 Getting to global | ||
Over the next 30 years, geographic and regulatory barriers will fall, electronic distribution will start to parallel and even to bypass physical distribution, installed capacity will become obsolete before it is depreciated, and focused competitors will attack like piranhas. Companies will have to restructure or die. — LOWELL L. BRYAN AND JANE N. FRASER The McKinsey Quarterly, 1999 Number 4, pp. 28—37 Truly global markets now produce and consume about 20 percent of world output—about $6 trillion of the planet’s $28 trillion gross domestic product.1 Within 30 years, as that GDP expands to $91 trillion (assuming an overall real growth rate of 4 percent), global markets could multiply 12-fold, reaching about $73 trillion, more than 80 percent of world output (Exhibit 1). 
Economic integration, the force driving this expansion, will promote the formation of global markets in accounting, chemicals, food, health care, the mass media, pulp and paper, telecommunications, and many other industries. Indeed, more integration will take place in the next 30 years than occurred in the previous 10,000 or more. Companies operating in these future global markets will have profit opportunities worth hundreds of billions of dollars. The annual pretax earnings of, for example, the global personal financial services (PFS) industry, now standing at some $300 billion, will double within a decade.2 At the same time, the world’s PFS markets, until recently segmented by regulation and technological limitations, so that no single participant captures more than 3 percent, or $9 billion, of the global profit pool—will integrate and become accessible to all. Thus any company that can capture 10 percent of the global PFS market can look forward to annual profits of $60 billion.3 In a world without economically significant geographic boundaries, the rules are going to change. The good news is that companies will have access to the world’s finest resources: the most talented labor, the largest markets, the most advanced technologies, and the cheapest and best suppliers of goods and services. The bad news is that the risks will be high because every business will have to compete against the world’s best, and integrating markets are volatile and uncertain. When companies that now dominate their national and local markets face white-hot competition, they will have to realize that their so-called global strategies have really been mere international expansion tactics. In the coming transitional decades, the geographically constrained economies familiar to us today will coexist with the emerging global economy. Although the picture will be confusing, confusion creates opportunity. To understand its nature, it is necessary first to grasp the way geographic barriers have influenced the character of industries and markets, as well as why and how these barriers are falling. THE POWER OF GEOGRAPHY In Guns, Germs, and Steel: The Fates of Human Societies,4 the physiologist Jared Diamond argues that geography is the key to the evolution of human societies. Diamond’s theory prompted us to think about the influence of geographic constraints on the development of different industries and on competitors within them. We mean not just physical obstacles but also symbolic barriers, such as constraints on interaction (differences in language, standards, and cultural norms) and legal and regulatory obstacles (tariffs, capital controls, and restrictions on products, markets, and labor). In a world constrained by geography, successful businesses obtain privileged access to markets. Different companies, like different societies, have natural advantages derived from their geographic starting points—in particular, differences of access (determined by the size of the markets that companies can access for technology, suppliers, and labor), opportunities to specialize, and the ability to achieve scale. Greater access means greater specialization (the organization of work so that those most skilled at each activity undertake it) and greater scale (spreading fixed costs over a wider base). For the most part, companies operating in their home territories get privileged access; outsiders can share in the spoils only by developing the skills needed to overcome geographic boundaries. The most important of these skills used to be military ones. Blessed with a superior army, the ancient Romans set out to dismantle the tangible and intangible barriers geography had created in the areas they wished to control. The construction of roads, the development of a legal system and coinage, and the spread of Latin as a medium of communication permitted them to build a framework for social order and commerce. Geographic expansion brought access to new sources of labor and raw materials and made possible increasingly specialized industries, such as metal working in what is now France. By the beginning of the 20th century, corporations had replaced conquerors as the active agents of economic integration. Superior use of railroads and pipelines permitted John D. Rockefeller, for instance, to create a “virtuous cycle” of geographic expansion based on ever-increasing advantages of access and scale that made his company, Standard Oil, the world’s biggest enterprise. Further technological developments, mainly in transport and communications, helped other corporations overcome basic geographic barriers. Yet human barriers remained. The problems of different languages and currencies had existed since long before Roman times, but in the present century national governments have added to these problems by imposing controls on capital flows, foreign exchange, and interest rates. Restrictions on national markets for goods, services, and labor may have promoted stability, but they also dampened international economic activity. Trade was often limited through tariffs and other barriers; subsidies and protectionism were rife. Devices of this sort led countries to develop idiosyncratic industry and market structures. All nations, and sometimes regions within them, had their own rules. In the United States, for example, legal structures even now differ so much from state to state that lawyers must qualify separately in each one where they wish to practice. Without access to local knowledge, customers, regulators, and politicians, a company that had grown up in one area had difficulty entering another. Nonetheless, through hard work and patience, some companies have overcome geographic boundaries and won access to new customers, raw materials, labor, and technologies. They have thus developed the ability to integrate over a wider geographic arena to gain the benefits of scale and specialization and thus to enjoy virtuous cycles of the sort that helped Rockefeller. For years, these successful companies followed either of two geographic expansion strategies: multilocal or global. Multilocal companies sought to become insiders in a range of geographic markets by building or acquiring full business systems in each. ABB, Nestlé, Shell, and Unilever took this approach internationally, Bank One and HCA in the United States. At the heart of the multilocal approach is the privileged local access stemming from huge local investments. But from the 1960s