating in those countries formore than three decades.

Wal-Mart also faces a similarchallenge in Germany, where its 94stores give it between two percentand four percent of the local market.Recently, a Mercer Consulting retailspecialist noted that Wal-Mart mustincrease its share of the Germanretail market to at least ten percent

Customers

InputsOfferingO F F E R I N G & B R A N D

Offering

AccessA C C E S S Acc

ess

SegmentationS E G M E N T A T I O N

CustomersC U S T O M E R S

Technology

Inputs

T E C H N O L O G Y OperationO P E R A T I O N

CHART 1: SOURCES OF COMPETITIVE ADVANTAGE

hy is it so difficultfor a retailer likeWal-Mart, which isuniversally recog-nized as one of the

world’s shrewdest merchants, toreplicate its domestic success inoverseas markets? And what lessonscan other retailers learn from Wal-Mart’s expansion overseas? Asshown in Chart 1, retailers typi-cally distinguish themselves fromtheir domestic competition throughseven main sources of competitiveadvantage including: Inputs,Operation, Offering, Brand, andAccess. It’s hard enough to replicate

one of these sources in a new cli-mate, especially one where you aregoing up against established com-petitors. But to pull off all of them –which Wal-Mart needs to do to inorder to dominate foreign consumermarkets as it does the U.S. – isextremely difficult. And when retail-ers fail to replicate these sources ofcompetitive advantage overseas,their performance in the new mar-kets can be mediocre.

Superior InputsWhen retailers expand overseas,

one of the most crucial issues to

W

I N P U T S

36 Sternbusiness

THE BIG STORE GOES GLOBAL

before it can exert power over localsuppliers. And until it does, Wal-Mart may find it difficult to competewith German retailers for superiorinputs.

Superior OperationFor retailers in general, and for

Wal-Mart in particular, building andmaintaining an efficient operationis another source of low costs, andhence competitive advantage.Operation here is defined as thelogistical distribution network thatfacilitates goods flow from manu-facturers to retail customers. Thecompany’s logistics and inventorycontrol systems, which Wal-Martbuilt to service far-flung stores fromits rural Arkansas base, have longbeen the envy of the retail industry,and of plenty of other industries.

A new entrant can either buy anexisting distribution network orbuild one from scratch. Whenentering a developed country, it isgenerally easier to buy than to build.First, local players in a developedcountry usually have efficient logis-tical networks and sophisticatedoperations. Second, a new entrantcan use an acquisition to avoiddealing with heavy regulations thatcommonly exist in developed mar-kets, which often hinder a newentrant’s efforts to build fromscratch. And so in entering WesternEuropean countries, such as theU.K. and Germany, Wal-Martacquired local players – but withdifferent results.

In the U.K., Wal-Mart’s 1999acquisition of ASDA proved success-ful. It was immediately profitableand made Wal-Mart the third largestmass merchandiser in the U.K., with258 stores. The deal worked for tworeasons. First, ASDA, like Wal-Mart,had an efficient distribution net-work strategy. Second, before theacquisition, ASDA followed pricing

and promotional strategies that weresimilar to those of Wal-Mart. TheASDA acquisition was so successfulthat Wal-Mart was reluctant toimplement new changes. In fact,according to BusinessWeek, Wal-Mart learned a few lessons fromASDA in food merchandising andstaff incentive programs.

In Germany, however, Wal-Mart’sacquisitions of Wertkauf (1998) andInterspar (1999) were less suc-cessful because Wal-Mart had tointegrate two companies with differ-

ent logistical distribution schemes.According to the Financial Times,local suppliers initially were so con-fused with the combined networksthat in the first few years of opera-tion, Wal-Mart stores in Germanysuffered many stock-outs. Needlessto say, integration issues play crucialroles in determining the success ofan acquisition.

When entering a developingcountry, by contrast, it is generallybetter to build from scratch for tworeasons. First, local players in devel-oping countries usually do not haveefficient distribution networks. Thismeans a new entrant has to create anew distribution network to meet itsneeds. Second, regulations in devel-

oping markets are usually not asrestrictive as those in developedcountries. In China, however, Wal-Mart built its logistical distributionnetwork from scratch because mostChinese retailers are either ownedby, or affiliated with, the govern-ment, and their distribution net-works are mostly inefficient. Inaddition, Chinese geographic anddemographic patterns resemblethose of the United States, whichmakes it possible to replicate thescale of U.S. operations. In a recentinterview with Newsweek, Wal-MartInternational CEO John Menzer saidthat Wal-Mart’s Chinese operationshad the potential to grow from 25stores today to 3,000 by 2028.

