Extending your Reach.

As more Canadian businesses adapt to global market opportunities, they must also develop new strategies to serve foreign markets effectively.

After more than a decade, most Canadian businesses have adapted to the broader market opportunities provided by the Free Trade Agreement (FTA) and its successor, NAFTA. Their attention is now turning to globalization, which has been increasingly facilitated by advances in communications and transportation technology, and liberalized trade agreements. Here, the term "globalization" means regarding the world as a potential market and/or source of supply. Many companies have extended their geographic reach in their quest for new markets and suppliers by the use of the Internet; however, this is only a tool and alone cannot be considered globalization.

Globalization has already changed the structure of many industries and the basis of competitive advantage. Canadian industries, such as those producing price sensitive, standardized consumer goods such as apparel -- which are labour intensive and require low input costs -- have virtually disappeared as production has moved to low wage countries. For many industries, globalization has brought new competitors into play. Retailing in Canada, long regarded as the preserve of Canadian companies, has seen the "big box" entrants like Wal-Mart and Home Depot win dominant positions. Wal-Mart in particular is demonstrating the effectiveness of its concept on a global scale.

The adjustments necessary to adapt to the FTA were relatively easy because we were dealing with markets in close geographic proximity with similar cultures, values and language. The addition of Mexico by NAFTA added some complications, however, these have been softened by its relative proximity and the existence of convenient transportation links. To this point, Mexico has primarily been a low wage source of supply rather than a significant market. However, the pursuit of globalization requires consideration of much more difficult strategic issues. The major issues can be defined by three basic questions:

1. What are the economics of your business and the implications of globalization?

2. Can you adapt your product or service to the needs of the different markets?

3. What form of organization is necessary to effectively service foreign markets?

The economics of globalization

The decision as to whether to purse globalization and undertake the effort necessary to implement it, like virtually all strategies, is primarily based on the potential reward to the bottom line. This requires a detailed understanding of the economics of the business and the industry in which it is operating. If the objective of globalization is to seek broader markets, the impact on earnings will be determined by the marginal contribution provided by the expected increase in sales volume less the additional costs involved. The potential for dramatic increases in earnings is the greatest for businesses with high fixed costs but low variable costs to produce each additional unit to be sold. Such fixed costs commonly result from research and development outlays and capital intensity -- which must be amortized over the production run -- infrastructure costs for administration and marketing, and automated production facilities, which cannot be economically run at partial capacity. Computer software is a business where the cost structure results in increased sales from broader markets, providing exceptional earnings leverage because development costs are fixed and each additional unit can be delivered at very low variable cost.

While a high marginal contribution from increased sales makes globalization an attractive strategy, it creates the temptation to discount prices in foreign markets. This may be considered dumping with the risk of severe penalties, a risk that has increased since the U.S. recently enacted legislation allowing such penalties to be paid directly to the aggrieved companies. Recognizing how aggressively litigious Americans tend to be, you can be sure that countervailing duty actions will multiply rapidly. However, the high marginal contribution can be safely used on marketing programs and a higher quality of service, which can enhance sales.

The potential increase in volume offered by global markets becomes particularly attractive when traditional mature markets are saturated and an increase in sales can only come from a higher market share. An aggressive pursuit of market share in a situation of competitive stalemate usually provokes competitor reaction, such as discounting prices, and can therefore be counterproductive. Sales outside of the domestic arena can minimize this problem.

On the cost side, the globalization of procurement offers opportunities to reduce costs and increase productivity. First, it can reduce input costs by tapping additional sources of supply for both components and infrastructure services. Many Canadian companies have difficulty doing this because the relatively small Canadian domestic market alone has not provided enough suppliers to create competition. Second, the availability of a broader range of components and services may allow the company to reduce the scope of its operations and focus on its core competence. This can both concentrate effort and free up financial resources. In fact, such focus may not just be a strategic opportunity but rather the key to survival in the global economy. Many companies, such as the athletic shoe companies like Nike, have retreated to their core competence in product development and marketing and have totally outsourced production. Detailed value chain analysis can reveal where such leverage may be found. However, it follow s that a company facing global competition must optimize its efficiency and productivity by employing the best available technology on a world scale basis.

Adapting the product or service

The characteristics of any market are defined by a combination of physical and intangible specifications, which it demands in its products or services. The physical specifications are dictated by such variables as the local infrastructure (power availability and voltage of power) and regulations. Markets in developed countries demand technological sophistication, which is not necessarily the case in developing countries where products like wringer washing machines and treadle operated sewing machines are still in demand. While these market variables should be obvious, even major companies have made mistakes by not doing the research. For many years, for example, the North American auto makers complained about being unable to penetrate the Japanese market but did not supply the right-hand drive vehicles that, the market required.

