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8.4 CAGE Analysis

Learning Objectives

  1. Understand the inputs into CAGE analysis.
  2. Know the reasons why CAGE analysis emphasizes distance.
  3. See how CAGE analysis can help you identify institutional voids.

The Inputs into CAGE Analysis

Pankaj “Megawatt” Ghemawat is an international strategy guru who developed the CAGE frameworkThe analytical framework used to understand country and regional differences along the distance dimensions of culture, administration, geography, and economics. to offer businesses a way to evaluate countries in terms of the “distance” between them.Pankaj Ghemawat, “Distance Still Matters,” Harvard Business Review 79, no. 8 (September 2001): 1–11. In this case, distance is defined broadly to include not only the physical geographic distance between countries but also the cultural, administrative (currencies, trade agreements), and economic differences between them. As summarized in Table 8.2 "The CAGE Framework", the CAGE (cultural, administrative, geographic, and economic) framework offers a broader view of distance and provides another way of thinking about location and the opportunities and concomitant risks associated with global arbitrage.Pankaj Ghemawat, “The Forgotten Strategy,” Harvard Business Review 81, no. 11 (September 2003).

Table 8.2 The CAGE Framework

Cultural Distance Administrative Distance Geographic Distance Economic Distance
Attributes Creating Distance
Different languages Absence of colonial ties Physical remoteness Differences in consumer incomes
Different ethnicities; lack of connective ethnic or social networks Absence of shared monetary or political association Lack of a common border

Differences in costs and quality of the following:

• Natural resources

• Financial resources

• Human resources

• Infrastructure

• Intermediate inputs

• Information or knowledge

Different religions Political hostility Lack of sea or river access
Different social norms Government policies Size of country
Institutional weakness Weak transportation or communication links
Differences in climates
Industries or Products Affected by Distance
Products have high-linguistic content (TV).

Government involvement is high in industries that are

• producers of staple goods (electricity),

• producers of other “entitlements” (drugs),

• large employers (farming),

• large suppliers to government (mass transportation),

• national champions (aerospace),

• vital to national security (telecommunications),

• exploiters of natural resources (oil, mining), and

• subject to high-sunk costs (infrastructure).

Products have a low value-of-weight or bulk ratio (cement). Nature of demand varies with income level (cars).
Products affect cultural or national identity of consumers (foods). Products are fragile or perishable (glass or fruit). Economies of standardization or scale are important (mobile phones).
Product features vary in terms of size (cars), standards (electrical appliances), or packaging. Communications and connectivity are important (financial services). Labor and other factor cost differences are salient (garments).
Products carry country-specific quality associations (wines). Local supervision and operational requirements are high (many services). Distribution or business systems are different (insurance).
Companies need to be responsive and agile (home appliances).

To apply the CAGE framework, identify locations that offer low raw material costs, access to markets or consumers, or other key decision criteria. You might, for instance, determine that you’re interested in markets with strong consumer buying power, so you would use per capita income as your first sorting criterion. As a result, you would likely end up with some type of ranking. Ghemawat provides an example for the fast-food industry, where he shows that on the basis of per capita income, countries like Germany and Japan would be the most attractive markets for the expansion of a North American fast-food company. However, when he adjusts this analysis for distance using the CAGE framework, he shows that Mexico ranks as the second most attractive market for international expansion, far ahead of Germany and Japan.Pankaj Ghemawat, “Distance Still Matters,” Harvard Business Review 79, no. 8 (September 2001): 1–11. Recall though, that any international expansion strategy still needs to be supported by the specific resources and capabilities possessed by the firm, regardless of the picture presented by the CAGE analysis. To understand the usefulness of the CAGE framework, consider Dell and its efforts to compete effectively in China. The vehicles it used to enter China were just as important in its strategy as its choice of geographic arena. For Dell’s corporate clients in China, the CAGE framework would likely have revealed relatively little distance on all four dimensions—even geographic—given the fact that many personal-computer components have been sourced from China. However, for the consumer segment, the distance was rather great, particularly on the dimensions of culture, administration, and economics. For example, Chinese consumers didn’t buy over the Internet, which is the primary way Dell sells its products in the United States. One possible outcome could have been for Dell to avoid the Chinese consumer market altogether. However, Dell opted to choose a strategic alliance with distributors whose knowledge base and capabilities allowed Dell to better bridge the CAGE-framework distances. Thus the CAGE framework can be used to address the question of where (which arena) and how (by which entry vehicle) to expand internationally.

CAGE Analysis and Institutional Voids

While you can apply CAGE to consider some first-order distances (e.g., physical distance between a company’s home market and the new foreign market) or cultural differences (e.g., the differences between home-market and foreign-market customer preferences), you can also apply it to identify institutional differences. Institutional differences include differences in political systems and in financial markets. The greater the distance, the harder it will be to operate in that country. Emerging markets in particular can have greater differences because these countries lack many of the specialized intermediaries that make institutions like financial markets work. Table 8.3 "Specialized Intermediaries within a Country or Other Geographic Arena" lists examples of specialized intermediaries for different institutions. If an institution lacks these specialized intermediaries, there is an institutional voidThe absence of key specialized intermediaries found in the markets of finance, managerial talent, and products, which otherwise reduce transaction costs.. An institutional void refers to the absence of key specialized intermediaries found in the markets of finance, managerial talent, and products, which otherwise reduce transaction costs.