There’s a third alternative forentering markets. Instead of an out-right buy or build strategy, a newentrant can also choose a local jointventure partner. This choice is par-ticularly desirable if a new entranthas little international experience,little local market expertise, orwants to limit its risk exposure. Thedrawback is that the new entrantmay have to compromise on funda-mental issues ranging from storename to merchandising mix. In1991, Wal-Mart picked Mexico asthe first international market toenter. It chose the Mexican discountsupermarket chain Cifra as its joint-venture partner, and Cifra’s localmarket expertise greatly compensat-ed for Wal-Mart’s lack of interna-tional experience. More than adecade later, Wal-Mart’s 595-storejoint-venture operation in Mexico isprofitable. The company is noweven starting to use the Wal-Martname in its newly opened store unitsrather than the local Aurrera,Bodega, and Suburbia store names.

Superior OfferingSuperior product offering is a

critical element of retailers’ success.

"In Germany...Wal-Marthad to integrate two

companies with differentlogistical distribution

schemes...local suppliersinitially were so confused

with the combined networks that in the firstfew years of operation,

Wal-Mart stores inGermany suffered many

stock-outs."

Sternbusiness 37

Wal-Mart is distinguished by itsability to offer thousands of prod-ucts – including brand names – atlow prices. But because a new retail-er who expands into new overseasmarkets often lacks superior inputs,operation or both, the new entrantmay often lack superior productoffering. As a result, the valueproposition may differ across geog-raphy. In the U.S., Wal-Mart canoffer the greatest value relative to allits competitors because of its domi-nant position over suppliers. InArgentina and Brazil however, Wal-Mart’s product offerings are general-ly priced higher than those ofCarrefour. That means Wal-Marthas to differentiate itself from thecompetition in South America basedon other factors.

Of course, a retailer can only pro-vide superior product offerings if ithas an intimate knowledge of itscustomers’ desires and needs.Frequently, however, global retailers

fail to conduct the due diligencenecessary to gain such knowledge.As a result, new retailers often carryproduct offerings that do not meetlocal tastes. According to an articlein The New York Times, when Wal-Mart first opened its doors inArgentina in 1995, its stores carriedthe 110-volt appliances commonlyfound in the U.S. – even though thelocal voltage standard in Argentinais 220-volt. Wal-Mart’s first storesalso carried merchandise favored byU.S. consumers, but that did notappeal to local Argentine tastes.After a period of trials and errors, asWal-Mart began to imitate localcompetitors’ product offering, itssales in Argentina and Brazilimproved.

Wal-Mart learned from its mis-takes in Argentina when enteringthe Chinese market. Wal-Mart’sChinese stores are stocked with localdelicacies like barbecued pigeons,live frogs, fish, and snakes – a far

cry from what you’d see in a Wal-Mart in Denver, Colorado. The aislesare made wider and checkout coun-ters shorter to accommodateChinese customers’ habits of makingmore frequent shopping trips perweek but buying smaller quantitiesper trip. On average, Chinese cus-tomers shop groceries on a dailybasis while U.S. customers shop atWal-Mart about two times a week.Wal-Mart also adjusts its shoppingbags to fit the needs of Chineseshoppers who mostly still travel bymotorcycles or bicycles. In Korea,where real estate is expensive, Wal-Mart builds multi-level stores – fourlevels for parking and three forshopping – as opposed to the single-level sprawling warehouse formatcommonly found in the U.S.

Superior BrandThe final ingredient of a success-

ful international retailer is thebrand. Branding creates special

"A retailer can

only provide

superior product

offerings if it

has immediate

knowledge of

its customers’

desires and

needs."

38 Sternbusiness

THE BIG STORE GOES GLOBAL

relationships between products andcustomers. It adds special meaningsto products beyond their functional-ity. Coca-Cola means refreshingdrinks; Sony signifies high-qualityconsumer electronics; Gap standsfor comfortable casual clothing; andWal-Mart means value shopping andeveryday low price (EDLP). For anycompany, whether it’s a serviceprovider like UPS, or Coke, orMcDonald’s, it’s the ultimateachievement to have your brand rec-ognized on a global basis. Creating aglobal retail brand, however, can bechallenging because retailers gener-ally don’t have a tangible product torepresent what the brand is all about– the way that a Sony VCR rep-resents high quality consumerelectronics for the Sony brand. Tocreate branding relationships withcustomers, a retailer is highlydependent on the overall shoppingexperience, which is influenced byfactors such as pricing, merchandisemix, store atmosphere, and cus-tomer service friendliness.