onward, a different type of company began to emerge—one aiming to create global markets for specific products. Such companies succeed by creating global demand and establishing global standards. Boeing, for example, could use scale in airframes and Canon its specialization in 35-millimeter cameras to enter local markets without investing large sums, because local distributors and customers wanted these products badly. Such global companies tend to grow up in relatively large national economies where advantages of access, specialization, and scale permit them to develop significant intangible assets, such as patents and proprietary production techniques, that they can reuse throughout the world. Like multilocal companies, they owe much of their achievement to having ready access to capital. Only a very few—for instance, the engineering firm Bechtel—have succeeded globally by leveraging intangibles rather than physical capital. More recently, multilocal and global companies have begun converging around a global-local, or transnational, model combining the best aspects of each approach.5 The transnational model relies on greater internal integration to capture global specialization and scale advantages and on local approaches to gain privileged access. ENTERING THE TRANSITION ECONOMY Access to geography, capital, and technology underlies all three models. Yet privileged access is beginning to disappear. The geographic barriers that have held back economic integration since the end of World War II are falling: national governments are removing legal and regulatory barriers to international economic interaction, a vast global capital market has come into existence, and rapid advances in digital technology are slashing the cost of communications and computing.6 Access for all When governments open up economies, they gain access to skills and capabilities developed abroad. Local companies can avail themselves of internationally competitive inputs and expertise and thereby increase their productivity. Consumers have access to the world’s best products and services. Open economies definitely outperform closed ones (Exhibit 2). Fifty years ago, there was little difference between the per capita GDP of Hong Kong and that of mainland China. In 1997, the figure for Hong Kong was $20,493; in China, even after a decade of spectacular growth, it was only $3,561.7 However, despite the obvious advantages of globalization, until the late 1980s there was little reason to think that closed economies would open up. 
Then the Soviet bloc, and soon afterward the Soviet Union itself, collapsed, and assets in those countries were privatized. China, influenced by the 57 million overseas Chinese, dipped its toes in the waters of capitalism. After many decades of growing state intervention, it had become apparent that government-led development had run out of steam. The ensuing shift to market-based economies is among the defining political events of the late 20th century. Closed societies were not the only ones to be so transformed. The financial crisis that hit Indonesia, Malaysia, South Korea, and Thailand in 1997 and 1998 was a reminder that relatively open countries too have tried to achieve national objectives through centrally planned, state-subsidized economies. All of these nations are now moving, reluctantly or not, toward fundamental economic reform—removing restrictive regulations, eliminating protection and subsidies, and reforming banking systems. Reform in hitherto closed markets is offering real access to nonlocal enterprises. Take banking. Some countries are welcoming foreign banks for the first time, often to provide long-term solutions for the problems of local banks that made government-directed loans to failing state-sponsored companies and ill-advised speculative loans to well-connected local insiders.8 Less dramatic, but no less important, has been the deregulation and privat-ization of the government, service, and utility sectors in much of the developed world, once certain European countries—above all, the United Kingdom—realized that their utilities systems were inefficient. Global companies are thus emerging in the electricity supply industry, in telecommunications, and in water and waste management. Eventually, global powerhouses will blossom even in fields such as education and health care. Of course, in certain economies the day of reckoning has yet to come. Despite massive increases in the liabilities of the public sectors of such European countries as France, Germany, and Italy, for example, their governments are reluctant to play a more open game. Some of them have met the new debt-to-GDP requirements of the European Union’s monetary-integration effort by raising taxes rather than reducing their own roles. Japan too has been slow to liberalize its economy. Nonetheless, in nation after nation the threat of financial crisis is forcing reform and, with it, the destruction of barriers against foreign companies. Capital for the strong As the influence of governments has waned, the world’s financial markets have grown at an extraordinary pace.9 This expansion has its roots in the collapse, in the early 1970s, of the Bretton Woods system, which had governed world monetary markets since the end of World War II. Under the pressure of the Vietnam War, the United States had inflated its currency, which became overvalued. Persistent US trade deficits led to the accumulation of a significant stock of “Eurodollars” elsewhere in the world. Everyone who could do so borrowed dollars and invested in stronger currencies. Eventually, the system broke down, and foreign-exchange rates were allowed to float. Suddenly, traders could capture “risk-free” pricing anomalies between financial instruments in different markets. They could borrow at one rate in one currency and lend at another rate in others, without foreign-exchange risk. These practices spread quickly. Volumes soared. Foreign-exchange markets responded by integrating, and by the end of the 1970s the process was largely complete. The subsequent liberalization of the developed world’s bond markets, followed by their integration over the next decade, meant that by the early 1990s more than two-thirds of the world’s liquid financial stock was integrated. The process of integrating the last third—equity markets and the financial markets of emerging economies—is well under way. Meanwhile, capital is becoming more mobile as the influx of massive sums of money into emerging markets shows. In 1996, foreign direct investment in these markets exceeded $138.8 billion, up from $24.2 billion in 1986.10 We estimate that the world’s liquid financial assets will reach almost $80 trillion by 2000—seven times the corresponding figure in 1980 (Exhibit 3). Of course, mobile capital is a double-edged sword: the market rewards some participants and punishes others. Governments, including those of the developed world, are not immune: in early 1995, Canada and Italy had very high domestic debt, so their governments were paying real interest rates 2 to 4 percent higher than the US rates for debt of the same maturity. Within 18 months, Canada and Italy had been obliged to bring their fiscal policies in line with the demands of the global capital market. 
