SPRING/SUMMER 2003 STERNbusiness InformationCrossing Nation Borders

CEO Interviews: How UPS Delivers How Bic Stays on the Ball CreativeNiall Ferguson onThinking: Anglobalization India’s Software Giant EntrepreneurshipWhy Major Economies Don't in Move the in SyncDigitalUnderstanding Age New Consumer Markets Wal-Mart’s Foreign Travels Rx Coverage: Curing Telecom and Argentina a letter fro m the dean

It’s more than fit- Metropolitan Opera, Munich’s Bayerische Staatsoper, ting that this issue and Milan’s La Scala. focuses on the topic Meeting in the heart of Europe, and with people of globalization and from different business cultures and scholarly crossing borders. In disciplines, added a great deal of context to all our recent months, Stern discussions. Of course, history is an important com- has seen significant ponent of context. Business history – long a strength milestones in our at Stern – has been augmented by the arrival in international efforts. This past January the inaugu- January of Professor Niall Ferguson, who recently ral, 28-person class of executive MBA students from joined us from Oxford University and is the author TRIUM, the program Stern offers jointly with the of the definitive two-volume history of the London School of Economics and the HEC School of Rothschild banking empire. His most recent book, Management in Paris, completed their studies. The Empire – which is partially excerpted in this issue – second TRIUM class, with 35 members, completed is a significant contribution to the growing literature its first module at our campus in New York that on globalization. same month. This innovative program, geared As several articles in this issue argue, toward inculcating a global perspective in its stu- understanding the historical development of dents, will continue throughout the year with international markets, companies, and financial sessions in Paris, London, Brazil, and Hong Kong. systems is crucial for leaders grappling with While many of our alumni remain in the New contemporary questions and challenges. After York area, and hence can easily maintain connec- all, locating our place and role in an increasingly tions to Stern, and with one another, Stern graduates connected world is the fundamental task of all edu- who live in 98 countries have fewer opportunities to cational endeavors, but in particular of business do so. In October, we held our second international and management education. alumni conference at La Pietra, NYU’s conference We look back on recent accomplishments with center in Florence, Italy. pride and a sense that we are affording all members At La Pietra, where nearly 160 people gathered of the Stern community a greater understanding of for a weekend of fine food, fine art, and fine discus- the world in which we live and work. And we look sion, Stern’s approach toward business – and busi- forward eagerly to the future – and to this issue of ness education – was on full display. Panels brought STERNbusiness. together executives and scholars to discuss topics ranging from corporate governance to the direction of the global economy. A session on the business of Thomas F. Cooley opera included the administrators of New York’s Dean contents SPRING/SUMMER 2003 Crossing Borders

30 Don’t Cry For Argentina A Roundtable Discussion 10 Stern A Passage From India 34 ChiefExecutive by Raghu Garud, The Big Store Goes 44 Series Arun Kumaraswamy and Global Telecommunications: Monica Malhotra by David Liang Excess Capacity by Lawrence J. White 18 40 The Market Next Door It’s A Small World 48 Endpaper Interviews with by Peter Golder and After All? by Daniel Gross Debanjan Mitra Bruno Bich, page 2 by Jonathan Heathcote Michael Eskew, page 4 and Fabrizio Perri 24 Anglobalization STERN by Niall Ferguson business A publication of the Stern School of Business, New York University

President, New York University John E. Sexton Dean, Stern School of Business Thomas F. Cooley Chairman, Board of Overseers William R. Berkley Chairman Emeritus, Board of Overseers Henry Kaufman 8 Associate Dean, Marketing Crossing Borders and External Relations Joanne Hvala by Daniel Gross Editor, STERNbusiness Daniel Gross Project Manager Rika Nazem Design Esposite Graphics

Illustrations by Letters to the Editor may be sent to: Chris McAllister, Timothy Cook, NYU Stern School of Business Warren Gebert Office of Public Affairs Gordon Studer, 44 West Fourth Street, Suite 10-83 Robert O’Hair, New York, NY 10012 and Michael Caswell http://www.stern.nyu.edu sternChiefExecutiveseries Bruno Bich chairman and chief executive officer Société Bich

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

ML: You certainly are the In three years or so, business the tough market. Computers that market head on would quintessential multi-national, will come back to its normal have not really done much to have been extremely difficult. multi-lingual executive. Tell us pace. our White Out business. That Instead, we went into the one- what's going on in the global market also grows two, three piece or disposable razor. We economy. Is it really as difficult, ML: Do any of your major percent a year. Our highlighter went through the side door. demanding, and daunting as it products face specific chal- business has actually And today, if you look at the appears? lenges now? For example, increased quite a bit. People western world, 55 to 60 per- BB: We are slightly affected lighters. We see what's hap- are highlighting a lot of com- cent of the people shave with by the downturn in the econo- pened with cigarette smoking puter reports. a disposable razor. There are my. There are good reasons to in this country, and notably in more people shaving with the be careful right now. We creat- this city, and presumably that ML: Shavers must be a chal- disposable razor than with the ed a bubble and we are paying will spread. Or your White Out lenging market, especially with system razor. Now, the system the price. There was a bubble business, when more and a goliath of a competitor like is bigger in value. But, in vol- in Asia, which corrected a cou- more people are using com- Gillette. How do you make that ume, we are about equal with ple of years ago, and now is puters? business grow? Gillette, in the U.S. and in trying to recover. In Europe, BB: Smoking is going down BB: Our company was started Europe. there was an Internet bubble, one to two percent per year in right after World War II by my but to a lesser extent than in the U.S. or world. That's a very father. In the U.S., we went in ML: What is your strategy for the U.S. It's just like a pendu- small decline. In fact, we have the shaver business against expanding in terms of new and lum. We went too far one way, increased our sales of lighters Gillette. Gillette was strong in different products? we go too far the other way. about four percent a year over what I call the system and BB: First of all, the consumer Short term, I'm concerned. the last five years. We keep on replaceable blade. To go goes to the store, and has a Long term, I'm very optimistic. gaining market share despite through the door and attack choice. Consumers usually

2 Sternbusiness Marshall Loeb, the former managing editor of Money and Fortune, conducts a regular series of conversations with today’s leading chief executives on the Stern campus.

"We can never forget that in today’s time, and somewhere else 20 of each toward the same goal, percent of the time. We have versus focusing on the differ- world, approximately 20 percent of the put together a group of man- ences. That's arduous work. people earn less than $2 a day." agers who come from different But the payoff is great. backgrounds and different civi- lizations, because there is a lot ML: You have some of the spend about 20 seconds we can never forget that in of value to finding what are the world's best known brands. deciding which product to buy. today’s world, approximately common points between con- How do you develop a brand, The quality of the brand name 20 percent of the people earn sumers in Europe and the and how important is that to in the subconscious of the con- less than $2 a day. So our United States, South America you? sumer becomes very impor- strategy is serve the con- and Europe, and even Asia. I BB: Our brand name is my tant, as does his recollection of sumer, never forget the basic think too often, people start to family name so I look at it as a how well he was served by the product, and work on the quali- talk about the differences. signature. I think that a brand product in the past. That is ty all the time. If people want First, let's talk about the com- stands for an agreement or a really where we concentrate to spend a bit more money, mon points. Ethics. Teamwork. contract, your signature to the our strategy. and they have the money in Internationalism. When you consumer that what you deliv- The second thing is, we certain countries of the world, look at consumers, they write er to him is what he expects. develop products with new then we'll present a wider the same way, they shave the You can build a brand, with technologies that offer different choice, with newer technology. same way. We use English as advertising, with a very good services to the consumer in our language of business, product, and with consistent relation to their purchasing ML: Where are you going to which is pretty advanced for a quality in your product. But you power. Thirty years ago, you make your major thrust for French company. Once a can lose it very, very quickly. I had a ball point pen and you expansion? month, we video-conference don't think that any brand in had a mechanical pencil. Then BB: My father started the busi- with top managers around the the world can be number one came the first felt products, the ness in France. But France, world. We get together face to or number two by offering infe- first flair pens. Instead of four today, represents only nine face every three months. rior quality. The strength of a colors, now there are 12 colors percent of our sales. Overall, If there's one weakness in brand is in the long-term faith of ink. And the point size, Europe is about 34 percent, the United States, it is that of the consumer around the which dictates the width of a North America about 56 per- American companies call world. The important ingredi- line of color on a piece of cent, South America eight per- themselves international when ents are quality, reliability, and paper. There used to be only cent. We have the most oppor- in fact, there are very few value. After that, you're going 0.7 millimeter and 1 millimeter. tunity in Asia. We started doing executives at American compa- to add the pride of having the Now we have 1.2, 1.0, 0.7, business two years ago in nies who are multi-lingual and product. And this is where 0.5, and even 0.3 in Japan. So Asia, but building a business very few people who come advertising comes in. For all those technologies offer there will take 10 or 20 years. I from foreign backgrounds. example, we used John choices to consumers, which think that in the 1970s, you McEnroe in our shaver adver- they like to indulge. could not call yourself an inter- ML: What are some of the dif- tising. That campaign showed Then there are different national company if you were ferences between American the consumer that Bic has a types of markets. In both not strong in the United States. managers and non-American simpatico side to it. When it developed markets and emerg- I think in 10 or 20 years you managers? comes to the advertising or the ing markets, but particularly in will not call yourself a strong BB: The main difference is design of the product, I per- the developed markets, you global company if you are not that the American managers sonally spend a lot of time on have the need market and the strong in Asia. are very results oriented. And it, because it affects the long pleasure market. People want the French, who are more term strength of the company. a basic ball pen that writes ML: You have a management intellectuals, love to discuss Our managers know exactly well. On the other hand, peo- team that is stationed all over and do more research. I think how to manage things like pric- ple--particularly young people-- the world. How do you manage Europeans are extremely ing. But they are not responsi- want to find a little bit of pleas- that? inventive in terms of technolo- ble for the soul of the compa- ure in their everyday life. And BB: Well, I have two offices-- gy. And when you put them ny, which is the brand name, that's where they really look at one in Paris and one in New together with Americans, who or the design of the product. the design of the product, and York. And I commute. I'm in are very good at process, you new technologies with different New York 50 percent of my have stupendous machinery. ML: When you seek to hire ink colors. At the same time, time, Europe 30 percent of the The idea is to use the strength continued, page 6 Sternbusiness 3 sternChiefExecutiveseries Michael Eskew chairman and chief executive officer United Parcel Service Michael Eskew is the Chairman and CEO of United Parcel Service. UPS is the world's largest package distribution company and logistics provider. In 2001, the company reported sales of $30.3 billion. After nearly a century in business, the UPS name is synonymous with reliability and integrity. Today UPS’ 360,000 employees deliver more than 13 million packages and documents each day, serving nearly 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 1972 as an engineer. In his 30-year career with the company, he has held a variety of posts in the U.S. and Germany, includ- ing Corporate Vice President for Industrial Engineering and Vice Chairman. In January 2002, he was named Chairman and CEO.