The more crowded a segment is,the harder it is for a new entrantto uniquely position its brand.According to The Economist, 30 per-cent of the German retail industry isdominated by local deep discoun-ters; and a price cut by one retaileris quickly matched by competitors.In this competitive environment,Wal-Mart’s everyday low price mes-sage did not revolutionize the indus-try the way it did in the U.S. and theU.K. It is difficult for Wal-Mart todifferentiate itself and to uniquelyposition its brand in Germany as avalue and everyday low price brand.Wal-Mart faces a similar challengein Argentina and Brazil, where thecompany has five direct competitorswith more-entrenched brands. Bycontrast, in the U.S. market, Wal-Mart only faces one or two directcompetitors. In such crowded mar-

kets as Germany, Argentina, andBrazil, a new entrant like Wal-Marthas to find alternative ways touniquely position its brand.

Another aspect of branding thatretailers must consider whenexpanding overseas is whether to usethe original American name oradopt a local name. In most cases,

the first option seems to be the mostpopular among retailers because itallows for building global brandawareness. The second option, how-ever, may resonate well with localconsumers and may somewhat alle-viate anti-Americanism that existsin many foreign countries. Eitherway, there is no clear-cut evidencethat one choice affects profitabilitymore than the other.

There is no noticeable differencein results whether a new entrantuses its original American name or anew local name in a new overseasmarket. But one thing is clear: thenew entrant must build its brand inthat new market. For when all else isequal (pricing, product offering,shopping atmosphere, customerservice), the store brand is the onlything that differentiates a newentrant from competitors.

Superior AccessFinally, a retailer’s survival is

highly dependent on its access strat-egy. With the exception of upscaleretailers, most retailers wish to

expand to as many store locations aspossible because widespread storelocations make it easier for cus-tomers to reach its stores and createa feeling of familiarity. In additionto familiarity, having numerousstores in a particular countryincreases economies of scale. Itspreads retailers’ fixed costs across alarger base and enhances the retail-ers’ leverage power over suppliers.In overseas markets like China,Wal-Mart builds not only largesupercenters, but also smallerneighborhood markets to takeadvantage of high consumer trafficsin urban centers.

Exporting to “the five key”sources of competitive advantage isa must for a retailer wishing to entera foreign market. While missing oneor some of these elements does notmean a new retailer cannot reachprofitability in new markets, it willprevent the new entrant fromachieving its full profitabilitypotential.

From Coca-Cola to Starbucks,from McDonald’s to Polo, many U.S.companies have excelled in takingsuccessful domestic brands andoperating systems, and exportingthem overseas. Wal-Mart, which hashad such tremendous success in thedomestic market, has faced someobstacles in its international efforts.But as it learns from mistakes andfrom its encounters with differentretailing and business cultures, theretailing giant based in ruralArkansas will surely continue toexpand its presence throughoutthe globe.

DAVID LIANG is a second-year MBAstudent at NYU Stern. This article waswritten under the supervision of MarcoProtano, visiting associate professor ofmarketing and John Czepiel, professorof marketing at NYU Stern.

Sternbusiness 39

"Wal-Mart’s Chinesestores are stocked with

local delicacies like barbecued pigeons, livefrogs, fish, and snakes –

a far cry from whatyou’d see in a Wal-Martin Denver, Colorado."

IT’S A SMALLWORLD

AFTER ALL?By Jonathan Heathcote and Fabrizio Perri

In recent years, the economies of the United States and itslargest trading partners have increasingly marched to their

own drummers – even as trade and financial integration haveincreased. It may sound like a paradox, but it's not.

n recent years, the UnitedStates economy has increas-ingly danced to its own tune.Between 1972 and 1986 the

business cycles of the U.S., on theone hand, and an aggregate ofEurope, Canada, and Japan, on theother, were rather close. But in morerecent years, in a trend we’vedubbed real regionalization, thepaths of these developed economieshave diverged. All the major worldeconomies went, synchronously,through a deep recession in 1973, arecovery in the mid- 1970s andanother recession in the early1980s. In the 1990s, by contrast,the U.S. experienced robust growth,Europe was mixed, while Japan andAsia experienced their worst post-war decade.

At the same time though, trade ininternational financial assets – or

financial globalization – has sharplyincreased, with Americans holdingfar more direct investment and equi-ty in foreign markets, and foreignersinvesting more in the U.S. markets.

Does one trend have anything todo with the other? Does financialglobalization help explain realregionalization? Or vice versa? Thusfar, very little research hasaddressed the effects of growth inforeign asset holdings on businesscycle dynamics. By constructingmodels of how economies function,and then running experiments, weset out to answer these questions.