The intangible product characteristics are less obvious and are often based on cultural sensitivities. Problems can arise from such seemingly innocent variables as brand names and colours. The well known auto names Pinto, Nova and Camero all had unfavourable connotations in Spanish. Blue is a macho colour in the U.S., as compared with red in the U.K. In China, the number four, which might be used in a product model number, is associated with death and is thus avoided. Fashion and lifestyle preferences also play a major role. European tastes in furniture are different from the North American and their household appliances, such as refrigerators, are smaller because they live in less spacious homes. In all cases, the characteristics of target markets must be understood in detail to avoid such problems. The old adage "know your market" applies.

In searching for global markets, Canadian companies should look for underserved niches or segments rather than mass markets in which they would be at a disadvantage to larger competitors. In certain industries, such as transportation, telecommunications and cold weather adaptation (furnaces, clothing, etc.) it may be possible to exploit the Canadian reputation for unique competence in these areas. But to serve global markets, there is one basic axiom that must be central to any company's strategy: sell on the basis of value, not price. First, few Canadian companies have the size of a domestic market base, low labour costs, or the economies of scale necessary to compete on price alone. Second, an essential part of such value is high quality. Not only has quality become a global market imperative, but adjustments to quality failures in distant markets are very costly.

Organizing for the global market

Even with favourable economics and a suitable product, there remains the issue of how to reach global markets. The multinational organization is the form usually associated with doing business globally. While such companies may be domiciled and identified with one county, they are essentially stateless, procuring and assembling where economically advantageous. However, they require mass markets without significant tariff or non-tariff barriers with products capable of being easily modified to meet different market requirements and products that have a high value-to-bulk relationship, which makes shipping them long distances economically feasible. Electronic products -- which can be easily modified for local voltage and labeling requirements, and where shipping costs are a small part of overall costs -- are the most common example. The multinational format is therefore primarily the preserve of large companies.

The easiest and most profitable format for smaller companies is to export directly. Exporting is usually the first step in pursuing a globalization strategy to test market potential. However, it requires that the product be capable of being modified to target market standards and shipped without excessive cost. It still requires the establishment of a marketing and distribution capability within the target market with packaging, directions and supporting material suitable to the market. This is often best done by an arrangement with a local company.

For products that have a common core but which must be modified to meet local specifications or volatile market tastes, the transnational organization may be necessary. This is used in heavy construction equipment where unique local requirements exist and in fashion items such as sweaters, which may be centrally manufactured but dyed in the destination market to meet local preferences and respond quickly to changes in fashion. Here, the establishment of a local processing function is a trade-off of economies of scale with the cost of local processing, however, the company can still leverage its core skills.

Many industries require the virtual duplication of the business in the target market, the multi-domestic form. This may be necessary because of the existence of local regulations or non-tariff barriers, such as those for drugs, or a preference for a domestic manufacturer, such as in armaments. However, the multi-domestic form may also be necessary where shipping costs are prohibitive and in services, such as consulting or construction, which require extensive local representation. In such situations, the duplication of operations may be costly but still provide a significant profit contribution to the parent company if it is obtaining more intensive use of the technology or unique skills which it is, in effect, exporting.

Another alternative for some industries is franchising or licensing local firms. This taps local sources of capital and provides knowledge of local markets that may be necessary to adapt the business to local tastes without damaging the basic concept. In Germany, for instance, you can have a beer with your Big Mac.

Increasingly, companies are recognizing that "going it alone" in foreign markets is a formidable task requiring a heavy commitment of management time, and are engaging in joint ventures and strategic alliances with local firms. Such partners may be vital where there is a need to deal with local regulations, bureaucrats or officialdom. The lumber industry, for example, is engaging in a number of such alliances to introduce Canadian housing construction techniques and products to the Japanese and Russian markets. Alliances can also distance the company from practices that may be questionable by Canadian standards, but which are necessary to doing business in that country.

There is, of course, a multitude of other challenges involved in arriving at global business arrangements. For many countries, it is difficult to break into traditional business arrangements such as "kieretsu" in Japan and the "caobols" of Korea. In negotiating arrangements, management must be aware of cultural differences and customs between countries. (Editor's note: see "Culture Shock" in this month's issue for more information on this topic.) North American impatience, informality, gestures and other common traits, as well as the inclusion of women in management, are offensive to many foreign management teams. Once established, it is necessary to resolve issues of reporting arrangements, performance standards, accounting practices and exchange rates. The relentless North American obsession with shareholder value based on short-term earnings and share price is not shared by all countries.

Notwithstanding its complexity, globalization is a logical strategic initiative for many companies. Like all strategies, it must be carefully planned with a full understanding of the difficulties and issues involved.

Ray Suutari ([e-mail]) is the author of Business Strategy and Security Analysis (1996, Irwin Publishing. Burr Ridge, Ill.) and currently coaches CEOs on strategy formulation.