ML: What do you think is ML: What do you see as the I went to a retail shop to buy it. to expand their markets. And going on in this economy? greatest spurs to innovation? All the computers looked alike. it's not just the big companies, What is really wrong, and ME: For our business, we They were all configured the it's the smallest companies, what's going to pull us out? think about two dynamics that same way. And they were companies that started with us ME: We released our earnings are in place: globalization and delivered by truckloads. Today when they were in a garage. in July and we concluded that what we call “consumer pull” - I can order one computer and I The nice thing is, we can act the economy, at that time, was consumers being able to look can configure it exactly as I like each customer’s package sluggish across all the different into the supply chain and pull want. I can select the screen is the only package we have. sectors that we serve. The through what they want, when size and printer. And today, We can tailor solutions on a only area where we saw any- they want it. As far as global- consumers can pull these cus- one-by-one basis. thing going on was in mort- ization goes, our international tom-made computers through gage refinancing. An awful lot business is strong. The last the supply chain one-by-one. ML: UPS is engaged in what of letters and documents were quarter our exports from They come one-by-one in a seems to be a pretty basic going back and forth between Europe were up 13 percent package delivered, I hope, by business. You deliver packages banks. We used to think that and our exports from Asia a brown package car. This by trucks. It doesn't sound like we were a good leading indica- were up 17 percent. China was dynamic is making the supply a very romantic or exciting or tor for Gross Domestic Product up nearly 40 percent year on chain cheaper. challenging business, yet I (GDP). But as inventory levels year. We see an awful lot of suspect that it is. over the last few years have power in that dynamic. The ML: Tell me about globaliza- ME: UPS has been in busi- come down, we don't think we other dynamic, consumer pull, tion and its effects upon your ness for 95 years. It was see changes in GDP until they is powerful as well. I'll give company. founded in 1907 by a teenager happen. you an example. The first com- ME: We have an awful lot of in Seattle named Jim Casey. puter I bought was an IBM XT. customers who really do want He started out delivering mes- 4 Sternbusiness sages in Seattle. In about was picked up, when it was "Our business is the flow of goods. And 1911, a new technology put delivered, and whether it was today, thanks to technology, we facili- Jim's company out of busi- signed for. tate the flow of information. We know ness: the telephone. The need Think about a camera or a exactly when a package was picked up, to run messages all over computer or an elevator or a when it was delivered, and whether it Seattle went down dramatical- printer or an aircraft or a med- ly. So he changed his business ical device, any high tech was signed for." and started to deliver goods for device. Usually folks that buy ness brand in the U.S., next to selves. We are a team. There stores. Jim had to go convince those devices need two-to- Coke. We've done a lot of are no private jets. We drive the stores of Seattle that if a four-hour part replacement work with our brand recently. It ourselves to the airport. I customer came downtown on when something breaks. You used to be that our purpose parked my own car and carried the streetcar and didn't want to can't run a McDonald's if the was to satisfy the small pack- my own bag today. And I carry his goods home, his cash register doesn't work. age needs of our customers. answer my own phone. Our company could deliver those Satisfying the need for two Now our purpose is to enable culture is that we are one goods to the customer’s home. hour part replacement any- global commerce. We went to group. We try to treat each And he could put all the pack- where in the world requires the brand consultants. They told other the same. For instance, I ages together and create best transportation company in us that we don't use our colors eat in the cafeteria every day scope and scale and put them the world, which we've been the way we should use our col- and I don't bring coffee and all in a clean car with a uni- building for 95 years. It ors. We need to call attention drinks to my desk because we formed driver and do it profes- requires a lot of technology. It to brown, the color we own. ask the drivers not to drink sionally. That's how the whole requires central stocking, We also need to think about coffee and eat lunch in their thing started. That business keeping those critical parts in more than just the package, cars. That driver is as impor- went on until after World War one or two or three locations in how to make the brand about tant as I am. That's part of our II. Then people didn't go down- the world. It requires forward enabling global commerce. culture. town to shop anymore. They stocking locations, places When the brown campaign drove to suburbs and shopping where you can keep parts so came out, we did a lot of sur- ML: Do your executives get centers, bought things and that they can be where they veys and we felt that there out and actually drive the drove them home. So the busi- are needed two hours after were two other colors that trucks? ness model was again threat- that phone call is made. We companies owned. Blue was ME: We all did, every one of ened by technology. Jim can put all those services one of them, that was IBM. us. I started at UPS as an Casey had to go into the com- together anywhere in the And pink was the other one, engineer. I did some basic mon carriage business and world. and that was Owens-Corning. engineering for about the first compete directly with the post We also have repair loca- And so we felt like we really two months. Then I went on to office. The business spread tions. We do repairs on those could stake brown. deliver packages for about two from there. parts also, because it all needs or three months. And you I joined UPS in 1972. We to come together at one time ML: What is unique and dis- never forget the look in the were in 37 states and had rev- and place. Those companies tinctive about the UPS cul- customer's eye, the things they enues of about a billion dollars. in the U.S., and in Asia, and in ture? look for. If a package is late, Since then, we've moved into South America, and in Europe ME: We have two strengths at you'll never, ever forget it. And 200 countries and we've want one throat to choke. We UPS. One is the way we're when you get it there on time moved beyond just ground, to are it. They want one entity to organized. We have district and it delights and they need- air, to ocean, to international. manage the supply chain. So organization so we can be ed it, you'll never forget it. And we've moved beyond just we do get excited about this close to the customer. The When I was a district manager small packages. We now serv- mundane business. It's making people that run our business in New Jersey I would ride ice the whole supply chain. All customers better. day-to-day are in the field. The once a month. I would ask the commerce is all about three other strength is our culture. staff to ride once a month. flows. Goods flow, information ML: You have a very strong We have 360,000 employees That’s not uncommon. flows, and funds flow. Our brand. How would you define in 200 countries around the business is the flow of goods. it? How do you preserve and world. And there are no super- ML: You have a lot of long And today, thanks to technolo- protect it? stars. None of us are more time, long-term employees. gy, we facilitate the flow of ME: Our brand was just evalu- important than the other. None ME: We do. We have about information and funds. We ated and we determined that of us are sufficient by our- know exactly when a package we have the second best busi- continued, page 7 Sternbusiness 5 Continued from page 3 you don't have debt in such a "I think that in the 1970s, you could not way that you are under pres- call yourself an international company if somebody, what do you look sure to make short-term deci- for? sions in order to cover your you were not strong in the United States. BB: Personal values. I don't debt. And you don't over prom- I think in ten or twenty years you will not think leopards change their ise to Wall Street. I sense that call yourself a strong global company if spots. We want to find people some of the things that have you are not strong in Asia." who believe in the same val- happened recently on Wall ues that we do. Respect for Street are the result of pres- as you do in China, India, or high-quality, high-end writing the consumer. Respect for sure to generate earnings, South America? Many retailers instruments. We need to revive your fellow workers. That leads which frankly were not realistic have a terrible problem when that part of the industry. We did you to teamwork. Modesty. in relation to the growth of the they price discriminate not thoroughly analyze the That leads you to the accept- market. Also, the people who because their merchandise is high-end of the business. We ance that there are good ideas work in the company must smuggled from third world did not do enough homework all over the world. Then you know that they will be evaluat- countries into developed mar- before the acquisition. move on to professionalism. ed and fairly promoted, even kets and sold at below market Internationalism. There was a though they are not in the fam- prices. Q: Would you please tell us time when I used to say, atti- ily. And we in the family must BB: We do price to market about your trajectory to the top tude is more important than do an excellent job. When I and we do have that issue. If of Bic? aptitude. I don't say this to the came to the U.S., and when I you want to grow in Eastern BB: When I was 16 or 17, human resources department got more and more responsi- Europe, you have to offer your instead of going to England to anymore. I tell them, I want bility, my father was testing product at a price that is lower learn English, I came here for both. There are good people me. If I had not succeeded in than in Western Europe the summer. And I loved it. all over the world, people with the U.S., I would not have the because people in Eastern Later, I took a year off and the right values, and the right job I have today. I tell my chil- Europe don't have the money. traveled all over the United brain. I also look for people dren and nephews and nieces, But you need to know your States driving a car. It was who are hungry. first you'll have to ask to join business. You need to know an 1964 and we were a very the business and then you'll account well enough to see small company. And I would go ML: Yours is a family busi- have to prove yourself. ness. The family owns a little that if you get an order from a to retail stores and check on wholesaler four times bigger our distribution. I became very more than a third of the shares Student questions than any order that you have interested. After a year, my and has a little more than 50 Q: How do you create syner- ever got from that wholesaler father asked me what I wanted percent of the voting power. gies between your managers before, there is something to do. I said, I want to go to What are some of the particu- of different nationalities around fishy about it. business school in America. In lar advantages and the partic- the world and what kind of dif- 1964, there was no other place ular challenges of being in a ferent talents do you expect Q: Failure is part of the grow- to go to business school. After family business? from them? ing process to become a good I graduated from NYU Stern, I BB: Over all, being a family BB: You create synergies by manager. Could you share with went into investment banking. I business is a big plus. The big choosing the right people. us one of the most humbling worked for White Weld in the plus is that you build the busi- You've got to have people who losses that you had while U.S. and Europe for about four ness for the long-term. In deliver on a regular basis. And growing up in your business? years, and then joined Bic. I Europe, we don't report quar- you have to be very careful BB: My biggest failure was the became president of the U.S. terly earnings. We report semi- about communication. When acquisition of Shaeffer Pen. It business in 1983. That's when annually. Of course, when you you have people from different hasn't worked out yet. I think we started to introduce new are a public company in the backgrounds who speak differ- one of the reasons is that a lot products which we didn't have U.S., you must report quarterly ent languages, you have to be of the Shaeffer business is in in Europe. And that's how earnings. That puts pressure very, very attentive. One of our Asia. And shortly after we North America became 56 per- on management to do things philosophies is, "It's not bought the business, Asia went cent of our global business. My that are not necessarily good enough to explain. You have to straight downhill. The second father gave me the chance to for the long-term. But if you're be understood." a family business, you can thing is that people today, show what I could do here in executives, do not have a the U.S. build for the long-term. And Q: Do you sell the same razor sense of pride in having a that means, in our view, that at the same price in the U.S. 6 Sternbusiness Continued from page 5 for new businesses. In terms "We went through brand consultants. of things we do internally, we They told us that we don't use our colors four percent turnover, which look at the product process the way we should use our colors. We means that people last on with our marketing group. For average 25 years among the need to call attention to brown, the example, they take next day color we own." full-time ranks. The loyalty that air and second-day air and they have is terrific. make it 8:30 and 10:30, and world every day and we want could do things there just like they replicate that model and to know where every one is at we did them in the U.S. For ML: What kind of characteris- integrated delivery network every moment. Right now, we example, we called each other tics and qualities do you look throughout 200 countries. The do that by scanning every by our first names in the U.S. for when you are hiring some- way we grow existing busi- package several times. That's Well, Germans don't do that one? nesses externally is through a lot of labor. What we'd like to because of the formality of the ME: We really think about mergers, acquisitions, partner- do is use RF transponders as language. We want to be able folks that can work with peo- ships, and alliances. We've a way to track packages. to build our overall brand so ple. This is a people business. done several acquisitions. It's not a place for everyone. If We've done hundreds of part- that folks all over the world you want private cars and pri- nerships and alliances, gener- Q: What items are on your learn to think of UPS. Our vate jets and country clubs and ally in the high- tech space. capital expenditures wish list? website is available in 19 dif- you want to see your name up We know that we have to go to ME: We spend a billion dollars ferent languages. It's tailored in lights, don't come to UPS. external sources to be able to every year on technology, and to 109 different countries. So if It's not that kind of place. But it grow existing some businesses. we have for the last 15 years. you're in a remote part of is a place that you can work With new businesses, we We've been described as a Nigeria, you can find out how and know that you do some- can try new things and we can technology company with long it takes to get a package thing that's honest and noble. fail small fast, so we try to Delivering a package is noble. trucks and that's a fair descrip- to Japan. We are enabling commerce, innovate down there. For tion. We're going to continue to making our customers better, example, we investigated web- spend money on technology. Q: UPS has invested very taking them places. It's an based grocery delivery. We We just opened our new air heavily in aviation over the honest job and it's a great tried it and failed fast. But we sort in Louisville. It's the most past decade. I know that you place to work. And we think we didn't fail with a lot of money. phenomenal sort you've ever have experimented with using make a difference. We use a strategic enterprise seen in your life. The pack- that aviation equipment in fund to examine new business ages sort themselves! The other ways. Can you tell us "We have 360,000 employees in 200 packages move 400 feet a about that? minute but if you could make ME: We do sometimes experi- countries around the world. And there time stand still, you could find ment in that kind of new busi- are no superstars. There are no private that package within 12 inches ness. We look at three differ- jets. I parked my own car and carried in a building that is the size of ent dynamics. First, it has to the Pentagon. It's a phenome- be an attractive market, a my own bag today. And I answer my nal thing. Also, we're going to growing market. Second, it has own phone." continue to add to the 300 air- to leverage our strengths, our craft we own, to be able to skills, our brand, our customer Student questions opportunities. We use that to take our customers' packages base, our technology, our peo- Q: Can you give us an exam- fund pre-IPO companies that around the world. ple. Third, it has to fit our strat- ple of how you create high do things in spaces that we're egy. Again, that strategy is to value, innovative solutions for interested in. And we support Q: In your ongoing effort to enable global commerce. We customers? research at universities. One globalize your market, how has didn't think flying passengers ME: We think about this in of those companies was a it been different doing busi- on the weekends to cruise terms of four dynamics. We company named Savi, which ness in other countries? ships necessarily was an think about things we do inter- does radio frequency (RF) ME: nally and things we do exter- We did our first interna- attractive market. It almost dis- nally, things we do for existing transponders. We move 13 tional expansion in Germany in tracted us. So we got out. businesses and things we do million packages across the 1976. We all thought that we

Sternbusiness 7 CROSSING

By Daniel Gross

rom the ability to communicate with friends in IT services to U.S. London via instant messaging to the presence clients from a of canned okra from Lebanon in the aisles of location as seem- Stop’n’Shop, there is evidence all around us ingly remote as thatF the world is becoming a smaller place. So too, alas, India. Today, are indicators that significant distances – political, cul- Infosys, a soft- tural, and economic – stand between us and our fellow ware giant based inhabitants of the earth. in India and In his 2000 best-seller, “The Lexus and the Olive listed on the Tree,” New York Times columnist Thomas Friedman Nasdaq, counts rhapsodized about the positive implications of global- dozens of blue- ization and the proliferation of the latest development in chip U.S. compa- information technology. No two countries with nies among its McDonald’s, he reported, had ever gone to war. His clients. In their 2002 best-seller, “Longitudes and Attitudes,” focuses case study (p. 10) more on the downsides of globalization. It turns out, of Raghu Garud, Aruna course, that in our global village, terrorists can use the Kumaraswamy and Monica Internet to organize, and that even isolated countries Malhotra show how Infosys like North Korea can gain the expertise needed to pro- is creating a new paradigm duce highly sophisticated weaponry. that can be emulated by compa- Despite today’s uncertainties – many of which have nies from Bangalore to Boston. been economically disruptive – the forces that spurred “What most distinguishes Infosys is the globalization are still immensely powerful. The trade in way it systematically built up a post-modern, goods, services, and ideas is increasing, not decreasing. scalable enterprise for harnessing intellectual capital in In a fascinating interview, Michael Eskew, the chairman the new information economy,” they write. and chief executive officer of United Parcel Service The realization that gaping cultural, political, and (UPS), provides insight into one of the workhorses of economic gulfs exist in a world theoretically made smaller the global economy (p. 4). UPS, which began life as a is just one of many apparent contemporary paradoxes. messenger operation in Seattle, now employees 370,000 Here’s another: In recent years, the trade in internation- people in 200 countries. But while UPS’ fleet of brown al financial assets has increased sharply. And yet at the trucks and brown-clad delivery people provide the same time, the major economies have seen their paths muscle, the human element is only half the story. “What diverge. We’re growing together while growing apart. really makes us the best is information,” Mr. Eskew These two phenomena – financial globalization and real says. “Information that tells us where that package is, regionalization – as Fabrizio Perri and Jonathan when it's late, what building it's been in, where it went, Heathcote tell us, are directly related (p. 40). After all, who sorted it in the wrong direction.” when capital moves more freely, it can follow and pursue Yes, information – and information technology (IT) – returns, and react quickly to local shocks. increasingly drive commerce. Unlike oil or bananas, bits The recent experience of Argentina, whose decision to and bytes can move freely and cheaply from pretty devalue the peso has caused massive economic disloca- much any point on the globe to another at the click of a tion, shows that discussions about capital flows are not mouse. That allows an enterprising company to provide simply academic exercises. At a lively Stern forum last

8 Sternbusiness BORDERS

fall (p. 30), Argentina’s declare bankruptcy, recognize and absorb losses, and former economy min- move on. And continue to use sound antitrust policy to ister Domingo F. encourage innovation. “Good public policy could steer us Cavallo (a Henry through the turmoil and allow us to emerge fairly rapid- Kaufman Visiting ly with a more efficient telecommunications sector.” Professor at NYU ature companies must expand in order to Stern), Mario Blejer, continue growing. But the leap into a foreign market can be daunting. Many companies a former governor gain initial knowledge from the experience of the Central Bank Mthey build up at home. But, report Peter Golder and of Argentina, and Debanjan Mitra, crucial knowledge “can also be gener- NYU Stern profes- ated in foreign markets in which the firm already oper- sor Nouriel Roubini ates that are similar to potential new markets.” In debated the causes of – examining Wal-Mart’s mixed efforts to expand overseas and potential solutions to (p. 34), David Liang concludes that the retailing giants – the Argentina morass. could have benefited from what Professors Golder and Surprisingly perhaps, the Mitra call “near-market knowledge.” When it first economists spent a good deal of opened in Argentina, Wal-Mart stores stocked 110-volt time talking politics. “For eco- appliances; the local standard was 220 volts. Wal-Mart nomic growth, you need strong insti- has stumbled, Mr. Liang concludes, in part because it tutions. And for that, you need a well- has failed to replicate sufficiently the sources of com- functioning political system,” Professor petitive advantage – its brand, product mix, logistics Cavallo said. “The functioning of the constitu- operations, among them – that it has developed at tional system is more important than any question home. Increasingly, growth-seeking giants like Wal-Mart related to the exchange rate system.” are going to turn to Asia, says Bruno Bich, the second Niall Ferguson, the distinguished Oxford historian generation chairman and CEO of the French consumer who is a professor at NYU Stern, similarly argues that products company. “I think that in the 70s, you could institutions matter. In an elegant and provocative essay – not call yourself an international company if you were drawn from his most recent book, “Empire” – Ferguson not strong in the United States,” he said in a NYU Stern argues that the institutions and practices promulgated by interview (p. 2). “I think in 10 or 20 years you will not the British Empire in the 19th and early 20th century call yourself a strong global company if you are not made it one of the original progenitors of globalization strong in Asia.” (p. 24). “A case can be made that the British Empire was Today, globalization is a loaded term. It inspires economically beneficial, not only to Britain herself, but visionary idealists and embittered protesters alike. also to her Empire – and perhaps even to the world econ- There’s a tendency on both sides of the debate to inflate omy as a whole,” he writes. the costs and benefits of this powerful and unstoppable History similarly informs Lawrence J. White’s pres- trend. But if you take the long view, and analyze trends, ent-minded discussion of the telecommunications melt- and place them in their proper context – as the authors down (p. 44). Drawing parallels between the current tele- in this issue do – you can’t help but think that the way of com glut and the overcapacity of railroads in the 1880s the future lies more in crossing borders than in isolation. and 1890s, the savings and loan debacle of the late 1980s, and Japan’s rolling crises of the past decade, Professor White offers some advice for regulators and entrepreneurs: DANIEL GROSS is editor of STERNbusiness.

Sternbusiness 9 A Passage From INDIA Infosys has emerged as a titan of the global software industry by carefully designing and constructing a unique corporate culture. Continued growth will test the quality and soundness of the company’s architecture.

By Raghu Garud, Arun Kumaraswamy and Monica Malhotra

he software company where ownership and control of growing across cultural value Infosys is one of India’s businesses have been concentrated in systems and value chains. This great business success sto- the hands of a few families, Infosys scalability is built into the compa- ries. Infosys was founded has distributed ownership and con- ny’s DNA, and it pervades the way Tin 1981, when seven professionals trol broadly among its 10,000 the company develops software, led by N.R. Narayana Murthy, cur- employees, known as “Infoscions.” mentors employees, formulates rently the chairman and chief men- But what most distinguishes strategy, and governs itself. tor, collectively invested $1000. Infosys is the way it systematically ndeed, this scalability has Now, Infosys is the third largest built up a post-modern, scalable allowed Infosys to evolve con-

company in India, with a market enterprise for harnessing intellectual tinually. In particular, Infosys ILLUSTRATIONS BY CHRIS MCALLISTER capitalization of more than $10 bil- capital in the new information econ- has created a malleable and lion. Based in the emerging informa- omy. Nandan Nilekani, Infosys’s responsive learning organiza- tion technology (IT) center of CEO and managing director, uses tionI that continually uses its experi- Bangalore, Infosys in 1999 became the term “scalability” to refer to ence to replenish and transform its the first Indian company to be listed Infosys’s ability to grow from past stock of resources and capabilities. on the Nasdaq. In a country where experiences even while maintaining In other words, Infosys is an organi- many companies have opaque the integrity of operations. In a zation that is perpetually in the financial statements, Infosys has broader sense, scalability means making – which is what it takes to voluntarily adopted stringent Infosys can simultaneously increase succeed in the fluid, global, rapidly accounting practices. In a country revenues and profitability while evolving IT industry.