Going Separate WaysThe divergence among economies

in the post-Bretton Woods period –1972-2000 – can be seen in thedecline in cross-regional correlationsin business cycle frequency fluctu-

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ations in factors such as GrossDomestic Product, consumption,investment, and employmentbetween the U.S. and an aggregateof the rest of the world (comprisingEurope, Japan, and Canada) (seeTable 1). The fact that the correla-tions of all four variables havedeclined markedly between the twoperiods stands as compelling evi-dence of real regionalization.

While the declines might be sim-ply due to a decline in the correla-tion of outside shocks – like theworldwide oil shocks in the 1970s –the relatively large falls in the cor-relations of investment andemployment suggest a change in theasset market structure. In particular,the development of internationalfinancial markets increases theopportunities for specialization inproduction in different countries.After all, when capital moves morefreely around the globe to pursueinvestment opportunities, economiesare less likely to move in sync.

Trading PlacesTo measure financial globaliza-

tion, we examined data on foreigndirect investment and purchases offoreign equity. For U.S. assets, thekey measure is the sum of the U.S.foreign direct investment (FDI)position and the equity part of thestock of portfolio investmentabroad, relative to the U.S. capitalstock. We focused on U.S. holdingsof assets in Western Europe plusCanada and Japan, and these coun-tries’ holdings of U.S. assets. Andthe data show that U.S. holdings of

foreign stocks have grown stronglysince the mid-1980s, while thestocks of FDI and foreign-ownedequity in the U.S. have risen steadi-ly over the entire period. Between1972 and 1999, United States grossholdings of FDI and equity in thisgroup of countries rose from four to23 percent of the U.S. capital stock.The observed growth in diversifica-tion appears to be robust to a widerdefinition of the rest of the world, tobroader classes of assets, and toalternative valuation methods.

For their part, Europe, Canada,and Japan jointly account for almostall foreign holdings of U.S. assets,and for the lion’s share of U.S. assetholdings abroad – although othercountries are attracting an increas-ing share of U.S. equity portfolioinvestment. Growth in diversifica-tion generally appears smaller whenstock market capitalization – andnot capital stock replacement costestimates – is used as a denominator.But even in this case we find strong

growth in the stocks of U.S. equityportfolio investment abroad andforeign direct investment in theU.S. Comparing the U.S. with theEurope/Canada/Japan aggregate,for example, U.S. holdings of foreignsecurities averaged 1.1 percent oftotal non-U.S. developed economiesmarket capitalization over the firsthalf of the sample, and 5.5 percentin the second half (see Figure 2).

There’s more evidence that linkstogether financial globalization andreal regionalization. Figure 1 dis-plays the evolution of correlation ofbusiness cycles and of internationalfinancial integration in the last 40years. The picture shows that untilthe mid-1980s the correlation ofbusiness cycles (left scale) was quitehigh and stable while the share offoreign assets over the total value ofU.S. assets (right scale) was stableand quite low (around five percent).Since the mid-1980s, the correlationof business cycles has markedlydeclined and the share of foreignassets has markedly increased.

The StoryWhy should real regionalization

and financial globalization be relat-ed? Our story is summarized inFigure 2. The driving forces are theshocks that shape both businesscycles and portfolio decisions. Theseinclude oil shocks, technology

Figure 1 Financial globalization and real regionalization

Foreign assets are stocks of US FDI and equity investments in Europe, Canada, and Japan. Investment correlation isthe correlation between US investment and investment in Europe, Canada, and Japan over the previous 58 quarters.

0.8

0.6

0.4

0.2

0.0

-0.2

-0.4

–

–

–

–

–

–

–

Cor

rela

tion

Fraction of US

capital stock

0.25

-0.20

-0.15

-0.10

-0.05

76 78 80 82 84 86 88 90 92 94 96 98| | | | | | | | | | | | | | | | | | | | | | |

–

–

–

–

–Investment correlation

Foreign assets

42 Sternbusiness

Table 1 International Correlation of Macroenomic VariablesBetween the U.S. and the Rest of the World

GDP Consumption Investment Employment

Period 1, 72Q1-86Q2 0.76 0.51 0.63 0.66

Period 2, 86Q3-00Q4 0.26 0.13 -0.07 0.03

IT’S A SMALL WORLD AFTER ALL

shocks, policy shocks, andother types of disturbancesthat affect a country’s macro-economic performance. Welabel them “productivityshocks.” Assume that the cor-relation of these shocks hasdeclined over time. This factobviously leads to less correlat-ed business cycles (Arrow 1).The reduction of the correla-tion also reduces the correla-tion of returns to capital; thesimple logic of risk reductionthrough diversification impliesthat when returns to capitalare less correlated it is more conven-ient to hold an internationally diver-sified portfolio. And thus financialglobalization arises (Arrow 2). Thefinal step is the link from financialglobalization to business cycle(Arrow 3). When people hold inter-nationally diversified portfolios,capital can easily flow from onecountry to another. Thus, inresponse to a small positive shock,say in the U.S., capital flows in fromEurope and from Japan. These flowsamplify the boom in U.S. andinduce a recession in Japan andEurope, thus making business cycleseven less correlated.

