14.1 Which Market to Select?

There are almost 200 countries, all of which offer differing potential to earn profit for firms that seek to expand internationally. When deciding on which market to choose, organizations must be careful not to overvalue the attractiveness of a market and ensure that all issues and risks associated with the market are evaluated. One way to do that is to analyze political, legal, economic, social, and cultural risks of a market which were discussed in early chapters. Another very helpful tool that assists organizations with international market evaluation is a framework developed by Pankaj Ghemawat, called the CAGE Distance Framework. CAGE is an acronym for different kinds of distances:

• Cultural
• Administrative/Political
• Geographic
• Economic

The CAGE Distance Framework

Most of the risks and costs associated with expanding the business to international markets are created by distance. Distance not only indicates geographic distance (kilometres, miles) but also, as the CAGE framework points out, cultural distance, administrative/political distance, and economic distance. The CAGE framework helps organizations to measure the distance between the home country and the target country. The greater the distance, the higher the risk level and the lower the opportunity for success.

Cultural Distance

This refers to cultural differences between home and host country, such as social norms and values, language, ethnicity, and religious beliefs. These cultural differences directly affect customer preferences and contribute to different perceptions of the same situation. An organization’s decision to enter an international market is largely influenced by cultural distance. Studies have shown that countries which share the same language engage more in international trade than countries with a different language. As former colonies of Great Britain, the USA, Canada, Australia, New Zealand, and Ireland exhibit a lower cultural distance and trade more among themselves than they trade with Russia, for instance, since they all speak the same language. Cultural distances can make interactions complicated and adaptation of cultural values time-consuming, thus increasing transactional costs.  The cultural distance can also hinder the development of trust, which can increase the cost of entry and reduce the possibility that international trade will occur. Therefore, the greater the cultural distance among countries, the higher the cost of conducting business in those countries.

Administrative/Political Distance

This refers to distances captured by factors such as political association, weak or strong legal and financial institutions, common currency, trade agreements, and shared history.

The distance is greater between countries that have different political systems, such as democracy versus a totalitarian system. The distance can also be created by differences in law between countries, for example, some countries have strict environmental and labour laws, which make compliance and doing business more costly.  Also, some countries may have restrictions regarding foreign investment in industries that are critical to national security e.g. communications, aerospace or a domestic business that is a large employer. These industries are hard to enter for foreign firms which are looking to expand, thus increasing the distance.

Geographic Distance

The physical distance between the home country and the new market is the main dimension of geographic distance. However, geographic distance captures more factors than the literal physical distance, such as a country’s physical size, the within–country distance to its borders, its time zones, topography, and whether the countries are next to each other or have access to waterways. All these factors contribute to the cost of international trade. Other determinants of geographic distance are the country’s infrastructure and communications networks. Lack of adequate infrastructure and communications system will lead to increased trade costs even if the host country is physically close.

Economic Distance

This refers to the differences in wealth and the per capita income of consumers; the bigger the difference, the greater the distance. Countries with similar economies have greater chance of success, however if the per capita income of the target country is relatively too low, doing business there could be challenging. Other differences that increase economic distance are financial resources and access to modern banking systems, knowledge and education level of human resources, infrastructure, and the differences in cost and quality of natural resources.

The Time of Entry

Once an organization decides which market to enter, the next important step is to decide on the time of entry. The right entry time is critical to the firm’s performance and success in an international market. When an international firm enters a market before other foreign firms, the entry is called early entry, and when a firm enters the market after other international firms have already established their operations, the entry is called late entry. The advantage gained by a firm that first introduces its product or service to a market is known as the first-mover advantage.

First Mover Advantage

This refers to the competitive benefits gained by a company that first introduces a product or a service to a specific market. The first-mover advantage framework was developed by Marvin B. Liebermann and David M. Montgomery in 1988.

The advantages associated with being the first entrant in the market are as follows:

• Initial market share – gaining significant market share speeds up brand recognition and customer loyalty which also helps to reduce marketing costs.
• Build sales volume – results in increased production, which potentially facilitates the achievement of economies of scale. Reducing the cost through economies of scale enables early entrant to cut prices below those of a later entrant, and drive competition out of the market.
• Control of resources – the initial access to scarce resources that could range from strategic location to raw materials used in the production process or top talent and skilled labour for their workforce. By controlling these resources, the first entrant can solidify its position in the market and gain a significant competitive advantage over subsequent entrants.
• Buyer switching costs – refers to the costs that a customer incurs when switching to a new supplier such as time and resources spent in qualifying a new supplier or investment that a buyer must make in adapting to a seller’s product: for example, installation of a new software and the financial burden of training employees (CFI Team, n.d.).

First Mover Disadvantage

There are some disadvantages to being the first mover, and those disadvantages are, in effect, advantages for those firms who are late entrants to the market, and they are:

• Informed buyers – the first mover has to invest heavily in customer education. This is a cost that the late entrants can avoid (CFI Team, n.d.).
• Product improvement – late entrants can take advantage of the reverse engineering process and make the product better. A reverse engineering process is when a product is deconstructed for the purpose of enhancing its performance or duplication (Lutkevich, 2021).
• Avoid mistakes – late entrants can save cost and time by avoiding mistakes that are made by the first mover.

The Scale of Entry

Another decision that an international business needs to make is the scale of entry. The entry could be large-scale or small-scale. In making the decision on the scale of entry, the firm must consider the cost and the risk associated with both large-scale and small-scale entry.

Entering a market on a large scale will require a commitment of significant resources and is considered a strategic commitment; that is, a commitment that has a long-term impact and is difficult to reverse. Large-scale entry also attracts customers by giving them assurance that the company is there to stay. It also may cause rivals from other countries to rethink their entry to the market. On the negative side, large-scale entry may limit a firm’s investment in other markets and may lead to a competitive response from local firms with similar products and services (Jordan, 2022).

Entry into a market on a small scale gives companies time to learn about the market and reduces the company’s risk exposure. However, with small-scale entry, it may be difficult to build market share and to capture meaningful first-mover advantages (Workspace, n.d.).

References

CFI Team. (n.d.). First mover advantage. Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/management/first-mover-advantage/

Ghemawat, P. (2001, September). Distance still matters. Harvard Business Review, 79(8): 1–11.

Jordan, N. (2022, March 18). How do firms go international? – Closer look at entry strategies. Trade Horizons. https://tradehorizons.com/market-entry-blog/2022/03/how-do-firms-go-international-closer-look-at-entry-strategies/

Lieberman, M.B. & Montgomery, D.B. (1988). First-mover advantages [PDF]. Strategic Management Journal, 9(Special Issue): 41–58. https://uol.de/f/2/dept/wire/fachgebiete/entrepreneur/download/Artikel_Internetoekonomie/Lieberman_First_Mover.pdf

Lutkevich, B. (2021, June 10). Reverse-engineering. Software Quality. TechTarget https://www.techtarget.com/searchsoftwarequality/definition/reverse-engineering

Workspace. (n.d.). How to enter a foreign market. https://www.workspace.co.uk/content-hub/business-insight/how-to-enter-a-foreign-market

Attributions

“The CAGE Distance Framework” is adapted from “9.3 CAGE Framework” from Strategic Management by Reed Kennedy, licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.