10 Sternbusiness Sternbusiness 11 A PASSAGE FROM INDIA

EXHIBIT 1 INFOSYS AUDITED FINANCIAL INFORMATION, 1994-2001 $ in thousands (except per share data) For the years ended March 31, 2001 2000 1999 1998 1997 1996 1995 1994

Revenues $413,851 $203,444 $120,955 $68,330 $39,586 $26,607 $18,105 $9,534 Cost of revenues 213,614 111,081 65,331 40,157 22,615 15,638 10,606 5,621 Gross profit 200,000 92,363 55,624 28,173 16,971 10,969 7,499 3,913 Operating expenses: Selling, general and administrative expenses 57,641 26,656 16,199 13,225 7,010 4,351 3,344 1,314 Amortization of deferred stock compensation expense 5,081 5,118 3,646 1,520 768 361 46 – Compensation arising from stock split – – 12,9061,047 – – – – Total operating expenses 62,722 31,864 32,751 15,792 7,778 4,712 3,390 1,314 Operation income 137,515 60,499 22,873 12,381 9,193 6,258 4,109 2,598 Equity in loss of deconsolidated subsidiary – – (2,086) – – – – Other income, net 9,505 9,039 1,537 801 769 1,460 746 322 Income before income taxes 147,020 69,538 22,324 13,182 9,962 7,718 4,856 2,920 Provision for income taxes 15,072 8,193 4,878 770 1,320 895 893 251 Subsidiary preferred stock dividends –––68–––– Net Income $131,948 $61,345 $17,446 $12,344 $8,642 $6,824 $3,963 $2,670 Earnings per share: Basic $2.01 $0.93 $0.28 $0.21 $0.15 N/A N/A N/A Diluted $1.98 $0.93 $0.28 $0.20 $0.15 N/A N/A N/A Cash dividend per equity share $0.14 $0.11 $0.09 $0.04 $0.02 N/A N/A N/A Balance sheet data: Cash and cash equivalent $124,084 $116,599 $98,875 $15,419 $8,320 $7,769 $8,046 $2,885 Total assets 342,348 219,283 153,658 48,782 32,923 27,261 23,051 9,400 Total long-term debt –––––––– Total stockholders equity 311.792 198,137 139,610 41,146 30,640 23,925 19,668 8,852 Source: Infosys Annual Reports

Scalable Strategy Professor Marti G. Subrahmanyam EXHIBIT 3 INFOSYS PSPD MODEL of NYU Stern School of Business, and an independent director of Quality People Transparency Infosys, pointed out that “A key ele- ment of a strategy for survival and Predictability Sustainability even rejuvenation in a downturn is a flexible financial framework Maintenance Translating clients to partners within which a company operates.” Long-term Relationship Infosys’s PSPD Model that empha- Offshore Software sizes predictability, sustainability, Development Center profitability, and “derisking,” is an integral component of such a flexi- Growth ble framework. These four strategic goals are, in turn, accomplished Higher value services Exposure limits for client concentration through a set of sub-models and Increase revenue productivity Exposure limit for dotcom businesses guiding principles. For instance, the Offshore model – Global delivery Exposure limit for opportunity Customer Relationship Model, which Upsell to existing clients businesses (like Y2K) emphasizes the creation of long- term relationships with each client, Iterative model of development Geographical diversification helps ensure the predictability and Profitability De-risking sustainability of revenues. More Source: Infosys Annual Reports

12 Sternbusiness than 80 percent of Infosys’s business EXHIBIT 2 Infosys Timeline, 1981-2001 is generated from repeat customers. The Global Delivery Model, under 1981 • Year of incorporation in India which a major portion of project exe- cution costs is shifted from costly 1987 • Opened first international office in the U.S. “on-site” client locations to relatively cheaper locations in India, plays an 1992 • IPO in India important role in ensuring profitabil- ity. Derisking is accomplished by, for 1993 • Listed successfully in India example, limiting exposure to any • Obtained ISO 9001/TickIT Certification specific client, domain or type of project to less than 10 percent of 1995 • Set up development centers across cities in India annual revenues, and by adopting a conservative financial policy that • Received best Annual Report Award from ICAI (every year from '95) limits debt. Of course, the PSPD model is not 1996 • Set up Infosys Foundation to focus on contributing back applied without reflection to address to the society new challenges that continually • Established e-Business practice arise. Models cannot replace human judgment, which is why Infosys has • Set up first European office in Milton Keynes, U.K. created several processes to study, review, and coordinate strategic ini- 1997 • Attained SEI-CMM Level 4 tiatives and operational priorities. • Set up office in Toronto, Canada These processes unfold in several • Set up Engineering Services practice forums, including the Board of Directors, and the 57-member 1998 • Rated first in Economic Times India’s "Award for Management Council, which Corporate Excellence" includes the board and department • Established Enterprise Solutions practice heads, as well as nine representa- tives from the younger generation at 1999 • Listed on Nasdaq Infosys. The Management Council • Crossed $100 mm in annual revenues meets frequently to discuss market • Attained SEI-CMM Level 5 trends and any other issues of strate- • Rated India's most admired company by gic/tactical relevance. The Economic Times Survey Even though Infosys departments • Opened offices in Germany, Sweden, Belgium and Australia enjoy considerable autonomy to • Established two development centers in U.S. develop and implement strategic and operational initiatives, the core • Established Infosys Business Consulting Services implementation process is essential- • Reorganization for competence building - DCG, ly the same across the company. SETLABS,CAPS Infosys also takes a measured approach to implementation. 2000 • Became first company to be awarded the "National Award “Usually, when we come up with a for Excellence in Corporate Governance" conferred by possible solution or a plan, we pilot the Government of India it to see how it works,” observed • Crossed $200 Million in annual revenue S.D. Shibulal, director of customer • Set up offices in France and Hong Kong delivery: “Then, we go back to the • Set up Global Development Centers in Canada and U.K.; solution and correct it based on the Set up third Development Center in the U.S. results. We institutionalize the solu- • Combined dedicated e-Business practice with rest of the tion only after two or three such organization cycles.” Infosys’s ability to learn and adapt as it evolves is implicit in this 2001 • Crossed $400 mm in revenues approach. Here, scalability is evi- • Rated Best Employer of India in a study by dent in the ways Infosys encapsu- Business Today-Hewitt Associates lates past experiences to shape • Opened new offices in Singapore, UAE, and Argentina future aspirations. • Set up new development center in Japan

Source: www.infy.com Sternbusiness 13 A PASSAGE FROM INDIA

Developing Intellectual on networking, interdepartmental prise-wide KM system during 1999- Capital socializing and meetings, fire- 2000. o company can execute fighting and logistics administration. Besides creating and recording strategies without the To design an effective leadership internal knowledge, white papers, right personnel in place. program, Infosys has established the and re-usable code, the KM system And Infosys has taken Leadership Institute at Mysore, affords Infoscions access to external great pains to recruit, India. content like websites and technology train,N and mold a scalable work- and business news. Eighteen differ- force. In the middle of Infosys’s Knowledge Management ent content types have been identi- sprawling ‘Infosys City’ university For an entire company to be scal- fied (BOK being one of them). Every campus sits an imposing structure able, it must be able to leverage item in the central KM repository is where Infoscions regularly receive knowledge across all its employees. associated with one or more nodes training. New employees enter a 14- “Learn once, use anywhere,” as a (representing areas of discourse) in week educational program. After key Infosys motto puts it. Infosys a ‘knowledge hierarchy’ and tagged this rigorous initial training, each has now instituted an integrated to facilitate ease of submission, clas- Infoscion must undergo 15 days of approach to the management of sification, and retrieval. Currently, formal training annually to upgrade approximately one fifth of all technical and managerial skills. In "What most distinguishes Infoscions have contributed at addition to training Infoscions, least one knowledge artifact to the the company’s 50-faculty strong Infosys is the way it central KM repository, and more Education and Research Center systematically built up a than a thousand knowledge artifacts (E&R) conducts research on new get downloaded by Infoscions for technologies and pilots them as they post-modern, scalable serious use every day. emerge. For example, E&R enabled enterprise for harness- Since practice units lack the time Infosys to leverage the late 1990s ing intellectual capital and resources to create domain or corporate “mind-shift” towards e- technology specific knowledge, commerce. Infosys’s revenues from in the new information Infosys created two internal consult- e-commerce related projects rose economy." ing groups: the Domain Competency from a mere 1.7 percent of revenues Group (DCG) and the Software in the first quarter of 1999 to Engineering & Technology Labs 18.8 percent of revenues in the knowledge. “The vision is that (SETLabs). The DCG covers first quarter of 2000. every instance of learning within industry dynamics and trends, key Intellectual growth is all-perva- Infosys should be available to every players, regulatory and accounting sive at Infosys. People learn from Infosys employee,” said Mahesh practices. SETLabs focuses on one another as they rotate from one Venugopalan, a member of Infosys’s technology architectures to create project group or from one knowl- Knowledge Management (KM) frameworks that can be used by edge domain to another. When Group. project teams and business units. recruiting, Infosys looks for people The four pillars of Infosys’s KM o sow the seeds for the with “learnability” – the ability to system – people, content, process, emergence of new derive generic conclusions from spe- and technology – comprise the knowledge and compe- cific situations and then apply them architecture that guides the creation, tencies, Infosys created to a general class of unstructured transfer, and reuse of knowledge at three new business units situations. Learnability is crucial to Infosys. Its origins can be traced to toT focus on the emerging e-business, manage the rapid career progres- company efforts starting around ERP solutions, and telecommunica- sion. “By 28, an Infoscion could well 1992 to create Bodies Of Knowledge tions sectors, and an engineering be a general manager, and by mid- (BOK), which are nuggets of experi- services group to offer engineering 30s, a director of the company,” said ential knowledge on topics ranging services focused on quantitative Nandita Gurjar, associate vice presi- from technologies and application modeling. S. Sukumar, head of cor- dent of Learning and Development. software to adapting to new cul- porate planning, explained: “Over “Those who have been rewarded are tures. Dr. J. K. Suresh, principal time, people from these business those who have been able to jump knowledge manager, pointed out units are moved around to other from one paradigm to the next.” that such BOKs, and other reusable units to transfer competencies.” Under the company’s intensive content, were created and reused in To facilitate the transfer of mentoring process, Infoscions at isolation within any given project knowledge and a culture of sharing, every level groom and teach those context. But they lacked visibility as Infosys developed an Intranet portal under them. Top executives coach well as extensive use across the – the K-Shop. If a question is posted newly minted middle managers organization till the development on an electronic bulletin board that on the need to spend ample time and deployment of a formal, enter- is part of the knowledge manage-

14 Sternbusiness ment system, it is not surprising to serves as a metric to assess content "In 1998, Infosys get several responses from employ- quality (as determined by the vari- ees across the organization within a ous attributes related to content decided to abandon its few minutes. The KM group has cre- usage, and ratings by users across traditional strategic ated an application called the the organization) and measure the “expert locator,” which allows effectiveness or benefits of the business unit structure Infoscions to declare their specific knowledge management program. in favor of a combina- expertise so colleagues may consult “Overall, the number of KCUs gen- them when necessary. The KM erated and distributed to employees tion of geography and group has also instituted formal – currently more than 160,000 – focused services based mechanisms for the sharing of best provides a clear indicator of the practices across the company – increasing level of knowledge shar- business units." quarterly meetings of business man- ing within Infosys,” said C.S. agers, for example. Mahind, a member of the KM group. traditional strategic business unit To encourage knowledge sharing, structure in favor of a combination the KM group has instituted various Organizing for Global of geography and focused services rewards, recognition, and incentive Delivery based business units (also known as programs. Specifically, Infoscions Infosys thrives on its ability to Practice Units (PU)). The three can earn Knowledge Currency Units solve clients' problems that lie dis- largest delivery units are located in (KCUs) for contributing, reviewing tributed across the globe with soft- the U.S., Infosys’s largest market, or using the BOKs or other knowl- ware solutions created in India. In which accounts for nearly 75 per- edge assets. Another form of KCUs 1998, Infosys decided to abandon its cent of its business. In keeping with (termed the composite KCUs) also Infosys’s Customer Relationship

CHIEF MENTOR Narayana Murthy N. R., (Chairman)

CEO & PRESIDENT Nandan M. Nilekani, (Managing Director)

NFOSYS EADERSHIP HRD, IS, QUALITY & CFO, ADMINISTRATION COO & CUSTOMER SERVICE CORPORATE PLANNING I L CEO & President CEO & President BANKING BUSINESS UNIT & TECHNOLOGY INSTITUTE PRODUCTIVITY AND CDG & FACILITIES Gopalakrishnan S. Sukumar S. Jayaram G. K. Dinesh K. (Director) Mohandas Pai T. V. Girish Vaidya (SVP) (Deputy Managing Director) (Manager Acting Head) (Head ILI) (Director)

HUMAN RESOURCES FINANCE & COMPANY CUSTOMER DELIVERY SALES & MARKETING DEVELOPMENT SECRETARY Shibulal S.D. (Director) SALES - APAC EDUCATION & RESEARCH QUALITY & COMMERCIAL & FACILITIES DELIVERY - APAC CHINA INITIATIVE PRODUCTIVITY SALES - CENA COMPUTERS & ACCOUNTS & DELIVERY - CENA COMMUNICATIONS INFORMATION SYSTEMS ESCP ADMINISTRATION SALES - ES PDC - BOSTON SECURITY AUDIT & SALES - ESCP ARCHITECTURE GROUP SALES - EURP COMMUNICATION INFRASTRUCTURE & SECURITY GDC - CANADA ESIGN ROUP DELIVERY - ES D G IT OUTSOURCING SALES - IBCS DC - HYDERABAD EXHIBIT 4 DC - MYSORE LIFE SCIENCES INITIATIVE SALES - IT OUTSOURCING PDC - NEW JERSEY Corporate Organization Structure - InfosysInfosys DCG SALES - SONA DC - PUNE Legend: Designations: SET LABS SALES - SYSTEMS APAC = Asia Pacific AVP = Associate Vice President DELIVERY - EURP INTEGRATION BPO = Business Process Outsourcing BDM = Business Development Manager CAPS = Communication and Product Services BM = Business Manager DELIVERY - QUALITY PDC - UK CENA = Canada & East North America CMO = Chief Marketing Officer SALES - WENA DC = Development Center PM = Project Manager DELIVERY - SONA IBCS DCG = Domain Competency Group RM = Regional Manager DELIVERY - CAPS ES = Enterprise Solutions SPM = Senior Project Manager DC - CHENNAI SPECIAL INITIATIVES ESCP = Engineering Services & Consultancy Practice SVP = Senior Vice President EURP = Europe VP = Vice President DC - MOHALI DELIVERY - WENA GDC = Global Development Center PCC = Product Competency Center DC - BHUBANESWAR SALES - CAPS PDC = Proximity Development Center IBCS = Infosys Business Consulting Services SONA = South North America PDC - CHICAGO & CORPORATE MARKETING SYSTEMS INTEGRATION SETLabs= Software Engineering and Technology Labs WENA = West North America PDC - FREMONT

DC - MANGALORE Sternbusiness 15 A PASSAGE FROM INDIA

model, a PU is responsible for its ment in processes. CMM generally want to be part of a team or work clients globally, even if the clients’ emphasizes learning from experi- for a large company,” said Chief operations are spread across regions ence and feedback. But Infosys Financial Officer T.V. Mohandas in other PUs. In addition to building learns not only from its own experi- Pai. “So, Infosys needs to retain the close relationships with clients, this ences, but also actively seeks to flexibility, speed, collegiality, and structure generates scale economies import relevant external knowledge. openness of a small company.” with support functions such as “If there is something better, we Infosys attempts to do so by ensur- human resources and finance locat- are willing to learn,” said S. ing that decision rights remain with ed in India. Gopalakrishnan, COO and deputy those who possess relevant knowl- Organizing for economies of scale managing director. “We look at edge – its front-line workers. does not necessarily result in scala- other organizations, study them, Such an inversion of the tradi- bility along the value chain, tional hierarchy is only possible if because PUs are purely oriented "Infosys reports its people assume the responsibility to toward execution. Infosys has creat- use information to arrive at superior ed structures and processes to financial performance decisions. K. Dinesh, director of HR, address this challenge. The domain in compliance with Quality and Productivity, offered the and technology specific knowledge following maxim as a guiding prin- that the DCG and SETLabs offer, the generally ciple for decision making: “In only combined with the relationship accepted accounting God we trust. The rest of you bring specific knowledge that PUs offer, facts.” Infoscions are encouraged to generates value that is scalable practices of seven challenge one another based on the across geographical contexts. Project facts they can marshal. As a result, teams are cross-functional with countries." the company culture itself is built members possessing multiple, over- around a dialectic tension where lapping skills. and then do it our own way.” employees agree to disagree, thereby ventually, whether or not The continuous improvement generating informed consensus. a company is scalable is philosophy inherent in CMM has What role can top management determined not just by been institutionalized for the rest of play if front line knowledge workers how its activities are par- the company in the Infosys make most decisions? At Infosys, titioned, but also by the Excellence Initiative. Using the managers are part of a larger processesE that integrate these vari- seven criteria of the Malcolm process of mutual mentorship, a ous parts. If processes are static, Baldrige National Quality Award process that the founders hope will the corporation may settle into an (MBNQA) framework, Infosys create an institution that survives efficient structure that lacks evolu- assesses its entire cross-functional them. “As we go up the corporate tionary capabilities. But there is supply chain to identify areas that ladder, our role becomes direction- nothing static about the organiza- need attention. In these areas, al,” said Pai. “Our philosophy and tional routines that govern Infosys has enacted changes to duty is to recruit people who are Infosys’s operations. The best way improve quality and productivity brighter than us and to mentor to understand these routines is by using the 6-Sigma technique and the them.” This paradox speaks to a examining the software develop- ISO 9001 initiative. deep sense of security among man- ment and deployment process. The agers. On the one hand, Infosys Capability Maturity Model (CMM), Inverting Traditional managers deploy their considerable developed by the Software Hierarchies experience to guide those under Engineering Institute at Carnegie Managing intellectual capital is them. On the other, they learn from Mellon University, forms the back- challenging. Employees can influ- the very employees they teach. bone of Infosys’s processes. CMM ence a company’s value proposition assesses the maturity level of a by determining the extent and Transparency software development company’s quality of their intellectual contri- Because investors are naturally processes and methodologies on a butions. As Chairman Narayana wary of new economy companies, scale of one to five. Each maturity Murthy observed, Infosys’s employ- Infosys has proactively adopted the level requires the organization to ees walk out of the door every day highest international financial stan- develop specific capabilities in cer- and it is the management’s task to dards. In 1994-95, it was the first tain key process areas. And Infosys make sure that they come back. Indian company to adopt stringent is one of the few organizations in the The need to maintain employee U.S. Generally Accepted Accounting world to be assessed at Level 5. loyalty has imposed demands Principles (GAAP) for financial An important component of upon Infosys’s management. accounting and to include complete CMM is the capability to learn, “Bright, young people want to work and detailed disclosures of accounts which ensures continuous improve- in smaller companies. They don’t and activities in annual statements.