A Model EconomyTo test our story about the rela-

tionship between real regionaliza-tion and financial globalization, weused artificial (computer simulated)economies. The modeling frame-work we employed was developedby David Backus, Patrick Kehoe,and Finn Kydland in 1994. Using atechnique developed by RobertSolow in the 1960s we constructed aseries for the productivity shockshitting the U.S. and the rest of theworld and we showed that the corre-lation of these shocks has indeeddeclined. We then plugged in theprocess for shocks into the modeleconomies and ran tests upon them.

The tests we did were geared atanswering two questions. First, can

a fall in the correlation of productiv-ity shocks account for the magni-tude of the observed increase indiversification? And second, isincreased diversification importantin accounting for the magnitude ofthe observed decline in businesscycle correlations?

Regarding the first question, themodel economies predict that, inresponse to the fall in shock correla-tion, the amount of foreign assetsheld by domestic consumers shouldincrease from 5.5 percent to 15 per-cent of total asset holdings. Thissuggests that the correlation ofshocks is a quantitatively importantfactor in determining the extent ofinternational diversification.

Regarding the second question,the models show that both the fall inthe correlation of productivityshocks and the resulting endogenousgrowth in international asset tradeare essential elements needed toaccount for most of the observedchanges in the international busi-ness cycle.

ImplicationsA fall in the correlation of macro-

economic shocks has increasedequilibrium diversification byincreasing the potential gains frominternational asset trade. Thisincreased portfolio diversificationhas left asset holders less exposed tocountry-specific risk, and the flow

of capital to its most produc-tive location is increasinglyunhindered by restrictions oninternational borrowing andlending. The combination ofless correlated shocks and theresulting deepening of interna-tional asset markets canaccount for the observedchanges in the internationalreal business cycle.

This coincidence of realregionalization and financialglobalization has larger impli-cations. It says that while theworld may be coming together

financially, we should be ready tosee it growing apart economical-ly. This is not necessarily a badthing as households, by holding aninternationally diversified portfolio,can diversify away the risk specificto their country of residence.

It also sheds light on the causes ofthe recent trend toward recentfinancial integration. Our expla-nation relies principally on thecorrelation of macroeconomicshocks that we view as an importantdeterminant of the gain frominternational diversification.

Some researchers instead havefocused on the diffusion of informa-tion technology as a leading cause.But this explanation is difficultto reconcile with evidence fromthe Gold Standard years. Then,although information technologywas obviously not very welldeveloped, international finan-cial integration was, by somemeasures, as high as it is today. Andit is interesting to note that businesscycle correlations in those years alsoappear to be low. That suggests thatour explanation might work for thatperiod too.

J O N AT H A N H E AT H C O T E is anassistant professor of economics atGeorgetown University.

FA B R I Z I O P E R R I is an assistantprofessor of economics at NYU Stern.

Figure 2

(2)Driving force

(1)

(3)

Sternbusiness 43

Financial Globalization

Real Regionalization

Reduction in Correlation of Shocks

he telecommunicationsindustry – a greatengine of growth in the1990s – today facesserious financial diffi-

culties. Major bankruptcies haveoccurred; more may well follow.

In retrospect, it’s easy to seewhere the industry went wrong. Themassive expansion of fiber-opticcable capacity and of cable’s comple-mentary components was accompa-nied by rapid technological progressthat greatly expanded the economiccapacity of that fiber-optic cableand those components. Meanwhile,growth in demand for telecommuni-cations services turned out to be sub-stantially lower than was forecast.These conditions were aggravated bya significant slowing of the U.S.economy in 2001 and 2002. Therevelations of corporate governanceand accounting misrepresentationproblems that cropped up at severaltelecommunications companies havefurther exacerbated an already diffi-cult situation.

As a result, a great deal of capac-

ity, representing hundreds of billionsof dollars of investment, stands idle.Global Crossing, WorldCom, andAdelphia have already declaredbankruptcy, and the industry isn’tout of the woods yet.