As equity markets globalize, the impact on companies and industries will be huge, for the global capital market serves the strong and undermines the weak. Companies that generate high returns while maintaining strong balance sheets will have ever-increasing opportunities to expand; underperforming companies will lose control over their destinies. Technology for all Interaction costs—expenses generated by the need to coordinate work among different parties—now represent as much as 51 percent of labor activity in the United States.11 This high figure helps explain why services such as health care and personal finance have mostly remained local. But technology is slashing interaction costs and eliminating the need for expensive face-to-face encounters between buyers and sellers. Since computing capacity is becoming steadily cheaper (Exhibit 4), by 2010 more than one billion people—20 percent of the world’s population—will use computers and networked devices, and electronic relationships will probably be the norm in many industries. Like cheaper transportation and infrastructure earlier in the 20thcentury, this will fundamentally change the way industries are structured, companies are organized, and customers behave: as the cost of outsourcing falls, integration within companies will become less important and cooperation among them more so. 
This is not just a first-world story. Although the poorer 70 percent of the world’s population now makes do with less than 5 percent of the main telephone lines, the number of lines in emerging markets is almost ten times higher than it was in 1984. The growth of penetration in low-income countries—9 percent annually for almost 20 years—is expected to average 17 percent a year over the next few years; China, for instance, plans to install 75 million fixed-telephone lines from 1996 to the year 2000.12 Electronic delivery of services will either make most of the remaining regulatory barriers to global trade irrelevant or confirm the need to reform the regulatory system. Maintaining closed markets will become impossible. INTANGIBLES: THE NEW SCARCE RESOURCE One of the most remarkable effects of dismantling geographic barriers will be the increased power wielded by customers. Until now, suppliers seeking access to new markets have driven economic integration—first through conquest, then through colonialism, and eventually through joint-stock companies. Since the interaction costs of finding suppliers better than those available locally have been prohibitive for most customers, their choices have been limited to local companies and to companies that could overcome geographic boundaries. Today, it is easier for customers to shop across boundaries than for local suppliers, with their heavy fixed investment in business systems, to restructure. As choice expands and falling interaction costs make value more transparent, customers will demand more value at better prices. Companies that make the most of their intangible assets will win in this world of expanding customer choice. As just about every business in the world loses geographically privileged access to customers, labor, capital, technology, and production techniques, many of the most important historic determinants of cost and value advantages will disappear, to be replaced by intangibles such as talent, intellectual property, brands, and networks. Intangibles now “buy” a company the access that used to come with geographic privilege. The integration of the global economy promotes specialization, and since intangibles lie at the heart of specialization, their importance is sure to increase. They will be the new scarce resource—the differentiating capability that generates enormous scale effects, for the cost of creating world-class drugs, software, movies, and the like varies little with volume, so Pfizer wins astounding returns from Viagra, Microsoft from Windows 98, and Paramount and Twentieth Century Fox from Titanic.