16 Sternbusiness leverage its collective knowledge effectively. Given that more than 90 percent of Infosys’s revenues accrue from outside India, any growth must be global in scope. As a result, employees may have to spend more time removed from their base in India. Not only does this impose enormous lifestyle and psychological burdens on remote employees, it also complicates the task of manag- ing and monitoring them. Infosys is trying to tackle this problem by rolling out company-wide e-mails, newsletters, and magazines. Furthermore, Infosys trains its man- agers to manage and monitor their teams more effectively over distances. However, as Infosys moves up the Also, it was the first Indian compa- this, while we are still able to retain value chain and grows globally, the ny to publish audited quarterly state- the quality and effectiveness we had length of time spent by employees at ments and release annual statements as a small company.” customer premises will increase. Ms. promptly after the end of its financial For example, Infosys would like Hema Ravichander, senior vice pres- year. Now, Infosys reports its financial to move up the value chain in the ident of Human Resources, worried performance in compliance with the software services industry – from that this may dilute the Infoscion generally accepted accounting prac- low-cost project execution to culture, values and processes, which tices of seven countries. high-margin end-to-end solutions. may make it difficult for an increas- By embracing transparent prac- According to Balakrishnan, Infosys’s ingly global organization to configure tices, Infosys is compelling other dream is “to get U.S. revenues at and integrate its systems, processes, large businesses in India to follow Indian costs.” But doing so means and business units effectively. Such suit. As V. Balakrishnan, vice presi- that the iterative model of software geographic dispersal and loss of iden- dent of Finance, pointed out: “We development and close contact with tity may also make it difficult for feel that transparency is a competi- clients will increase. Infosys will Infosys to develop leaders with a com- tive advantage. Investors have more thus lose some of its flexibility to mon purpose to manage for the future. faith in a company that is more move higher-margin consulting proj- The two faces of the Greek God transparent.” Infosys has leveraged ects off-shore. And as competition for Janus symbolize an end as well as a its pursuit of transparency into an programming talent increases in the beginning. If one were to apply this international brand. After embrac- global IT sector, salaries in India are image to Infosys, the promise of ing GAAP financial reporting stan- also rising. That will pressure scalability lies in Infosys's ability to dards, Infosys listed on the Nasdaq – Infosys to raise its incentive and continually evolve from the very a strategic move that created a cur- compensation packages, which will platforms it creates. Outcomes and rency to be used for stock options make it difficult for Infosys to main- processes are so intertwined that any and potential acquisitions. tain its profit margins. end state is but a new beginning. It To date, Infosys has grown contin- nfosys executives believe that remains to be seen whether this ually by employing its resources as organic growth may be too slow in promise will continue to hold as platforms for improving existing ini- accomplishing the desired trans- Infosys becomes a legitimate player tiatives and launching new ones. In formation. Therefore, Infosys is in the global market. this sense, Infosys has demonstrated Ievaluating acquisition opportunities. what it means to be a scalable corpo- But unless the potential target has a RAGHU GARUD is an associate profes- ration. However, this process will compatible culture, it would be diffi- sor of management at NYU Stern. surely be put to the test as Infosys con- cult for Infosys to integrate the alien tinues scaling across value creation culture without disrupting its well- ARUN KUMARASWAMY, Stern Ph.D. activities and cultural value spaces. As oiled processes and well-defined val- 1996, is assistant professor of manage- Mr. Nilekani observed, “The chal- ues. After all, any effort at integration ment at the Rutgers University School of lenge now is to ensure that we are would be Infosys’s first. Business, Camden. able to scale on all fronts – the Growth, coupled with geographic physical front, the global front as dispersion of employees, may also MONICA MALHOTRA is a Stern MBA well as on the soft issues front. All make it more difficult for Infosys to 2001.

Sternbusiness 17 18 Sternbusiness THE MARKET NEXT D R Too frequently, companies with global ambitions simply try to export a business model that works well in their home markets. But international expansion is not always so simple. Smart managers can gain valuable knowledge and experience by operating in markets that are culturally and economically similar to their ultimate targets.

By Peter N. Golder and Debanjan Mitra

arket entry decisions found decidedly mixed success development, trade, and infra- are among the most expanding in foreign markets. Wal- structure. But no current study has important strategic Mart, for example, did not initially considered the role of knowledge choices companies adapt its retail format in Argentina developed by a firm’s subsidiaries make. Entering any to the local culture. Nonetheless, the in similar markets on subsequent market requires a giant retailer’s experience in foreign market entries. majorM commitment of financial and Argentina provided it with valuable Intuitively, it makes sense that managerial resources, but foreign insights that it applied to subsequent the knowledge of the economic and markets can be especially demand- operations in similar countries. cultural environment of a foreign ing. Even though many companies Most of the research on the market will affect the probability of established multinational operations internationalization process focuses entering that market. Theories of long ago, some of today’s leading on two factors as the primary deter- organizational learning argue that companies are currently making the minants of foreign market entry: firms develop knowledge based on decisions to go global. Half of cultural similarity and economic their experiences. This store of Business Week’s top 50 companies attractiveness. Many researchers knowledge constitutes an important were established within the last 20 find that cultural similarity with resource and is a source of competi- years and began to internationalize respect to the domestic market is an tive advantage. At first, of course, only within the past decade – think important determinant of entry, knowledge comes entirely from the of blue-chips like Dell Computer, while others have found that market home market, and companies make Cisco Systems, Home Depot, and entry decisions are positively related comparisons between the character- Best Buy. And many companies have to country size and the levels of istics of the home market and those ILLUSTRATIONS BY CHRIS MCALLISTER ILLUSTRATIONS Sternbusiness 19 THE MARKET NEXT DOOR

of potential new markets. But such increase costs and risks, companies of entering similar markets. When knowledge can also be generated in are likely to enter countries with cul- companies have positive experiences foreign markets in which the firm tures similar to the domestic market in foreign markets, the cultural and already operates that are similar to before entering countries with less economic knowledge generated in potential new markets. Operating in similar cultures. those markets will lead to earlier Argentina, for example, may have Likewise, most people assume entry in similar markets. Both con- provided Wal-Mart with some that economic distance is negatively cepts – cultural and economic insights as to how to run a store in knowledge – are dynamic and Chile. change over time, with companies’ We have dubbed this phenome- "Knowledge can also be experience. non near-market knowledge. But the generated in foreign Perhaps the most important fac- term does not refer to markets that tor in foreign market entry decisions are geographically close. Rather, it markets in which the is the economic attractiveness of a refers to markets that are economi- firm already operates country. All things being equal, cally and culturally similar. Such firms are likely to choose more pros- knowledge can be broken down into that are similar to perous and accessible economies. near-market cultural knowledge, potential new markets. The extensive literature on foreign and near-market economic knowl- direct investment (FDI) supports edge. These terms refer to a firm’s Operating in Argentina, this view. FDI theory argues that understanding of the culture and firms face various disadvantages in economy, respectively, of potential for example, may have foreign markets and invest only new markets based on knowledge provided Wal-Mart with when expected benefits exceed those generated from operating in similar costs. These benefits depend on the markets. When multinational corpo- some insights as to how economic characteristics of each rations (MNCs) internationalize, to run a store in Chile." country. Finally, in general, they can use such near-market researchers have regarded economic knowledge to select other foreign factors as playing a larger role in markets where the firm is more like- related to foreign market entry tim- companies’ foreign market entry ly to succeed. ing. Why? Firms seem more likely to timing decisions than cultural deci- We set out to gauge the influence be successful operating in countries sions. Companies can mitigate the and relative importance of near- with economic characteristics that negative impact of cultural distance market cultural and economic are similar to the firm’s home mar- by gaining experience in similar for- knowledge by gathering extensive ket. Similar economic characteris- eign markets and by hiring man- data and using it to test the validity tics may reflect potentially impor- agers with knowledge of the local of several widely accepted assump- tant similarities between countries culture. But while companies can tions about foreign-market entry. where knowledge transfer is valu- learn about consumer demand and able. For example, similar economic economic institutions, they have Prevailing Assumptions conditions might be associated with practically no influence on the eco- First, we assume that cultural similarities in consumer demand nomic prosperity, size, and infra- distance is negatively related to for- and business institutions like distri- structure of a country. eign market entry timing. In other bution channels and media. Since words, companies will hesitate to knowledge of these factors can help Identifying Frequent enter markets that are culturally firms succeed in foreign markets, Entrants unfamiliar to them. Nearly all companies are likely to enter coun- As we set out to test these research on the impact of culture on tries whose economies are compara- assumptions, we conducted an foreign market entry has considered tively similar to the familiar domes- extensive search for the complete the distance between a firm’s tic market. entry data of many multinational domestic culture and the culture of The same set of assumptions per- firms. We focused on consumer each potential market. Differences tains when dealing with near-mar- products companies, based in a vari- in culture have been found to affect ket knowledge. Since companies can ety of domestic markets, that have brand image strategies, consumer acquire and share knowledge successfully entered many countries. innovativeness, negotiations, and throughout their organizations, they (The companies in our final sample marketing decision-making. When will likely make some effort to generate more than half of their rev- companies operate in countries with transfer knowledge generated from enue outside their domestic mar- different cultures, they need to mod- operating in foreign markets to kets). All these firms have survived ify their operations in these areas as other similar markets. The knowl- for at least several decades, hold well as other elements of the mar- edge generated in successful mar- leading market share positions, and keting mix. Since such modifications kets should increase the probability have not withdrawn from any for-

20 Sternbusiness eign market entered. Using largely these markets will increase cultural kets, operate for more years in those public sources, we were able to iden- knowledge, albeit with diminishing markets, and as the basic economic tify foreign market entry data for 19 returns. Thus, each potential market attractiveness variables change over of the 35 firms that satisfied these will have its own measure of near- time. criteria. The average year of the market cultural knowledge, and it We then ran all the data through most recent entry across these firms will change over time. a hazard model, which models the was 1992. We contacted all 19 com- The factors we used to measure rate at which market entry occurs panies and corroborated 292 of our near-market economic knowledge based on dependent and independ- entry events, finding only negligible were somewhat more straightfor- ent variables. In this instance, the differences for less than 1.5 percent ward. Essentially, we used three sets dependent variable is the time, in of these observations. The final data of variables: measures of economic years, between the year of incorpo- set includes 12 firms from the attractiveness, economic distance ration and the year each country is United States, two from the United between the home market and entered – through the initial estab- Kingdom, two from Japan, and one potential markets, and near-market lishment of a sales or manufacturing each from the Netherlands, France, economic knowledge. Economic subsidiary in that country. Our inde- and Switzerland. attractiveness can be calculated by pendent variables are the measures Next, we collected data on cultur- the measurement of four variables: of cultural distance, near-market cultural knowledge, economic TABLE 1 attractiveness, economic distance, SAMPLE OF COMPANIES and near-market economic knowl- Company Age of Company Number of Countries End of edge. When we finished the tests, we (Years) Entered Observation Period polled senior executives at the firms Burger King 45 44 1999 directly to gauge their opinions. Cadbury 100 28 1995 Campbell Soup 98 20 1997 Danone 33 40 1998 Examining the Results General Foods 70 28 1984 What did we find? Table 2 shows General Mills 71 28 1995 Gillette 98 38 1998 that on average, it took 24 years for Johnson & Johnson 112 48 1990 these firms to enter their first foreign Kellogg 93 24 1981 markets. However, this time has Kimberly Clark 127 29 1995 Matsushita 81 46 1990 decreased significantly to nine years McDonald’s 44 41 1990 for newer companies. This suggests Nabisco 123 37 1994 Nestle 132 60 1990 that firms have sought international Philips 108 59 1995 opportunities more quickly over Pillsbury 130 25 1997 time. There was no significant dif- Procter & Gamble 109 26 1981 Sony 53 36 1997 ference in time to first entry among Unilever 109 45 1974 firms based in different countries. Table 2 also shows that, on aver- al and economic factors. As most consumer prosperity, as measured age, firms have entered 37 coun- other researchers of cultural dis- by Gross National Product per capi- tries. Therefore, the typical firm in tance do, we rely upon the measures ta; economic size, as measured by our sample has yet to enter many of the four dimensions of culture Gross National Product; population countries. We did find that the identified by Dutch social scientist density; and the development of newest firms were significantly more Geert Hofstede: individualism, infrastructure, as measured by the likely to have entered more foreign uncertainty avoidance, power dis- density of railroad networks. markets than the middle-aged firms tance, and masculinity. By calculat- Economic distance is calculated as in our sample. However, there was ing the variance of these measures the difference of such measures no significant difference between the across different countries, we across countries. Our measures of newest and the oldest firms. Overall, derived a quantitative measure of near-market economic knowledge we believe that Table 2 shows a cultural distance. We based our capture the economic similarity common number of countries measure of near-market cultural between each foreign market and entered over time and across firms knowledge on two key criteria. First, the similar foreign markets in which from different countries. These find- every market in which a firm oper- the firm already operates, based on ings suggest that newer firms move ates that is more similar to a poten- the four economic attractiveness through the internationalization tial market than the domestic mar- measures for each country. Just as is process more quickly. It also sug- ket is to that potential market will the case with near-market cultural gests that there is some central ten- increase the cultural knowledge of knowledge, near-market economic dency for the number of countries in the potential market. Second, the knowledge will change over time as which firms choose to operate. duration of experience in each of firms enter additional similar mar-

Sternbusiness 21 THE MARKET NEXT DOOR

TABLE 2 knowledge may be a better measure Characteristics of Foreign Market Entry than cultural distance for the impact of culture on foreign market entry Criteria Sample Number Average Years to First Average Number of of Firms Foreign Market Entry Foreign Countries Entered timing. (Standard Deviation) (Standard Deviation) With respect to the economic questions, we found that higher All Firms 19 24 (15) 37 (12) near-market economic knowledge is associated with higher probability of Age of Firms <50 years 3 9.0 (4.4)1, 2 42 (2.8) 1 entry. And we found that all four 51 to 100 years 8 22 (13)1 32 (9.0) 1 economic attractiveness variables >100 years 8 32 (16)2 37 (15) are positively associated with for- eign market entry timing. Not sur- Home Country United States 12 27 (16) 33 (9.0) prisingly, firms tend to enter these Europe 5 18 (12) 47 (14) high-potential markets earlier. Japan 2 25 (23) 44 (4.9) Finally, the weight of our findings suggests that even though near-mar-