There are no magical, painlesssolutions to these difficulties. But thetelecommunications industry is a keycomponent of the U.S. economy, acontributor to national security, anda source of innovation. So as policymarkers and investors grapple withhow to deal with the fallout, andhow to prevent further damage,there are important principles thatboth the public and private sectorscan and should be following.

With All Deliberate SpeedFirst, all parties involved must

acknowledge and recognize the loss-es and pain – and move on.

Massive losses always accompanya large and expensive increase ineffective capacity that is not matchedby an equivalent expansion indemand. Those losses must beabsorbed by someone. In the first

instance, the owner-shareholders ofthe companies that made the ill-fatedinvestments will absorb the losses.Following them will be the lendersand creditors to those companies.

All things considered, it is betterfor these losses to be realized andabsorbed sooner rather than later.Why? The more rapidly losses arerecognized, the faster can companiesand markets recognize the trueprospective marginal costs of usingthese facilities for prospective servic-es. And that will encourage lowerprices, expanded demand, greaterutilization, and overall greater eco-nomic efficiency.

Delaying this process can onlyput off the pain and the agony,not avoid it. And delay will meaninefficient decisions in the interim.To be sure, no manager of a publiccompany likes to see the equity ofhis shareholders wiped out. Butinvestors do not “deserve” a returnon their investments. In a marketeconomy, investors undertake invest-ments that carry risks. Often, invest-ments are successful, and investors

Cleaning up the mess of the telecommunications glut will require making some hard choices.

The sooner we get started, the better. By Lawrence J. White

EXCESSCAPACITY

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prosper. Sometimes, investments areunsuccessful, and investors lose.This is the way a market economyshould function. To prop up losinginvestors in such situations is toinstitute a policy of privatizing gainsand socializing losses, which is arecipe for inefficient investmentdecisions and inequitable outcomes.

The absorption of losses alreadyhas involved a number of sizablebankruptcies, which have beenpainful but unavoidable. What mustbe remembered is that these bank-

ruptcies are the recognition of thechanged climate and provide theprocesses whereby losses areabsorbed by owners and creditors –thus setting the stage for the sectorto move on. Bankruptcies need notmean the shuttering of a company.If the products and services of thecompany and its brand name repu-tation are sufficiently desirable, aprospective owner, freed from someor most of the prior debt and con-tractual obligations, can find theoperation of a more-or-less intactcompany worthwhile. Even when acompany must be liquidated, itsequipment will find its way intoother hands, unless its economicvalue is zero. In all instances, speedof resolution is imperative.

Further, it is important thatemployees, suppliers, and customersof companies operating under bank-ruptcy protection receive resolutionof their uncertainties, so that theytoo can move on. The same is truewith respect to companies that aretottering on the edge of Chapter 11.After all, lenders, suppliers and cus-tomers are frequently loathe to enter

transactions with companies thatmay be heading into bankruptcy.Once again, speed of resolution isimportant.

Bankruptcy is surely not anenjoyable experience for those whogo through it; and it is not a perfectprocess. But it provides resolution,and an orderly mechanism for thesettlement of claims.

Accurate HistoricalParallels

Many observers have drawn his-torical parallels between today’stelecommunications glut and theover-capacity of the railroad indus-try in the late nineteenth century.The parallels are valid. In the 1880sand 1890s, a large amount of capac-ity had been built. But demand forfreight and passenger service did notexpand sufficiently to absorb thatcapacity at economic prices in manymarkets. As a result, the affectedcompanies went into bankruptcy;surviving railroads emerged; and therail sector became the core of pas-senger and freight transportation forthe next half century. The infrastruc-ture and routes laid down in the late19th century remain central tofreight transportation in the U.S. inthe early 21st century.

There are at least two more recentexamples of the importance of rapiddisposition of excess capacity. Thefirst centers on the savings and loan(S&L) crisis of the late 1980s. It isnow widely recognized that thisdebacle, and the parallel failure ofalmost 1,500 commercial banks, waslargely the result of excessive invest-ment in commercial real estate in theearly and mid 1980s, combined withinadequate safety-and-soundnessregulation. This excessive invest-ment was driven by overly optimisticeconomic projections for the Sunbeltand elsewhere, much of it based onthe expectations of the favorableeffects of a high price for petroleumfor the Southwestern economy andthe favorable effects of the EconomicRecovery Tax Act of 1981 for theeconomy at large. The excessivelyoptimistic investments were fundedby S&Ls and banks that were not

subject to sufficient safety-and-soundness regulation by state andfederal authorities. When the conse-quences of the excessively optimisticexpectations first became apparentaround 1985-1986, “see-throughoffice buildings” became a commonphrase in Sunbelt cities.