Take the experience of SAP, the German world leader in the provision of client-server environments for business. It started in 1972 with three people. In 1997, operating in 50 countries, SAP made pretax profits of $930 million, an increase of 72 percent over 1996, on sales of $3.4 billion, three-quarters from abroad. In 1997, it invested an extraordinary $460 million (14 percent of its sales) in research and development—a testimonial to its belief in the value of intangible capital. In this way, SAP dominates its specialty. Because the company’s brand is perceived as the industry’s best, SAP is the supplier of choice. It thereby benefits from enormous advantages of scale and can invest its savings in efforts to sustain its edge in its specialty. Indeed, SAP has easy access not just to customers but also to partners with their own intangible assets. UNLIMITED POTENTIAL Globalization is often associated with emerging markets, and much is indeed happening there. But enormous opportunities—perhaps most of them—lie in the developed world, particularly within Europe and North America, as well as between Europe and North America. The economies of Europe, with a population of 450 million and 32 percent of the world’s dollar-denominated GDP, will soon be considerably more integrated. The adoption by some members of the European Union of a common currency, the euro, is the most visible manifestation of this tendency, but other developments—including the harmonization of regulation and the opening of national borders to the free flow of traffic—are also important. Although significant barriers to interaction (notably differences in language, as well as regulatory barriers such as labor laws) remain, the next decade will give rise to a European economy that, from the standpoint of economic integration, will look more like today’s US economy. By then, however, the United States will have moved on to the next stage. Already the world’s largest, most integrated economy, it has long benefited from its size, common language and currency, nationwide federal regulation, and low barriers to labor mobility. But continuing major advances in communications in an already massively “wired” society mean that the transformation of industry structures has barely begun. In addition, the ratification of the North American Free Trade Agreement (NAFTA), greater capital mobility within North America, falling interaction costs, and expanded customer choice are all binding the economies of Canada and Mexico more closely to that of the United States. Moreover, the same factors lowering barriers to the integration of individual companies within regions are also promoting integration between regions; within ten years, it seems likely that the economies of Europe and North America will be more tightly integrated than they are today. Beyond all this lies the long-term need to integrate the economies of emerging nations with those of advanced ones. The developed world, with 20 percent of the Earth’s population but 80 percent of its GDP, is the center of gravity of the global economy in its current form. Nonetheless, such emerging countries as Brazil, China, India, Indonesia, Russia, and Turkey now fall within the global frontier. In 1996, the volume of trade between the developed world and emerging markets exceeded $2 trillion, compared with $802 billion in 1986 (calculated in constant dollars). Given the intensity of competition in the first world, these emerging countries represent a lifeline to profitability, particularly for industries such as consumer goods. For other industries, the rewards may be further down the line, but the race starts today. And the race is not just for new opportunities to expand sales volumes. Emerging markets introduce a new resource: an almost inexhaustible supply of cheap, potentially highly skilled labor. Labor productivity in developing countries might be only one-third to one-half of the levels in developed ones, but wage rates can be 10 or 20 times lower (Exhibit 5). If quality can be maintained, this translates into labor cost advantages of 50 percent or more. 
India, for example, has already become a world leader in the development of computer software: in 1997, the industry there generated $1.8 billion in sales, an eightfold increase over its levels five years previously. Most of this output is exported. India has the world’s second-largest pool of English-speaking scientific labor, which is among the world’s cheapest. Of course, as the economy becomes truly global, such labor cost differentials will disappear. But the process will be slow and more than offset by a massive improvement in the standard of living of billions of people. These effects are likely to be so great that by 2010, only 48 percent of the world’s middle-income consumers will live in today’s high-income nations. For companies that can meet the challenge, the transition economy offers unprecedented opportunities. Ultimately, the ability to spread fixed costs over a global economy of six billion people will dwarf anything that might be achieved within a local, national, or regional economy. TRANSITION AHEAD With high growth comes high risk but also high reward. Social unrest, market crises, and political stress will probably accompany the transition from a world where 90 percent of competitive advantage reflects geography to a world where 90 percent of it doesn’t. Formerly durable competitive advantages such as physical distribution and breadth of offerings will become millstones. Local producers will find that they lack the profits to defend themselves. Insiders will suddenly discover that friends in government have lost their jobs or can no longer write the rules. With geographic and regulatory barriers falling, electronic distribution starting to parallel and to even bypass physical distribution, installed capacity becoming obsolete before depreciation, and focused competitors attacking like piranhas, companies will find that they must restructure or die. In such an environment, the incentives of participants in local geographic markets will change. Rather than colluding, incumbents will scramble to find outside partners to continue serving customers, albeit in a diminished role. New local competitors that emerge in surprising places will play by different rules. Fully integrated producers will start to shed the parts of their business systems in which they are not competitive. Broad-based distributors will focus on discrete segments. Large cracks will appear in local cartels. But what opportunities there will be! Under these conditions, companies will require not only the analytic techniques of traditional operations research but also the active, synthetic skill of inventing and implementing the future. Strategy is back with a capital S. It is literally a race for the world. Notes Requests |
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Last revised on 20 July, 2000
URL: http://www.global.com/eng/ed/art/getting-to-global.html