1 significantly different at p < 0.05 ket cultural knowledge is signifi- 2 significantly different at p < 0.01 cant, as we suspected, economic fac- tors are relatively more important We analyzed the results further to have access to similar types of determinants of foreign market determine which factors seem to media. entry timing. have an impact on foreign-market In contrast with our results on entry. And here the results were cultural distance, we find that high- Asking the CEOs somewhat surprising. er near-market cultural knowledge To validate our model results, we In a conclusion that differs from is associated with higher probability sought input from executives at suc- that of much research on interna- of entry. That suggests that culture cessful multinational firms. Since tionalization, we found that, after still has an important impact on top executives are responsible for controlling for other variables cul- entry decisions. However, cultural international entry decisions, we tural distance had no impact on knowledge generated in similar contacted only the Chief Executive foreign market entry timing. Even markets seems to be more important Officer and the other top executive when we estimate a model with only than cultural knowledge from the most directly responsible for inter- cultural distance and economic home market. This result seems log- national operations at each firm. attractiveness variables, cultural ical because companies should be Nine of these executives agreed to distance was not significant. This more successful when they transfer answer questions about how eco- suggests that previous studies may knowledge from countries that are nomic and cultural factors influence have overstated the importance of more similar. Therefore, our results their foreign market entry decisions. cultural distance by not controlling suggest that near-market cultural In Table 3 we present the survey for economic attractiveness. In addition, one of our assump- Table 3 tions was that companies will be Survey of Senior Executives on Foreign Market Entry more likely to enter countries with market conditions that are similar to Questions Mean Response* their domestic market. But our results did not find that the measure 1. I prefer to enter a country that is similar to the home market of my company in terms 2.6 of economic distance, overall, bore of economic factors like market size, income, infrastructure, etc. 2. any particular relation to market I prefer to enter a country that is similar to the home market of my company in terms 2.2 entry. However, we did find that one of cultural factors like attitudes, beliefs, customs, etc. 3. of the variables – economic prosper- In selecting foreign markets, I place more importance on economic factors than 5.1 ity distance – had a significant bear- cultural factors. 4. ing on market entry. This variable In selecting foreign markets, I value experience gained in other foreign markets that 5.4 may be more likely than the other are economically similar. 5. economic distance variables to In selecting foreign markets, I value experience gained in other foreign markets that 4.9 reflect knowledge that might be are culturally similar. 6. valuable in other markets. For When entering a new country, I transfer knowledge developed in the most similar 5.0 countries. example, consumers in foreign mar- 7. When entering a new country, I prefer to use managers with experience in other 4.7 kets with GNP per capita similar to foreign countries that are most similar. the domestic market are more likely to buy similar types of products and * responses on 7 point scale where 1=strongly disagree and 7=strongly agree

22 Sternbusiness the role of culture on foreign market entry. We find that this new measure "In a conclusion that differs from that of captures a more significant impact of culture than the traditional meas- much research on internationalization, we ure of cultural distance. This finding found that. . . cultural distance had no provides support for the importance of being market-oriented by collect- impact on foreign market entry timing." ing and disseminating relevant knowledge throughout the organiza- tion. The firms in our sample seem to have based their entry decisions on knowledge generated in similar foreign markets. Companies making foreign mar- ket entry decisions today can learn from the successful multinationals in our data. Today’s internationaliz- ing firms may be wise to place less emphasis on cultural differences and more on economic factors. However, the successful multinationals in our data may have been able to over- come some of the negative effects of cultural distance by hiring local managers and transferring knowl- edge from similar markets. Indeed, our results confirm the importance of considering both economic and cultural factors in modeling foreign market entry timing. And since both sets of factors play some role, it is not surprising that small cultural distances do not always lead to strong performance. Finally, the primary implication of our findings for today’s expand- ing companies is to consider devel- oping experience in foreign markets that will provide the best basis for entering other similar markets. By questions along with the mean market is not an important determi- investing in a small country first and response for each question. These nant of foreign market entry. learning about the cultural and eco- responses support our model results. However, an alternative explanation nomic characteristics of its con- In particular, knowledge generated for this result may be that most of sumers and business institutions, a in similar markets is important to the executives who participated firm may be more successful when these executives. When selecting for- work at companies that have entering a larger country with simi- eign markets, they highly value already entered many countries sim- lar characteristics. experience gained in markets that ilar to their home market. These are economically and culturally sim- responses support our thesis about PETER N. GOLDER is associate ilar. Moreover, once they have near-market knowledge and the professor of marketing at NYU Stern. entered countries, they transfer importance of including our new knowledge and managers from sim- measures of near-market cultural DEBANJAN MITRA is an assistant professor at the University of Florida ilar countries. The survey also con- and economic knowledge. and an alumnus of the NYU Stern Ph.D. firmed that executives place more program. importance on economic factors What it All Means than cultural factors. Finally, these Our new measure of near-market A longer version of this article was pub- responses support our finding that cultural knowledge is one step lished in the Journal of Marketing cultural distance from the home toward a broader consideration of Research in August 2002.

Sternbusiness 23 24 Sternbusiness ANGLOBAL ZATION

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

ecent economic history (GDP) growth among developing But as Robert Lucas, the Nobel has not been kind to the countries, economists Jeffrey Sachs Prize winning economist, has point- British Empire. According and A.M. Warner found that “the ed out with respect to the United to one influential school open economies grew at 4.49 per- States and India in the 1970s, this ofR thought, late 19th century cent per year, and the closed coun- does not seem to happen. capital exports to the country’s tries grew at 0.69 percent per year.” Although some measures of inter- numerous colonies diverted In the previous era of globalization – national financial integration seem resources away from the moderniza- the period from the mid-19th centu- to suggest that the 1990s saw bigger tion of British industry. It’s even ry until the First World War – eco- cross-border capital flows than the been claimed that the Victorians nomic openness was imposed by 1890s, in reality most of today’s could have withdrawn from Empire Britain (and the other colonial pow- overseas investment takes place with impunity, and reaped a ‘decol- ers) not only on Asian and African within the developed world. In 1996 onization dividend’ in the form of a colonies, but also on South America only 28 percent of foreign direct 25 percent tax cut. and even Japan. investment went to developing But a case can be made that the A similar point can be made with countries; by 2000 their share was British Empire was economically respect to flows of labor. The more less than a fifth. The overwhelming beneficial, not only to Britain her- free movement there is of labor, the majority takes place between the self, but also to her Empire – and more international income levels United States, the European Union, perhaps even to the entire world will tend to converge. One reason and Japan. Investors in the devel- economy. In fact, when we consider that modern globalization is associ- oped world prefer to invest in its influence on capital and labor ated with high levels of inequality is countries with high levels of per flows, on creating and promulgating that there are so many restrictions capita GDP. the infrastructure that supports eco- on the free movement of labor. But nomic development, it is clear that the British Empire actively promot- Did Empire Encourage the British Empire was a major ed emigration. Investment? force for global integration. Call it Consider also the evidence on In the first era of globalization Anglobalization. international capital flows, another the share of cross-border capital It’s now widely accepted that key component of globalization. going to poorer countries was signif- protectionism in less developed According to the simple classical icantly larger then than it is today. economies was one of the principle model of the world economy, capital In 1997 only around five percent of reasons for widening international should flow naturally from devel- the world stock of capital was inequality in the 1970s and 1980s. oped to less developed economies, invested in countries with per capita When they compared per capita where returns are likely to be higher. incomes of 20 percent or less of U.S.

ILLUSTRATIONS BY CHRIS MCALLISTER Sternbusiness 25 per capita GDP. In 1913 the figure CHART 1 was 25 percent. In 1995 the share of PERCENTAGE OF ALL UK OVERSEAS EMIGRANTS GOING TO EMPIRE, 1900-1963 developing countries in total inter- 90 national liabilities was 11 percent, 80 compared with 33 percent in 1900 70 and 47 percent in 1938. Those fig- ures suggest the possibility that the 60 existence of formal empire encour- 50 aged investors to put their money in less developed economies. 40 Finally, we need to consider 30 recent empirical work on the insti- 20 tutional and political preconditions for growth. The historian David 10 Landes has argued that “the ideal 0 growth-and-development” govern- 1900-4 1905-9 1910-12 1913-14 1915-19 1920-24 1925-29 1930-34 1935-38 1946-49 1949-63 ment would secure rights of private property (the better to encourage British Empire were also kept low. before 1914 – without the British saving and investment) and enforce Abandoning formal control over Empire. True, the independent rights of contract. Such a govern- Britain’s colonies would almost cer- United States was always the ment would be stable, honest, tainly have led to higher tariffs most attractive destination for responsive, governed by publicly being erected against British exports 19th-century emigrants. But as known rules, and hold taxes down. in their markets. After they secured American restrictions on immigra- hile British colonial independence, for example, the tion increased, the significance of rule was not dem- United States and India pursued the white “Dominions” as a destina- ocratic (outside highly protectionist policies. Britain’s tion for British emigrants grew Canada, Australia, imperial rivals, France, Germany, markedly (see Chart 1). They and New Zealand), and Russia also maintained high attracted around 59 percent of all manyW of these criteria were among tariff regimes after the late 1870s. British emigrants between 1900 and the British colonial administration’s According to one estimate, the 1914, 75 percent between 1915 and defining characteristics. Indeed, a economic benefit to Britain of 1949, and 82 percent between 1949 striking number of the things cur- enforcing free trade could have been and 1963. Nor should we lose sight rently recommended by economists anywhere between 1.8 and 6.5 per- of the vast numbers of Asians who to developing countries were in fact cent of GNP. But what about the left India and China to work as imposed by British rule. benefit to the rest of the world? As indentured laborers, many of them In an ideal world, of course, free one eminent Victorian put it, Britain on British plantations and mines, in trade would occur naturally. But was “the great Emporium of the the course of the 19th century. history and political economy tell us commerce of the World.” Between Perhaps as many as 1.6 million that it does not. For most of the 19th 1871-5 and 1925-9, the colonies’ Indians emigrated under this sys- century, free trade spread more share of Britain’s imports rose from tem. There is no question that the because of Britain’s power than a quarter to a third. More generally, majority of them suffered great because of Britain’s example. From as Jeffrey Williamson has argued, it hardship. But we cannot pretend the 1840s until the 1930s, the was (mainly British) colonial that this mobilization of cheap and British political elite and electorate authorities that resisted protectionist probably underemployed Asians to remained wedded to the principle of backlashes to the dramatic falls in grow rubber or dig gold had no eco- laissez faire – and the practice of factor prices caused by late 19th- nomic significance. “cheap bread.” That meant that – century globalization. certainly from the 1870s – British In the same way, there would not Capital Exports tariffs were significantly lower than have been so much international From the mid-19th until the those of her European neighbors, mobility of labor – and hence so mid-20th centuries, Britain acted as and that tariffs in much of the much global convergence of incomes the world’s banker, channeling 26 Sternbusiness “A striking number of colossal sums of British (and other the things currently varying degrees and at various European) savings overseas. By recommended by times, Argentina, Brazil, Chile, 1914 total British assets overseas Mexico, Japan, Russia, and Turkey amounted to somewhere between economists to developing all did. But British colonies were £3.1 and £4.5 billion, compared countries were in fact unlikely to suspend convertibility with a British GDP of £2.5 billion. imposed by British rule.” and not much more likely to default True, around 45 percent of British than Britain herself. investment went to the United States against 2.9 percent. So when the In addition to the cast-iron com- and the Dominions. But 16 percent same countries returned to the bond mitment of colonial governors and of British foreign investment went to market in the inter-war years, they administrators, a variety of explicit Asia and 13 percent to Africa, com- paid significantly different risk pre- legal guarantees offered by the pared with just six percent to the mia. On average, the returns Latin Colonial Loans Act (1899) and the rest of Europe. As late as 1938, American borrowers had to offer Colonial Stock Act (1900) gave around 18 percent of British over- investors were 270 basis points colonial bonds the same “trustee seas assets were in Asia, and 11 per- higher than those on new colonial status” as the benchmark British cent in Africa. British investment in issues. Even so, actual returns on government perpetual bond, the developing economies principally Latin American bonds were once consol. It was inconceivable, took the form of portfolio invest- again worse than expected and declared the Governor of the Gold ment in infrastructure, especially worse than those on colonial bonds. Coast in 1933, that the interest due railways. But the British also sank n other words, money invest- on Gold Coast bonds should be com- considerable sums directly into ed in a de jure British colony pulsorily reduced: why should plantations to produce new cash such as India, or in a colony British investors “accept yet another crops like tea, cotton, indigo, and in all but name like Egypt, burden for the relief of persons in rubber. was more secure than money another country who have enjoyed Why were British investors will- investedI in an independent country all the benefits but will not accept ing to risk such an exceptionally such as Argentina. This was because their obligation”? high proportion of their savings by the commitment to the gold stan- This sentiment explains why an purchasing securities or other dard was essentially voluntary. Gold increasing share of British overseas assets overseas? One possible standard members who were sover- investment ended up going to the answer is that the adoption of the eign states could not only suspend Empire after the First World War gold standard by developing gold convertibility in an emergency, (see Chart 2). Between 1856 and economies offered investors a “Good they could also default on debts. To 1914, approximately two-fifths of Housekeeping seal of approval.”

Yet there is a need to distinguish CHART 2 here between anticipated and actual IMPERIAL SHARE OF NEW CAPITAL ISSUES IN LONDON, 1900-1938 (AVERAGE PER YEAR) returns on overseas investments. For the period 1850 to 1914, anticipat- 100 ed returns were not significantly 90 86 lower on colonial bonds than they 80 were on other foreign bonds. But the 70 same cannot be said of the actual 70 66 59 returns. In a sample of 11 major 60 capital-importing economies, if one 50 takes an average of the three colo- 39 nial countries – Australia, Canada, 40 and Egypt – the anticipated yield 30 was 5.3 percent, compared with 20 4.7 percent for the three South American countries in the group. 10 But the actual returns were signifi- 0 cantly different: 4.7 percent as 1900-14 1919-23 1924-28 1929-33 1934-38