By early 1986 it was quite clearthat much of Sunbelt commercialreal estate was over-priced anduneconomic at those prices, and thathundreds of S&Ls that had financedthose projects were insolvent.Nevertheless, there were strongpolitical pressures on federal regula-tors and on Congress to proceedslowly in taking any action thatwould pressure financial institutionsto recognize and absorb the losses.Advocates against action frequentlyargued that, given time, conditionswould turn around on their own.Real estate market participantsfeared that acknowledging lossesand selling uneconomic commercialreal estate to buyers who might putthose properties to better use wouldcause prices to fall further.

This was not good advice. Rapidaction in recognizing losses was thebest course of action in dealing withthe S&L insolvencies and in dealingwith the commercial real estate over-hang. In both cases, the marketsweren’t fooled into believing thatproblems were not present. And thedelayed action with respect to insol-vent S&Ls meant that the ownersand managers of those insolventS&Ls might take risky and uneco-nomic actions in efforts at resurrec-tion. Delayed action with respect tocommercial real estate meant a con-tinued overhang of uncertaintyabout prices and uses.

Though the clean-up of the S&Lproblem took longer than it shouldhave, it eventually did proceed in anexpeditious fashion. Similarly, theResolution Trust Corporation (RTC)moved swiftly to deal with the com-mercial real estate that it inheritedfrom insolvent S&Ls. Rapid actionin both dimensions helped both sec-tors emerge sooner and stronger.

A second example involves learn-ing from others’ errors, specifically

"The more rapidly losses are recognized,

the faster can companies and markets

recognize the trueprospective

marginal costs of using these facilities

for prospective services."

46 Sternbusiness

those of the Japanese. For more thana decade, Japan has moved very ten-tatively in dealing with the difficul-ties of its banking sector. Once theJapanese stock market and realestate bubble burst in the early1990s, the appropriate actions forthe government of Japan would havebeen to force Japan's banks to dealquickly with the bad loans and otheruneconomic investments on theirbooks and to recognize their losses.The government could have helpedinsolvent banks by injecting publicfunds to protect depositors – but notbank owners – and by finding newowners who would inject fresh capi-tal into the banks. Japan couldthereby have established a rejuve-nated banking system that couldperform its role in making new loansto the rest of the economy.

Instead, the government of Japanhas taken few such actions. Banks,which were largely unwilling to forcecompanies into bankruptcy, havebeen allowed to keep vast sums ofnon-performing loans on theirbooks. When the government didact, its actions have been too littleand too late. As a consequence, theJapanese banking industry remainssaddled with bad loans on which ithas yet fully to recognize the losses,the banks remain moribund andreluctant to lend, and the Japaneseeconomy has remained mired in eco-nomic stagnation for over a decade.

Serial Bankruptcies?One specter raised by opponents

to revived companies is that thesecompanies’ ability to reduce theircosts by renegotiating debt and othercontracts will lead to aggressivepricing and then to a cascade ofother bankruptcies. But this argu-ment ignores the fact that companieswill stay intact only if their creditorsbelieve that the intact entity hasmore value than the liquidatedassets. Also, even if a bankrupt com-pany were liquidated, its equipmentwould be sold at low levels that thenbecome the basis for low productprices. Finally, it ignores the realitythat industries such as telecommuni-cations are characterized by high

fixed costs and lowmarginal costs, whichis likely to yield aggres-sive pricing so long ascustomers see competi-tive firms’ offerings asnear-commodities.

Sound AntitrustPrinciples

As they formulateresponses to the cur-rent telecommunica-tions crisis, policy-makers should alsocontinue to followsound antitrust princi-ples. The resolution ofthe telecommunica-tions industry's current over-capacity surely warrants some con-solidation. But that doesn’t meanthat exceptions should be made togood antitrust policy. The HorizontalMerger Guidelines of the U.S.Department of Justice and theFederal Trade Commission providethe right antitrust guidance for per-mitting efficient combinations thatwill also avoid the creation of marketpower. They should be followed –even in a time of crisis.

The “excuse” of financial diffi-culties in the telecommunicationssector should not be used as a routefor allowing firms to exercise marketpower. After all, the slack antitruststandards that have sometimes beenthe norm in other regulated indus-tries, such as for railroad and airlinemergers, have not had salutary con-sequences.