Table 8.3 Specialized Intermediaries within a Country or Other Geographic Arena

Institution Specialized Intermediary
Financial markets

• Venture-capital firms

• Private equity providers

• Mutual funds

• Banks

• Auditors

• Transparent corporate governance

Markets for managerial talent

• Management institute or business schools

• Certification agencies

• Headhunting firms

• Relocation agencies

Markets for products

• Certification agencies

• Consumer reports

• Regulatory authorities (e.g., the Food and Drug Administration)

• Extrajudicial dispute resolution services

All markets • Legal and judiciary (for property rights protection and enforcement)

Three Strategies for Handling Institutional Voids

When a firm detects an institutional void, it has three choices for how to proceed in regard to the potential target market: (1) adapt its business model, (2) change the institutional context, or (3) stay away.

For example, when McDonald’s tried to enter the Russian market, it found an institutional void: a lack of local suppliers to provide the food products it needs. Rather than abandoning market entry, McDonald’s decided to adapt its business model. Instead of outsourcing supply-chain operations like it does in the United States, McDonald’s worked with a joint-venture partner to fill the voids. It imported cattle from Holland and russet potatoes from the United States, brought in agricultural specialists from Canada and Europe to improve Russian farmers’ management practices, and lent money to farmers so that they could invest in better seeds and equipment. As a result of establishing its own supply-chain and management systems, McDonald’s controlled 80 percent of the Russian fast-food market by 2010. The process, however, took fifteen years and $250 million in investments.“McDonald’s in Russia: Accept or Attempt to Change Market Context?,” Economic Times of India, April 30, 2010, accessed February 17, 2011, http://economictimes.indiatimes.com/features/corporate-dossier/McDonalds-in-Russia-Accept-or-attempt-to-change-market-context/articleshow/5874306.cms; Tarun Khanna and Krishna G. Palepu, Winning in Emerging Markets: A Road Map for Strategy (Cambridge, MA: Harvard Business School Press, 2010).

An example of the second approach to dealing with an institutional void—changing the institutional context—is that used by the “Big Four” audit firms (i.e., Ernst & Young, KPMG, Deloitte Touche Tohmatsu, and PricewaterhouseCoopers) when they entered Brazil. At the time, Brazil had a fledgling audit services market. When the four firms set up branches in Brazil, they raised financial reporting and auditing standards across the country, thus bringing a dramatic improvement to the local market.Tarun Khanna, Krishna G. Palepu, and Jayant Sinha, “Strategies That Fit Emerging Markets,” Harvard Business Review 83, no. 6 (June 2005): 2–16.

Finally, the firm can choose the strategy of staying away from a market with institutional voids. For example, The Home Depot’s value proposition (i.e., low prices, great service, and good quality) requires institutions like reliable transportation networks (to minimize inventory costs) and the practice of employee stock ownership (which motivates workers to provide great service). The Home Depot has decided to avoid countries with weak logistics systems and poorly developed capital markets because the company would not be able to attain the low cost–great service combination that is its hallmark.Tarun Khanna, Krishna G. Palepu, and Jayant Sinha, “Strategies That Fit Emerging Markets,” Harvard Business Review 83, no. 6 (June 2005): 2–16.

Ethics in Action

Nestlé’s Nespresso division is one of the company’s fastest-growing divisions. The division makes a single-cup espresso machine along with single-serving capsules of coffees from around the world. Nestlé is headquartered in Switzerland, but the coffee it needs to buy is primarily grown in rural Africa and Latin America. Nespresso set up local facilities in these regions that measure the quality of the coffee. Nespresso also helps local farmers improve the quality of their coffee, and then it pays more for coffee beans that are of higher quality. Nespresso has gone even further by advising farmers on farming practices that improve the yield of beans farmers get per hectare. The results have proven beneficial to all parties: farmers earn more money, Nespresso gets getter quality beans, and the negative environmental impact of the farms has diminished.Michael E. Porter and Mark R. Kramer, “The Big Idea: Creating Shared Value,” Harvard Business Review, January–February 2011, accessed January 23, 2011, http://hbr.org/2011/01/the-big-idea-creating-shared-value/ar/pr.

Key Takeaways

  • CAGE analysis asks you to compare a possible target market to a company’s home market on the dimensions of culture, administration, geography, and economy.
  • CAGE analysis yields insights in the key differences between home and target markets and allows companies to assess the desirability of that market.
  • CAGE analysis can help you identify institutional voids, which might otherwise frustrate internationalization efforts. Institutional differences are important to the extent that the absence of specialized intermediaries can raise transaction costs just as their presence can reduce them.

Exercises

(AACSB: Reflective Thinking, Analytical Skills)

  1. Explain what distance is in relation to the CAGE framework.
  2. What are the key elements in CAGE analysis?
  3. What is an institutional void?
  4. How might CAGE analysis help you identify institutional voids?
  5. What are three possible choices firms have when they’re considering entering a foreign market with large institutional voids?