Sternbusiness 27 British overseas capital went to the CHART 3 Empire. But between 1919 and THE AVERAGE ANNUAL GROWTH RATE OF PER CAPITA GDP, 1820-1950 1938, the Empire received two- 2.0 thirds of such investment while the 1.79 rest of the world got one third. Nor 1.57 is it surprising that more than three- 1.5 quarters of all foreign capital invest- 1.08 ed in sub-Saharan Africa was 1.0 invested in British colonies. 0.55 Encouraging Imports 0.5 0.38 For much of the 19th and 20th 0.12 centuries, British economic policy 0.0 was heavily influenced by the finan- Dominions USA UK Africa Other Asia India China ciers of the City of London, with -0.24 their ethos of “gentlemanly capital- -0.5 ism.” International finance came first and British export industries a poor were in many ways astounding. The ponents. First, the British de- second. In order to ensure that loans combination of free trade, mass industrialized India by opening it to developing economies were repaid, migration and unprecedented over- to factory-produced textiles from British policy-makers were prepared seas investment propelled large Lancashire, whose manufacturers to go to considerable lengths, ulti- parts of the Empire to the forefront were initially protected from Indian mately allowing a system of differen- of world economic development. competition. Secondly, they imposed tial tariffs to evolve that gave colo- Canada, Australia, and New Zealand excessive and regressive taxation. nial manufacturers easier access to produced more manufactured goods Thirdly, they drained capital from the British home market than British per capita than Germany in 1913. India, even manipulating the rupee- Between 1820 and 1950, their sterling exchange rate to their own “Money invested in a de economies were the fastest growing advantage. Finally, they did next to jure British colony such in the world. Indeed, per capita nothing to alleviate the famines that as India, or in a colony GDP grew more rapidly in Canada these policies caused. This negative than in the United States between view of the British role in India con- in all but name like 1820 and 1913 (see Chart 3). tinues to enjoy wide currency. Egypt, was more secure Yet recent research casts doubt on than money invested in The Asian Exception key aspects of the nationalist cri- But the performance of the tique. Economic historian Tirthankar an independent country Dominions was not matched in the Roy has shown that the destruction such as Argentina.” rest of the Empire, least of all in of jobs in the Indian textile industry Asia. India attracted £286 million of was probably inevitable, regardless manufacturers enjoyed to colonial capital raised in London between of who ruled India, and that an equal markets. 1865 and 1914 – 18 percent of the if not greater number of new jobs The British did not see the eco- total placed in the Empire, second were created in new economic sectors nomic development of Asia and only to Canada. But between 1857 built up by the British. Even in the Africa as their primary concern. and 1947, Indian per capita GDP case of textiles, by the 1920s the Nevertheless, the intended policy of grew by just 19 percent, compared Government of India was clearly giv- financial rather than industrial with an increase in Britain of 134 ing preference to Indian manufactur- domination of the world economy percent. Chart 3 shows that ers over Lancashire’s mills. Roy also had secondary positive outcomes. between 1820 and 1950, it grew at casts doubt on the idea that taxation Under the right circumstances, this a mere 0.12 percent per annum. under the British was excessive. And policy was conducive to rapid eco- The nationalist explanation for the supposed drain of capital from nomic growth on the periphery. Indian “underdevelopment” under India to Britain turns out to have The results of Anglobalization British rule has four essential com- been comparatively modest: only 28 Sternbusiness “about 0.9 to 1.3 percent of Indian were sins of omission more than of the 19th century this distinction national income from 1868 to the commission. Unfortunately for had faded somewhat. Even in the 1930s,” according to one recent esti- Indians, the nationalists who came tropics, the British endeavored to mate of the export surplus. to power in 1947 drew almost com- introduce the institutions that they oreover, British rule pletely the wrong conclusions about regarded as essential to prosperity: had some distinctly what had gone wrong under British free trade, free (and indeed forced) positive effects. It rule, embarking instead on a pro- migration, infrastructural invest- greatly increased the gram of sub-Soviet state-led autarky ment, balanced budgets, sound importance of trade whose achievement was to widen money, and the rule of law and incor- toM India, from between 1-2 percent still further the gap between Indian rupt administration. If the results of national income to over 20 per- and British incomes, which reached were much less impressive in Africa cent by 1913. The British created an its widest historic extent in 1973. and India than they were in the integrated Indian market: they uni- Economic historians continue to colonies of British settlement, that fied weights, measures and the cur- debate the causes of the “great diver- was because even the best institu- rency, abolished transit duties and, tions work less well in landlocked, in Roy’s words, introduced a “legal “The combination of free excessively hot, or disease-ridden framework [which] promoted pri- trade, mass migration and places. There, the investments vate property rights and contract unprecedented overseas which would have been needed to law more explicitly.” Between 1891 investment propelled overcome geography, climate, and its and 1938, the acreage under irriga- attendant deleterious effects on tion more than doubled. The British large parts of the Empire human capital were beyond the introduced a postal and telegraph to the forefront of world imaginings of colonial rulers. system, deployed steamships on economic development.” Yet it is far from clear that the very internal waterways, and built more different policies adopted by post- than 40,000 miles of railway track gence” of economic fortunes which independence governments and inter- (roughly five times the amount con- has characterized the last half millen- national agencies have been more structed in China in the same peri- nium. In this debate, the role of colo- successful. A simple calculation of the od). The railway network alone nialism – and specifically the British ratio of British per capita GDP to that employed more than a million peo- Empire – has a crucial role to play. If of 41 former colonies is instructive. ple by the last decade of British rule. geography, climate, and disease pro- Between 1960 and 1990 the gap Finally, there was a significant vide a sufficient explanation for the between the British and their former increase in financial intermediation. widening of global inequalities, then subjects narrowed in just 14 cases. By comparison with the other major the policies and institutions exported While it is convenient for contempo- Asian empire – China, which by British imperialism were of mar- rary rulers in countries like Zimbabwe remained under Asian political con- ginal importance. However, if the key to blame their problems on the “lega- trol – India fared well. to economic success lies in the adop- cy of British rule,” the reality is that The explanation for the disap- tion of legal, financial, and political British rule was on balance conducive pointing impact of these improve- institutions favorable to technical to economic growth. Tragically, most ments in per capita incomes lies not innovation and capital accumulation, post-independence governments have in British exploitation, but rather in then it matters a great deal that failed to improve on it. the insufficient scale of British inter- between around 1880 and 1940 a ference in the Indian economy. The quarter of the world was under British expanded Indian education – British rule. NIALL FERGUSON is Herzog professor of financial history at NYU Stern and but not enough to make a real In all likelihood, the dichotomy visiting professor of history at Oxford between geography and institutions is impact on the quality of human cap- University. ital. The British invested in India – a false one. The British settled in but not enough to pull most Indian large numbers in temperate zones, His most recent book is Empire: The farmers up off the base line of sub- taking their institutions with them; in Rise and Demise of the British World sistence. The British built hospitals the tropics, they preferred to rely on Order and its Lessons for Global Power and banks – but not enough to make monopoly companies and plantations (Basic Books), from which this article is adapted. significant improvements in public run in (unequal) partnership with health and credit networks. These indigenous elites. But by the last third © Niall Ferguson 2003. Sternbusiness 29 ILLUSTRATIONS BY CHRIS MCALLISTER 30 Sternbusiness DON’T CRY FOR ARGENTINA The continuing crisis in Latin America’s third largest economy is a matter of global concern. At a Stern event, Argentina’s former Economic Minister and a former governor of its Central Bank dissect the roots of the nation’s problems – and point toward solutions.

he collapse of the Argentinian economy has been one of the most hotly PAUL WACHTEL: Should Argentina have debated economic events of the past year. Fiscal and monetary reforms left the currency board? enacted in the late 1980s seemed to tame the country’s cycle of hyper- DOMINGO CAVALLO: When a domestic inflation and devaluation. In 1991, Argentina established a currency currency has to compete with foreign cur- board, under which the value of the peso was pegged directly to that of rencies you have to create some credibility the U.S. dollar. After several years of growth in the mid-1990s, the Argentine economy so you need a tutor. Most modern curren- Tbegan to slip into recession. And as government deficits rose and the solvency of the cies had gold as a tutor during the gold standard period. More recently, it’s been banking system came into question, depositors began to withdraw their funds. Amid social the dollar. And we thought that using a tutor unrest, Argentina announced in late 2001 that it would stop paying interest on its $155 bil- for a while would be important. The time to lion in foreign debt – the largest such default in history. In January 2002, it abandoned exit the currency board and abandon the the currency board and let the peso float against the dollar. Within a month, the peso had tutor is when your currency has become credible. Argentina could have exited the lost half its value, destroying savings and rendering borrowers unable to repay debts. currency board in 1997 after having avert- At NYU Stern on November 26, 2002, a distinguished panel gathered to discuss the ed the devaluation forecasted at the time. Argentinian crisis and its implications. It included: Domingo F. Cavallo, the Henry Kaufman The currency was growing very fast and Visiting Professor at NYU Stern, who served as Minister of Finance for Argentina from 1989 there was a significant inflow of capital. If to 1996 and was the architect of the currency board; Mario Blejer, a former governor of the the Central Bank had let the peso float, it would have appreciated vis-a-vis the Central Bank of Argentina and currently Director, Bank of England Centre for Central dollar. That’s what happened with Banking Studies; and Nouriel Roubini, associate professor of economics at NYU Stern, and Singapore in the 1970s, and they start- a former senior economist for international affairs at the White House Council of Economic ed to have a strong currency. Advisers. NYU Stern Economics Professor Paul Wachtel moderated the discussion. But Argentina didn’t abandon the cur- Sternbusiness 31 rency board for a very simple reason. As when this happens, emerging markets can use regulation to reduce the currency part of the competition for the presidency in tend to move either toward flexible mismatch by encouraging more equity 1999, the government was trying to finance exchange rates or toward hard pegs. Until investment. And if you have periods in very large deficits of the provincial govern- recently I think people categorized dollar- which hot money is flowing in, some con- ments. [Then-President] Carlos Menem ization and currency boards as among the trols on inflows of capital may be useful. would call the private banks and get them to hard pegs. But after what happened in provide financing to the provinces. This fis- Turkey and Argentina, we realize that if WACHTEL: So, Domingo views the dollar cal management, which stemmed from the your policies are not consistent, even a as a tutor, Mario views the dollar as not political competition, prevented the govern- currency board can collapse. being responsible, and Nouriel views the ment from taking the natural opportunity to dollar as being a monster that helped cre- exit the currency board. "The convertibility of ate the crisis. Perhaps we can turn our the peso to the dollar attention back to the present situation in WACHTEL: Let me ask Mario about that, helped bring down Argentina, and ask what are the prospects and more generally, whether emerging hyper-inflation in for policy and economic reform in economies should maintain currency Argentina, but this Argentina? boards? rigidity imposed certain constraints on the BLEJER: To restore and start rebuilding MARIO BLEJER: I’d distinguish between conduction of macro- confidence you need to pacify some sec- the currency crisis and the crisis in confi- economic policy that tors, like the foreign exchange market. I'm dence. Governments were clearly afraid of were not respected." not talking about the need to fix the abandoning the one-to-one peso to dollar exchange rate, but the need to stop chaos. peg. In 1997, the main constraint was the Certain types of capital control may restore cost. They didn’t want to have the risk of In each crisis, fixed exchange regimes that sort of confidence. The situation in having the currency first appreciate and collapsed and there was some overvalua- January 2002 was very chaotic in then depreciate. The IMF put out a paper tion of the currency. That led to current Argentina: a lack of confidence in the peso, that concluded you should exit currency account deficits, which led to an accumu- the abolition of convertibility, and a lack of boards when things are good. This is lation of foreign debt or foreign liabilities. confidence in the government. appealing academically, but it’s not practi- When you have a current account deficit, The supposed outcome at that point cal advice. It’s like saying you should have you can finance it either by equity inflows, would have been hyper-inflation, and the a divorce when the marriage is going well. or in the form of debt. These countries all total collapse of the financial sector. We’ve The crisis really stems from the incon- had too much debt and too little equity. avoided that so far. You have to intervene in sistency between fiscal policies and the And eventually that means the banks are the foreign exchange markets, provide liq- saving investment balances. The sharp going to be in trouble. Argentina met most uidity to the banking sector, and have a increase in the government’s fiscal deficit of these conditions. Two thirds of very active and aggressive monetary brought a very high increase in the interest Argentinian bank assets were in debt to policy with very high interest rates. rate spreads. The convertibility of the peso households or to the government, which These are the preconditions for a turn- to the dollar helped bring down hyper-infla- was borderline insolvent. around. The question is if the turnaround tion in Argentina, but this rigidity imposed How can countries be less vulnerable can be sustained. The problems are daunt- certain constraints on the conduct of to financial crisis? First of all, you need ing, because the foreign and domestic macro-economic policy that were not sound macroeconomic and fiscal policy. debt has not been negotiated, wages are respected. And if you're an emerging market, you frozen, and inflation is 40 percent. have to overachieve. Countries like this NOURIEL ROUBINI: I'd like to put should have debt ratios that are lower than CAVALLO: For economic growth, you Argentina in the context of other emerging those of developed countries. Having need strong institutions. And for that, you market crises we’ve seen in the last a sustainable exchange regime means need a well-functioning political system. decade in Mexico, Thailand, Korea, either you pay the cost of dollarization – The historical problem was that Malaysia, Indonesia, Russia, Brazil, and and few countries are truly willing to do so Argentinians in general did not consider most recently in Turkey. One of the lessons – or otherwise go to a floating regime and paying debts as something that you had to we've learned from all these episodes is maybe use inflation targeting or some other do. In a sense inflation was a reflection of that capital markets tend to collapse. And anchor as a way to stabilize inflation. You that attitude. The government would print 32 Sternbusiness money to finance its deficit, and would per- political task. But I think these problems will manently devalue the currency to soften its be fixed, because fortunately we have a "The idea that a domestic debt. Of course in a country in republic. I think the judiciary will force the dollar in a Buenos which nobody honors their debt, there is no executive and the legislative power to Aires bank is the credit. reverse many of the decisions that were In the 1990s, the convertibility law – not adopted. The functioning of the constitutional same thing as a the currency board – but the convertibility system is more important than any question dollar in Miami or law, made the difference. So did the deci- related to the exchange rate system. New York was a sions to have savings protected by dollars false idea." and the emphasis we put in legislation on ROUBINI: There's no disagreement that honoring obligations and fighting tax eva- institutions matter. But compare Hong sion. Our development in the 1990s was Kong and Argentina. They both had a cur- that with any monetary regime. really financed from domestic savings. And rency board. Hong Kong in 1998 had a BLEJER: Saved in pesos, in dollars, or in that permitted the incredible expansion of major shock. But there was no budget deficit, no public debt problem, a very chewing gum, the banking crisis would the banking system, from $10 billion up to dynamic economy, and high productivity have happened because the government $80 billion, and the creation of the pension growth. They cut wages by 15 percent and was crowding out the private sector. The funds. This modernized much of the econ- that's how you achieve the real devalua- government was pushing bonds into the omy and created an increase in productiv- tion. In Argentina, you have a large public banking sector. And this has nothing to do ity, particularly in traditional export sectors debt, a large budget deficit, a current with the exchange rate. like agriculture. account deficit, and rigid labor markets. As for the next decade? If the old ideol- When you have a bunch of shocks, eventu- CAVALLO: He’s right. We created the cli- ally the regime collapses. So institutions mate for getting a lot of financing from our mattered, but having also some policies citizens, because they were convinced that "Two thirds of mattered as well. they were saving dollars and that their sav- ings were protected. They left their savings Argentinian bank On convertibility, I'll be really blunt. I in the country and that generated credit. assets were in debt think they lived under the delusion that one But if this facility for credit simply allows the to households or to peso was one dollar. You know these cur- government to raise funds, and the rencies tend to collapse, so one peso is the government, government wastes those resources and worth much less than a dollar. What’s more, which was borderline accumulates debt, of course it’s bad. The the peso-based assets were loans made to question is how to keep the savings and insolvent." a government that was bankrupt. So the create credit while also protecting property idea that a dollar in a Buenos Aires bank is rights of the people. The answer is to the same thing as a dollar in Miami or New ogy that destroyed savings, prevented impose discipline on the fiscal sector to York was a false idea. investment, and generated inflation in the prevent the misuse of those savings. past, rules the day, then the first decade of CAVALLO: I’d argue that the illusion that BLEJER: Without macro-economic stabil- the new century will be a lot like the 1980s. Argentina had that we were saving dollars ity you are not going to have investment The 1980s started with a default, and we is exactly the same illusion that people in and growth. Argentina has paid a tremen- struggled with foreign creditors. Eventually, Texas had that they were saving in dollars dous high price for this crisis, no doubt. it will wind up in the complete collapse of after the collapse of the price of oil in the Today more than 50 percent of the popula- late 1980s. the monetary and financial system through tion lives below the poverty line, 25 percent inflation. are below what's called extreme poverty. ROUBINI: But that's why all those savings Argentina has realized that the rules of Unemployment is 22 percent. I think that and loans and oil companies went bank- the game of the 1990s were much superior there is basic agreement in the fact that one rupt in Texas. to the previous rules. The recent rule needs to rebuild a different framework, but changes did not come about because the at the same time one has to be very careful CAVALLO: But they went bankrupt in spite to implement macro-economic policies that markets forced them. They were created of the fact that the dollar was the American are conducive to the recuperation of confi- by big private sector debtors associated currency. If relative prices go down – like if dence of credibility. with the governors and with some politi- the price of oil plummets – of course all the cians. sectors whose income is tied to those Building institutions is a very difficult prices will have a problem. You can’t solve Sternbusiness 33 34 Sternbusiness THE BIG STORE GOES GLOBAL

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

By David Liang

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 W 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

ILLUSTRATIONS BY CHRIS MCALLISTER ILLUSTRATIONS 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.