Encouraging InnovationFinally, as we come to grips with

the fallout of the telecommunica-tions glut, we should continue toencourage and foster innovation.Indeed, we should not delay effi-ciency-increasing developments inspectrum allocation and usage.Improvements in the allocation andusage of the electromagnetic spec-trum continue to be possible – part-ly through improved technologies,and partly through reforms in howthe spectrum is regulated and dereg-ulated. Improvements ought not to

be delayed because of any concernsabout spill-over effects on the capac-ity utilization of fiber-optic cable.Efficiency improvements in the waythat spectrum is allocated and usedshould always be welcomed, regard-less of how and when they occur.

In this regard, spectrum auctionshave been and continue to be a goodstart at improving efficiency. Butthey are only a start. Auctions wouldaffect far too little of the spectrum.Instead, the effort to “propertyze”the spectrum – to treat it as propertyin a manner that is analogous to howreal estate is treated – is the rightway to proceed. Only then can mar-kets do their job in increasing theefficiency with which the spectrum isused.

Times of financial crises are oftenwatershed epochs. This is likely tobe true for telecommunications.Good public policy could steer usthrough the turmoil and allow us toemerge fairly rapidly with a moreefficient telecommunications sector.Poor public policy could leave us ina quagmire of continuing uncertain-ty and poor performance. Politicalleadership in Washington will becrucial in determining the path.

L AW R E N C E J . W H I T E is Arthur E.Imperatore professor of economics atNYU Stern. This article is adaptedfrom an October 7, 2002 presentationat the Federal CommunicationsCommission.

Sternbusiness 47

industrializednations – has yet toformally adopt whatis, in essence, the world’soperating system.

The fact that we use feet whilemost of our trading partners usemeters highlights the occasionallyastonishing degree to which ouraffairs are still not governed byglobal standards. Despite theadvent of the Euro, currenciesremain stubbornly diverse. And inBritain, drivers persist in keeping tothe left-hand side of the car.Indeed, as the global marketplacebecomes more tightly integrated,significant pockets of the worldcontinue to hew to their ownstandards.

DANIEL GROSS is editor of STERNbusiness.

he InternationalOrganization ofStandards (ISO), basedin bucolic Geneva,Switzerland, rarely

attracts the attention of slick busi-ness magazines and television net-works. But perhaps it should. Afterall, industrial and commercial stan-dards stand at the center of ourincreasingly global system of trade,manufacturing, and exchange.

The ISO was founded inFebruary, 1947, as engineers andscientists forged a new force forinternational harmony. The firstISO standard was published in1951 – “a standard reference tem-perature for industrial length meas-urement.” More standards areadded each year. The 813 issued in2001 brought the total to 13,544,covering everything from cine-matography to cryogenic vessels.

Some, of course, are more usefulthan others. An ISO standard onsmart-card thickness allows atourist to use the same ATMmachine in Beijing, Brussels, orBoston. More broadly, industrialstandards permit a can of Coca-Cola to look, feel, and taste thesame in Red Square as it does inBlue Bell, Pennsylvania.

The story of standards startswith the railroads. Early 19th cen-tury railroads were designed to con-nect one town to another. But youcould only haul goods over two dif-ferent lines if the rails were laid

down with the same gauge.So in 1846 the British gov-ernment smartly decreed allrailroads should be laiddown precisely four feet,eight and one half inchesapart. This distancebecame the so-calledstandard gauge in theU.S., which, nonethe-less failed to imposeuniform standards.Throughout the South, forexample, five-foot gauge wasprevalent. And some historianstheorize that the Confederacy’s lackof a standardized rail networkhampered its ability to move menand materiel efficiently during theCivil War.

In the 19th century, time wasgenerally kept locally, and dictatedby the sun. The result: at 10:00a.m. in Philadelphia, it might be9:48 a.m. in Pittsburgh. But sincetrains had the ability to travel farenough, and fast enough, to con-fuse people, U.S. railroads in 1883divided the nation into four timezones. It took another 35 years forCongress to codify the railroads’practice for the broader public withthe Standard Time Act of 1918.

Of course, the U.S. has remainedaloof from some nearly universalstandards. The metric system wasfirst developed in France in the late18th century. But more than twocenturies after its creation, theUnited States – alone among

endpaper

TStandard Fare By Daniel Gross

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P r o g r a m s

You’ll find the world in New York, and you’ll find New York in our Executive Programs. High-potential

professionals, who prove themselves daily in the business capital of the world, hone their skills in our

programs to reach new heights. Our students are razor sharp. Our faculty are the luminaries of finance

and management. And the knowledge exchange and once-in-a-lifetime experience create energy as

electric as our city. Options include: Executive MBA Program, TRIUM Global Executive MBA Program,

The Langone Program: A Part-Time MBA For Working Professionals, Corporate Degree Programs,

Custom Non-Degree Programs and Open Enrollment Programs.

The business of new york is our business.

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