Sternbusiness 35 THE BIG STORE GOES GLOBAL

resolve is how to get the right prod- CHART 1: ucts from suppliers at the right price SOURCES OF COMPETITIVE ADVANTAGE and at the right time. In the U.S., established retailers have powerful leverage over suppliers that they can InputsINPUTS use to obtain products at the lowest Inputs costs. And because Wal-Mart is such a large customer of so many suppli- ers, it can demand and receive the best prices. This ability is what Offering accounts for Wal-Mart’s higher profit margins and its ability to pass TechnologyTECHNOLOGY OperationOPERATION along value to customers in the form of low prices. But in overseas mar- kets, in which a new retailer’s pres- ence is still relatively miniscule, it is a different story. Overseas suppliers may know of Wal-Mart, but they OFFERINGOffering & BRAND may not have a record of doing busi- ness with the company. As a result, a recent arrival usually does not start with significant leverage power over suppliers. ACCESS Access Because local suppliers may not be familiar with the new entrant, Access they may refuse to comply with its demands on product quality and delivery speed. Local suppliers may SegmentationSEGMENTATION see little reasons to change their operations to accommodate a new entrant with low order volume. Wal-Mart’s operation in Brazil and CustomersCUSTOMERS Argentina provides a perfect exam- Customers ple. After eight years in these large South American countries, Wal- Mart is the sixth-largest player, with hy is it so difficult one of these sources in a new cli- 11 stores in Argentina and 22 in for a retailer like mate, especially one where you are Brazil. As such, Wal-Mart has far Wal-Mart, which is going up against established com- less leverage over local suppliers universally recog- petitors. But to pull off all of them – compared with that enjoyed by the nized as one of the which Wal-Mart needs to do to in market leader, Carrefour, which has world’sW shrewdest merchants, to order to dominate foreign consumer been operating in those countries for replicate its domestic success in markets as it does the U.S. – is overseas markets? And what lessons extremely difficult. And when retail- more than three decades. can other retailers learn from Wal- ers fail to replicate these sources of Wal-Mart also faces a similar Mart’s expansion overseas? As competitive advantage overseas, challenge in Germany, where its 94 shown in Chart 1, retailers typi- their performance in the new mar- stores give it between two percent cally distinguish themselves from kets can be mediocre. and four percent of the local market. their domestic competition through Recently, a Mercer Consulting retail seven main sources of competitive Superior Inputs specialist noted that Wal-Mart must advantage including: Inputs, Operation, Offering, Brand, and When retailers expand overseas, increase its share of the German Access. It’s hard enough to replicate one of the most crucial issues to retail market to at least ten percent

36 Sternbusiness before it can exert power over local and promotional strategies that were oping markets are usually not as suppliers. And until it does, Wal- similar to those of Wal-Mart. The restrictive as those in developed Mart may find it difficult to compete ASDA acquisition was so successful countries. In China, however, Wal- with German retailers for superior that Wal-Mart was reluctant to Mart built its logistical distribution inputs. implement new changes. In fact, network from scratch because most according to BusinessWeek, Wal- Chinese retailers are either owned Superior Operation Mart learned a few lessons from by, or affiliated with, the govern- For retailers in general, and for ASDA in food merchandising and ment, and their distribution net- Wal-Mart in particular, building and staff incentive programs. works are mostly inefficient. In maintaining an efficient operation In Germany, however, Wal-Mart’s addition, Chinese geographic and is another source of low costs, and acquisitions of Wertkauf (1998) and demographic patterns resemble hence competitive advantage. Interspar (1999) were less suc- those of the United States, which Operation here is defined as the cessful because Wal-Mart had to makes it possible to replicate the logistical distribution network that integrate two companies with differ- scale of U.S. operations. In a recent facilitates goods flow from manu- interview with Newsweek, Wal-Mart facturers to retail customers. The "In Germany...Wal-Mart International CEO John Menzer said company’s logistics and inventory had to integrate two that Wal-Mart’s Chinese operations control systems, which Wal-Mart had the potential to grow from 25 built to service far-flung stores from companies with different stores today to 3,000 by 2028. its rural Arkansas base, have long logistical distribution There’s a third alternative for been the envy of the retail industry, schemes...local suppliers entering markets. Instead of an out- and of plenty of other industries. right buy or build strategy, a new A new entrant can either buy an initially were so confused entrant can also choose a local joint existing distribution network or with the combined venture partner. This choice is par- build one from scratch. When networks that in the first ticularly desirable if a new entrant entering a developed country, it is has little international experience, generally easier to buy than to build. few years of operation, little local market expertise, or First, local players in a developed Wal-Mart stores in wants to limit its risk exposure. The country usually have efficient logis- Germany suffered many drawback is that the new entrant tical networks and sophisticated may have to compromise on funda- operations. Second, a new entrant stock-outs." mental issues ranging from store can use an acquisition to avoid name to merchandising mix. In dealing with heavy regulations that ent logistical distribution schemes. 1991, Wal-Mart picked Mexico as commonly exist in developed mar- According to the Financial Times, the first international market to kets, which often hinder a new local suppliers initially were so con- enter. It chose the Mexican discount entrant’s efforts to build from fused with the combined networks supermarket chain Cifra as its joint- scratch. And so in entering Western that in the first few years of opera- venture partner, and Cifra’s local European countries, such as the tion, Wal-Mart stores in Germany market expertise greatly compensat- U.K. and Germany, Wal-Mart suffered many stock-outs. Needless ed for Wal-Mart’s lack of interna- acquired local players – but with to say, integration issues play crucial tional experience. More than a different results. roles in determining the success of decade later, Wal-Mart’s 595-store In the U.K., Wal-Mart’s 1999 an acquisition. joint-venture operation in Mexico is acquisition of ASDA proved success- When entering a developing profitable. The company is now ful. It was immediately profitable country, by contrast, it is generally even starting to use the Wal-Mart and made Wal-Mart the third largest better to build from scratch for two name in its newly opened store units mass merchandiser in the U.K., with reasons. First, local players in devel- rather than the local Aurrera, 258 stores. The deal worked for two oping countries usually do not have Bodega, and Suburbia store names. reasons. First, ASDA, like Wal-Mart, efficient distribution networks. This had an efficient distribution net- means a new entrant has to create a Superior Offering work strategy. Second, before the new distribution network to meet its Superior product offering is a acquisition, ASDA followed pricing needs. Second, regulations in devel- critical element of retailers’ success.

Sternbusiness 37 THE BIG STORE GOES GLOBAL

"A retailer can only provide superior product offerings if it has immediate knowledge of its customers’ desires and needs."

Wal-Mart is distinguished by its fail to conduct the due diligence cry from what you’d see in a Wal- ability to offer thousands of prod- necessary to gain such knowledge. Mart in Denver, Colorado. The aisles ucts – including brand names – at As a result, new retailers often carry are made wider and checkout coun- low prices. But because a new retail- product offerings that do not meet ters shorter to accommodate er who expands into new overseas local tastes. According to an article Chinese customers’ habits of making markets often lacks superior inputs, in The New York Times, when Wal- more frequent shopping trips per operation or both, the new entrant Mart first opened its doors in week but buying smaller quantities may often lack superior product Argentina in 1995, its stores carried per trip. On average, Chinese cus- offering. As a result, the value the 110-volt appliances commonly tomers shop groceries on a daily proposition may differ across geog- found in the U.S. – even though the basis while U.S. customers shop at raphy. In the U.S., Wal-Mart can local voltage standard in Argentina Wal-Mart about two times a week. offer the greatest value relative to all is 220-volt. Wal-Mart’s first stores Wal-Mart also adjusts its shopping its competitors because of its domi- also carried merchandise favored by bags to fit the needs of Chinese nant position over suppliers. In U.S. consumers, but that did not shoppers who mostly still travel by Argentina and Brazil however, Wal- appeal to local Argentine tastes. motorcycles or bicycles. In Korea, Mart’s product offerings are general- After a period of trials and errors, as where real estate is expensive, Wal- ly priced higher than those of Wal-Mart began to imitate local Mart builds multi-level stores – four Carrefour. That means Wal-Mart competitors’ product offering, its levels for parking and three for has to differentiate itself from the sales in Argentina and Brazil shopping – as opposed to the single- competition in South America based improved. level sprawling warehouse format on other factors. Wal-Mart learned from its mis- commonly found in the U.S. Of course, a retailer can only pro- takes in Argentina when entering vide superior product offerings if it the Chinese market. Wal-Mart’s Superior Brand has an intimate knowledge of its Chinese stores are stocked with local The final ingredient of a success- customers’ desires and needs. delicacies like barbecued pigeons, ful international retailer is the Frequently, however, global retailers live frogs, fish, and snakes – a far brand. Branding creates special

38 Sternbusiness relationships between products and kets as Germany, Argentina, and expand to as many store locations as customers. It adds special meanings Brazil, a new entrant like Wal-Mart possible because widespread store to products beyond their functional- has to find alternative ways to locations make it easier for cus- ity. Coca-Cola means refreshing uniquely position its brand. tomers to reach its stores and create drinks; Sony signifies high-quality Another aspect of branding that a feeling of familiarity. In addition consumer electronics; Gap stands retailers must consider when to familiarity, having numerous for comfortable casual clothing; and expanding overseas is whether to use stores in a particular country Wal-Mart means value shopping and the original American name or increases economies of scale. It everyday low price (EDLP). For any adopt a local name. In most cases, spreads retailers’ fixed costs across a company, whether it’s a service larger base and enhances the retail- provider like UPS, or Coke, or "Wal-Mart’s Chinese ers’ leverage power over suppliers. McDonald’s, it’s the ultimate stores are stocked with In overseas markets like China, achievement to have your brand rec- Wal-Mart builds not only large ognized on a global basis. Creating a local delicacies like supercenters, but also smaller global retail brand, however, can be barbecued pigeons, live neighborhood markets to take challenging because retailers gener- frogs, fish, and snakes – advantage of high consumer traffics ally don’t have a tangible product to in urban centers. represent what the brand is all about a far cry from what Exporting to “the five key” – the way that a Sony VCR rep- you’d see in a Wal-Mart sources of competitive advantage is resents high quality consumer a must for a retailer wishing to enter electronics for the Sony brand. To in Denver, Colorado." a foreign market. While missing one create branding relationships with or some of these elements does not customers, a retailer is highly the first option seems to be the most mean a new retailer cannot reach dependent on the overall shopping popular among retailers because it profitability in new markets, it will experience, which is influenced by allows for building global brand prevent the new entrant from factors such as pricing, merchandise awareness. The second option, how- achieving its full profitability mix, store atmosphere, and cus- ever, may resonate well with local potential. tomer service friendliness. consumers and may somewhat alle- From Coca-Cola to Starbucks, The more crowded a segment is, viate anti-Americanism that exists from McDonald’s to Polo, many U.S. the harder it is for a new entrant in many foreign countries. Either companies have excelled in taking to uniquely position its brand. way, there is no clear-cut evidence successful domestic brands and According to The Economist, 30 per- that one choice affects profitability operating systems, and exporting cent of the German retail industry is more than the other. them overseas. Wal-Mart, which has dominated by local deep discoun- There is no noticeable difference had such tremendous success in the ters; and a price cut by one retailer in results whether a new entrant domestic market, has faced some is quickly matched by competitors. uses its original American name or a obstacles in its international efforts. In this competitive environment, new local name in a new overseas But as it learns from mistakes and Wal-Mart’s everyday low price mes- market. But one thing is clear: the from its encounters with different sage did not revolutionize the indus- new entrant must build its brand in retailing and business cultures, the try the way it did in the U.S. and the that new market. For when all else is retailing giant based in rural U.K. It is difficult for Wal-Mart to equal (pricing, product offering, Arkansas will surely continue to differentiate itself and to uniquely shopping atmosphere, customer expand its presence throughout position its brand in Germany as a service), the store brand is the only the globe. value and everyday low price brand. thing that differentiates a new Wal-Mart faces a similar challenge entrant from competitors. in Argentina and Brazil, where the Superior Access DAVID LIANG is a second-year MBA company has five direct competitors student at NYU Stern. This article was with more-entrenched brands. By Finally, a retailer’s survival is written under the supervision of Marco contrast, in the U.S. market, Wal- highly dependent on its access strat- Protano, visiting associate professor of Mart only faces one or two direct egy. With the exception of upscale marketing and John Czepiel, professor competitors. In such crowded mar- retailers, most retailers wish to of marketing at NYU Stern.

Sternbusiness 39 IT’S A SMALL WORLD AFTER ALL? By Jonathan Heathcote and Fabrizio Perri

In recent years, the economies of the United States and its largest trading partners have increasingly marched to their own drummers – even as trade and financial integration have increased. It may sound like a paradox, but it's not.

n recent years, the United financial globalization – has sharply States economy has increas- increased, with Americans holding ingly danced to its own tune. far more direct investment and equi- Between 1972 and 1986 the ty in foreign markets, and foreigners businessI cycles of the U.S., on the investing more in the U.S. markets. one hand, and an aggregate of Does one trend have anything to Europe, Canada, and Japan, on the do with the other? Does financial other, were rather close. But in more globalization help explain real recent years, in a trend we’ve regionalization? Or vice versa? Thus dubbed real regionalization, the far, very little research has paths of these developed economies addressed the effects of growth in have diverged. All the major world foreign asset holdings on business economies went, synchronously, cycle dynamics. By constructing through a deep recession in 1973, a models of how economies function, ILLUSTRA recovery in the mid- 1970s and and then running experiments, we another recession in the early set out to answer these questions. TIONS BY CHRIS MCALLISTER 1980s. In the 1990s, by contrast, the U.S. experienced robust growth, Going Separate Ways Europe was mixed, while Japan and The divergence among economies Asia experienced their worst post- in the post-Bretton Woods period – war decade. 1972-2000 – can be seen in the At the same time though, trade in decline in cross-regional correlations international financial assets – or in business cycle frequency fluctu-

40 Sternbusiness Sternbusiness 41 IT’S A SMALL WORLD AFTER ALL

growth in the stocks of U.S. equity Table 1 International Correlation of Macroenomic Variables portfolio investment abroad and Between the U.S. and the Rest of the World foreign direct investment in the U.S. Comparing the U.S. with the GDP Consumption Investment Employment Europe/Canada/Japan aggregate, Period 1, 72Q1-86Q2 0.76 0.51 0.63 0.66 for example, U.S. holdings of foreign securities averaged 1.1 percent of Period 2, 86Q3-00Q4 0.26 0.13 -0.07 0.03 total non-U.S. developed economies market capitalization over the first half of the sample, and 5.5 percent in the second half (see Figure 2). ations in factors such as Gross foreign stocks have grown strongly There’s more evidence that links Domestic Product, consumption, since the mid-1980s, while the together financial globalization and investment, and employment stocks of FDI and foreign-owned real regionalization. Figure 1 dis- between the U.S. and an aggregate equity in the U.S. have risen steadi- plays the evolution of correlation of of the rest of the world (comprising ly over the entire period. Between business cycles and of international Europe, Japan, and Canada) (see 1972 and 1999, United States gross financial integration in the last 40 Table 1). The fact that the correla- holdings of FDI and equity in this years. The picture shows that until tions of all four variables have group of countries rose from four to the mid-1980s the correlation of declined markedly between the two 23 percent of the U.S. capital stock. business cycles (left scale) was quite periods stands as compelling evi- The observed growth in diversifica- high and stable while the share of dence of real regionalization. tion appears to be robust to a wider foreign assets over the total value of While the declines might be sim- definition of the rest of the world, to U.S. assets (right scale) was stable ply due to a decline in the correla- broader classes of assets, and to and quite low (around five percent). tion of outside shocks – like the alternative valuation methods. Since the mid-1980s, the correlation worldwide oil shocks in the 1970s – For their part, Europe, Canada, of business cycles has markedly the relatively large falls in the cor- and Japan jointly account for almost declined and the share of foreign relations of investment and all foreign holdings of U.S. assets, assets has markedly increased. employment suggest a change in the and for the lion’s share of U.S. asset asset market structure. In particular, holdings abroad – although other The Story the development of international countries are attracting an increas- Why should real regionalization financial markets increases the ing share of U.S. equity portfolio and financial globalization be relat- opportunities for specialization in investment. Growth in diversifica- ed? Our story is summarized in production in different countries. tion generally appears smaller when Figure 2. The driving forces are the After all, when capital moves more stock market capitalization – and shocks that shape both business freely around the globe to pursue not capital stock replacement cost cycles and portfolio decisions. These investment opportunities, economies estimates – is used as a denominator. include oil shocks, technology are less likely to move in sync. But even in this case we find strong

Trading Places Figure 1 Financial globalization and real regionalization To measure financial globaliza- – 0.25 tion, we examined data on foreign Fraction of US capital stock – direct investment and purchases of –-0.20 foreign equity. For U.S. assets, the – 0.8 – Foreign assets key measure is the sum of the U.S. –-0.15 foreign direct investment (FDI) 0.6 – position and the equity part of the 0.4 – –-0.10

Correlation 0.2 – Investment correlation stock of portfolio investment –-0.05 abroad, relative to the U.S. capital 0.0 – stock. We focused on U.S. holdings -0.2 of assets in Western Europe plus -0.4 ||||||||||||||||||||||| Canada and Japan, and these coun- 76 78 80 82 84 86 88 90 92 94 96 98 tries’ holdings of U.S. assets. And Foreign assets are stocks of US FDI and equity investments in Europe, Canada, and Japan. Investment correlation is the data show that U.S. holdings of the correlation between US investment and investment in Europe, Canada, and Japan over the previous 58 quarters. 42 Sternbusiness shocks, policy shocks, and of capital to its most produc- other types of disturbances tive location is increasingly that affect a country’s macro- Figure 2 unhindered by restrictions on economic performance. We Financial international borrowing and label them “productivity Globalization lending. The combination of shocks.” Assume that the cor- less correlated shocks and the Driving force (2) relation of these shocks has resulting deepening of interna- declined over time. This fact (3) tional asset markets can Reduction in obviously leads to less correlat- Correlation of Shocks account for the observed ed business cycles (Arrow 1). (1) changes in the international The reduction of the correla- real business cycle. tion also reduces the correla- Real This coincidence of real tion of returns to capital; the Regionalization regionalization and financial simple logic of risk reduction globalization has larger impli- through diversification implies cations. It says that while the that when returns to capital world may be coming together are less correlated it is more conven- a fall in the correlation of productiv- financially, we should be ready to ient to hold an internationally diver- ity shocks account for the magni- see it growing apart economical- sified portfolio. And thus financial tude of the observed increase in ly. This is not necessarily a bad globalization arises (Arrow 2). The diversification? And second, is thing as households, by holding an final step is the link from financial increased diversification important internationally diversified portfolio, globalization to business cycle in accounting for the magnitude of can diversify away the risk specific (Arrow 3). When people hold inter- the observed decline in business to their country of residence. nationally diversified portfolios, cycle correlations? It also sheds light on the causes of capital can easily flow from one Regarding the first question, the the recent trend toward recent country to another. Thus, in model economies predict that, in financial integration. Our expla- response to a small positive shock, response to the fall in shock correla- nation relies principally on the say in the U.S., capital flows in from tion, the amount of foreign assets correlation of macroeconomic Europe and from Japan. These flows held by domestic consumers should shocks that we view as an important amplify the boom in U.S. and increase from 5.5 percent to 15 per- determinant of the gain from induce a recession in Japan and cent of total asset holdings. This international diversification. Europe, thus making business cycles suggests that the correlation of Some researchers instead have even less correlated. shocks is a quantitatively important focused on the diffusion of informa- factor in determining the extent of tion technology as a leading cause. A Model Economy international diversification. But this explanation is difficult To test our story about the rela- Regarding the second question, to reconcile with evidence from tionship between real regionaliza- the models show that both the fall in the Gold Standard years. Then, tion and financial globalization, we the correlation of productivity although information technology used artificial (computer simulated) shocks and the resulting endogenous was obviously not very well economies. The modeling frame- growth in international asset trade developed, international finan- work we employed was developed are essential elements needed to cial integration was, by some by David Backus, Patrick Kehoe, account for most of the observed measures, as high as it is today. And and Finn Kydland in 1994. Using a changes in the international busi- it is interesting to note that business technique developed by Robert ness cycle. cycle correlations in those years also Solow in the 1960s we constructed a appear to be low. That suggests that Implications series for the productivity shocks our explanation might work for that hitting the U.S. and the rest of the A fall in the correlation of macro- period too. world and we showed that the corre- economic shocks has increased lation of these shocks has indeed equilibrium diversification by declined. We then plugged in the increasing the potential gains from JONATHAN HEATHCOTE is an process for shocks into the model international asset trade. This assistant professor of economics at Georgetown University. economies and ran tests upon them. increased portfolio diversification The tests we did were geared at has left asset holders less exposed to FABRIZIO PERRI is an assistant answering two questions. First, can country-specific risk, and the flow professor of economics at NYU Stern. Sternbusiness 43 EXCESS CAPACITY 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

he telecommunications ity, representing hundreds of billions instance, the owner-shareholders of industry – a great of dollars of investment, stands idle. the companies that made the ill-fated engine of growth in the Global Crossing, WorldCom, and investments will absorb the losses. 1990s – today faces Adelphia have already declared Following them will be the lenders serious financial diffi- bankruptcy, and the industry isn’t and creditors to those companies. culties.T Major bankruptcies have out of the woods yet. All things considered, it is better occurred; more may well follow. There are no magical, painless for these losses to be realized and In retrospect, it’s easy to see solutions to these difficulties. But the absorbed sooner rather than later. where the industry went wrong. The telecommunications industry is a key Why? The more rapidly losses are massive expansion of fiber-optic component of the U.S. economy, a recognized, the faster can companies cable capacity and of cable’s comple- contributor to national security, and and markets recognize the true mentary components was accompa- a source of innovation. So as policy prospective marginal costs of using nied by rapid technological progress markers and investors grapple with these facilities for prospective servic- that greatly expanded the economic how to deal with the fallout, and es. And that will encourage lower capacity of that fiber-optic cable how to prevent further damage, prices, expanded demand, greater and those components. Meanwhile, there are important principles that utilization, and overall greater eco- growth in demand for telecommuni- both the public and private sectors nomic efficiency. cations services turned out to be sub- can and should be following. Delaying this process can only stantially lower than was forecast. put off the pain and the agony, These conditions were aggravated by With All Deliberate Speed not avoid it. And delay will mean ©WARREN GEBERT/IMAGES.COM, INC. a significant slowing of the U.S. First, all parties involved must inefficient decisions in the interim. economy in 2001 and 2002. The acknowledge and recognize the loss- To be sure, no manager of a public revelations of corporate governance es and pain – and move on. company likes to see the equity of and accounting misrepresentation Massive losses always accompany his shareholders wiped out. But problems that cropped up at several a large and expensive increase in investors do not “deserve” a return telecommunications companies have effective capacity that is not matched on their investments. In a market further exacerbated an already diffi- by an equivalent expansion in economy, investors undertake invest- cult situation. demand. Those losses must be ments that carry risks. Often, invest- As a result, a great deal of capac- absorbed by someone. In the first ments are successful, and investors 44 Sternbusiness Sternbusiness 45 prosper. Sometimes, investments are transactions with companies that subject to sufficient safety-and- unsuccessful, and investors lose. may be heading into bankruptcy. soundness regulation by state and This is the way a market economy Once again, speed of resolution is federal authorities. When the conse- should function. To prop up losing important. quences of the excessively optimistic investors in such situations is to Bankruptcy is surely not an expectations first became apparent institute a policy of privatizing gains enjoyable experience for those who around 1985-1986, “see-through and socializing losses, which is a go through it; and it is not a perfect office buildings” became a common recipe for inefficient investment process. But it provides resolution, phrase in Sunbelt cities. decisions and inequitable outcomes. and an orderly mechanism for the By early 1986 it was quite clear The absorption of losses already settlement of claims. that much of Sunbelt commercial has involved a number of sizable real estate was over-priced and bankruptcies, which have been Accurate Historical uneconomic at those prices, and that painful but unavoidable. What must Parallels hundreds of S&Ls that had financed be remembered is that these bank- Many observers have drawn his- those projects were insolvent. torical parallels between today’s Nevertheless, there were strong "The more rapidly telecommunications glut and the political pressures on federal regula- losses are recognized, over-capacity of the railroad indus- tors and on Congress to proceed the faster can try in the late nineteenth century. slowly in taking any action that The parallels are valid. In the 1880s would pressure financial institutions companies and markets and 1890s, a large amount of capac- to recognize and absorb the losses. recognize the true ity had been built. But demand for Advocates against action frequently prospective freight and passenger service did not argued that, given time, conditions marginal costs of expand sufficiently to absorb that would turn around on their own. capacity at economic prices in many Real estate market participants using these facilities markets. As a result, the affected feared that acknowledging losses for prospective companies went into bankruptcy; and selling uneconomic commercial services." surviving railroads emerged; and the real estate to buyers who might put rail sector became the core of pas- those properties to better use would ruptcies are the recognition of the senger and freight transportation for cause prices to fall further. changed climate and provide the the next half century. The infrastruc- This was not good advice. Rapid processes whereby losses are ture and routes laid down in the late action in recognizing losses was the absorbed by owners and creditors – 19th century remain central to best course of action in dealing with thus setting the stage for the sector freight transportation in the U.S. in the S&L insolvencies and in dealing to move on. Bankruptcies need not the early 21st century. with the commercial real estate over- mean the shuttering of a company. There are at least two more recent hang. In both cases, the markets If the products and services of the examples of the importance of rapid weren’t fooled into believing that company and its brand name repu- disposition of excess capacity. The problems were not present. And the tation are sufficiently desirable, a first centers on the savings and loan delayed action with respect to insol- prospective owner, freed from some (S&L) crisis of the late 1980s. It is vent S&Ls meant that the owners or most of the prior debt and con- now widely recognized that this and managers of those insolvent tractual obligations, can find the debacle, and the parallel failure of S&Ls might take risky and uneco- operation of a more-or-less intact almost 1,500 commercial banks, was nomic actions in efforts at resurrec- company worthwhile. Even when a largely the result of excessive invest- tion. Delayed action with respect to company must be liquidated, its ment in commercial real estate in the commercial real estate meant a con- equipment will find its way into early and mid 1980s, combined with tinued overhang of uncertainty other hands, unless its economic inadequate safety-and-soundness about prices and uses. value is zero. In all instances, speed regulation. This excessive invest- Though the clean-up of the S&L of resolution is imperative. ment was driven by overly optimistic problem took longer than it should Further, it is important that economic projections for the Sunbelt have, it eventually did proceed in an employees, suppliers, and customers and elsewhere, much of it based on expeditious fashion. Similarly, the of companies operating under bank- the expectations of the favorable Resolution Trust Corporation (RTC) ruptcy protection receive resolution effects of a high price for petroleum moved swiftly to deal with the com- of their uncertainties, so that they for the Southwestern economy and mercial real estate that it inherited too can move on. The same is true the favorable effects of the Economic from insolvent S&Ls. Rapid action with respect to companies that are Recovery Tax Act of 1981 for the in both dimensions helped both sec- tottering on the edge of Chapter 11. economy at large. The excessively tors emerge sooner and stronger. After all, lenders, suppliers and cus- optimistic investments were funded A second example involves learn- tomers are frequently loathe to enter by S&Ls and banks that were not ing from others’ errors, specifically

46 Sternbusiness those of the Japanese. For more than fixed costs and low a decade, Japan has moved very ten- marginal costs, which tatively in dealing with the difficul- is likely to yield aggres- ties of its banking sector. Once the sive pricing so long as Japanese stock market and real customers see competi- estate bubble burst in the early tive firms’ offerings as 1990s, the appropriate actions for near-commodities. the government of Japan would have been to force Japan's banks to deal Sound Antitrust quickly with the bad loans and other Principles uneconomic investments on their As they formulate books and to recognize their losses. responses to the cur- The government could have helped rent telecommunica- insolvent banks by injecting public tions crisis, policy- funds to protect depositors – but not makers should also bank owners – and by finding new continue to follow owners who would inject fresh capi- sound antitrust princi- tal into the banks. Japan could ples. The resolution of thereby have established a rejuve- the telecommunica- nated banking system that could tions industry's current over- be delayed because of any concerns perform its role in making new loans capacity surely warrants some con- about spill-over effects on the capac- to the rest of the economy. solidation. But that doesn’t mean ity utilization of fiber-optic cable. Instead, the government of Japan that exceptions should be made to Efficiency improvements in the way has taken few such actions. Banks, good antitrust policy. The Horizontal that spectrum is allocated and used which were largely unwilling to force Merger Guidelines of the U.S. should always be welcomed, regard- companies into bankruptcy, have Department of Justice and the less of how and when they occur. been allowed to keep vast sums of Federal Trade Commission provide In this regard, spectrum auctions non-performing loans on their the right antitrust guidance for per- have been and continue to be a good books. When the government did mitting efficient combinations that start at improving efficiency. But act, its actions have been too little will also avoid the creation of market they are only a start. Auctions would and too late. As a consequence, the power. They should be followed – affect far too little of the spectrum. Japanese banking industry remains even in a time of crisis. Instead, the effort to “propertyze” saddled with bad loans on which it The “excuse” of financial diffi- the spectrum – to treat it as property has yet fully to recognize the losses, culties in the telecommunications in a manner that is analogous to how the banks remain moribund and sector should not be used as a route real estate is treated – is the right reluctant to lend, and the Japanese for allowing firms to exercise market way to proceed. Only then can mar- economy has remained mired in eco- power. After all, the slack antitrust kets do their job in increasing the nomic stagnation for over a decade. standards that have sometimes been efficiency with which the spectrum is the norm in other regulated indus- used. Serial Bankruptcies? tries, such as for railroad and airline Times of financial crises are often One specter raised by opponents mergers, have not had salutary con- watershed epochs. This is likely to to revived companies is that these sequences. be true for telecommunications. companies’ ability to reduce their Good public policy could steer us costs by renegotiating debt and other Encouraging Innovation through the turmoil and allow us to contracts will lead to aggressive Finally, as we come to grips with emerge fairly rapidly with a more pricing and then to a cascade of the fallout of the telecommunica- efficient telecommunications sector. other bankruptcies. But this argu- tions glut, we should continue to Poor public policy could leave us in ment ignores the fact that companies encourage and foster innovation. a quagmire of continuing uncertain- will stay intact only if their creditors Indeed, we should not delay effi- ty and poor performance. Political believe that the intact entity has ciency-increasing developments in leadership in Washington will be more value than the liquidated spectrum allocation and usage. crucial in determining the path. assets. Also, even if a bankrupt com- Improvements in the allocation and pany were liquidated, its equipment usage of the electromagnetic spec- LAWRENCE J. WHITE is Arthur E. would be sold at low levels that then trum continue to be possible – part- Imperatore professor of economics at become the basis for low product ly through improved technologies, NYU Stern. This article is adapted prices. Finally, it ignores the reality and partly through reforms in how from an October 7, 2002 presentation that industries such as telecommuni- the spectrum is regulated and dereg- at the Federal Communications cations are characterized by high ulated. Improvements ought not to Commission.

Sternbusiness 47 endpaper

Standard Fare By Daniel Gross

he International down with the same gauge. Organization of So in 1846 the British gov- Standards (ISO), based ernment smartly decreed all in bucolic Geneva, railroads should be laid Switzerland, rarely down precisely four feet, attractsT the attention of slick busi- eight and one half inches ness magazines and television net- apart. This distance works. But perhaps it should. After became the so-called all, industrial and commercial stan- standard gauge in the dards stand at the center of our U.S., which, nonethe- increasingly global system of trade, less failed to impose manufacturing, and exchange. uniform standards. The ISO was founded in Throughout the South, for February, 1947, as engineers and example, five-foot gauge was scientists forged a new force for prevalent. And some historians international harmony. The first theorize that the Confederacy’s lack ISO standard was published in of a standardized rail network 1951 – “a standard reference tem- hampered its ability to move men industrialized perature for industrial length meas- and materiel efficiently during the nations – has yet to urement.” More standards are Civil War. formally adopt what added each year. The 813 issued in In the 19th century, time was is, in essence, the world’s ILLUSTRATION BY TIMOTHY COOK 2001 brought the total to 13,544, generally kept locally, and dictated operating system. covering everything from cine- by the sun. The result: at 10:00 The fact that we use feet while matography to cryogenic vessels. a.m. in Philadelphia, it might be most of our trading partners use Some, of course, are more useful 9:48 a.m. in Pittsburgh. But since meters highlights the occasionally than others. An ISO standard on trains had the ability to travel far astonishing degree to which our smart-card thickness allows a enough, and fast enough, to con- affairs are still not governed by tourist to use the same ATM fuse people, U.S. railroads in 1883 global standards. Despite the machine in Beijing, Brussels, or divided the nation into four time advent of the Euro, currencies Boston. More broadly, industrial zones. It took another 35 years for remain stubbornly diverse. And in standards permit a can of Coca- Congress to codify the railroads’ Britain, drivers persist in keeping to Cola to look, feel, and taste the practice for the broader public with the left-hand side of the car. same in Red Square as it does in the Standard Time Act of 1918. Indeed, as the global marketplace Blue Bell, Pennsylvania. Of course, the U.S. has remained becomes more tightly integrated, The story of standards starts aloof from some nearly universal significant pockets of the world with the railroads. Early 19th cen- standards. The metric system was continue to hew to their own tury railroads were designed to con- first developed in France in the late standards. nect one town to another. But you 18th century. But more than two could only haul goods over two dif- centuries after its creation, the ferent lines if the rails were laid United States – alone among DANIEL GROSS is editor of STERNbusiness.

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