Global Business

GLOBAL BUSINESS

Third Edition

Mike W. Peng, Ph.D. Jindal Chair of Global Business Strategy

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Executive Director, Center for Global Business Jindal School of Management University of Texas at Dallas

Fellow, Academy of International Business

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Global Business, Third Edition Mike W. Peng

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To Agnes, Grace, and James

Preface ix

About the Author xix

Part 1 Laying Foundations 1

Chapter 1: Globalizing Business 2

Chapter 2: Understanding Formal Institutions: Politics, Laws, and Economics 32

Chapter 3: Emphasizing Informal Institutions: Cultures, Ethics, and Norms 62

Chapter 4: Leveraging Resources and Capabilities 92

PengAtlas 1 118

Integrative Cases 124

Part 2 Acquiring Tools 139

Chapter 5: Trading Internationally 140

Chapter 6: Investing Abroad Directly 174

Chapter 7: Dealing With Foreign Exchange 204

Chapter 8: Capitalizing on Global and Regional Integration 232

PengAtlas 2 264

Integrative Cases 270

Part 3 Strategizing around the Globe 285

Chapter 9: Growing and Internationalizing the Entrepreneurial Firm 286

Chapter 10: Entering Foreign Markets 310

Chapter 11: Managing Global Competitive Dynamics 336

Chapter 12: Making Alliances and Acquisitions Work 364

Chapter 13: Strategizing, Structuring, and Learning around the World 394

PengAtlas 3 424

Integrative Cases 428

Part 4 Building Functional Excellence 465

Chapter 14: Competing on Marketing and Supply Chain Management 466

Chapter 15: Managing Human Resources Globally 492

Brief Contents

Brief Contents v

Chapter 16: Financing and Governing the Corporation Globally 522

Chapter 17: Managing Corporate Social Responsibility Globally 552

PengAtlas 4 578

Integrative Cases 582

Glossary 598

Name Index 607

Organization Index 617

Subject Index 621

Preface ix

About the Author xix

Part 1 Laying Foundations 1

Chapter 1: Globalizing Business 2

What Is Global Business? 4

Why Study Global Business? 10

A Unified Framework 14

What Is Globalization? 18

Global Business and Globalization at a Crossroads 21

Organization of the Book 25

Chapter 2: Understanding Formal Institutions: Politics, Laws, and Economics 32

Understanding Institutions 35

What Do Institutions Do? 36

An Institution-Based View of Global Business 38

Political Systems 40

Legal Systems 43

Economic Systems 47

Debates and Extensions 48

Management Savvy 54

Chapter 3: Emphasizing Informal Institutions: Cultures, Ethics, and Norms 62

Where Do Informal Institutions Come From? 64

Culture 65

Cultural Differences 70

Ethics 78

Norms and Ethical Challenges 80

Debates and Extensions 81

Management Savvy 84

Chapter 4: Leveraging Resources and Capabilities 92

Understanding Resources and Capabilities 94

Resources, Capabilities, and the Value Chain 96

From SWOT to VRIO 100

Debates and Extensions 104

Management Savvy 109

Part 1 Integrative Cases 124

1.1 Coca-Cola in Africa 124

1.2 Whose Law Is Bigger: Arbitrating Government-Firm Disputes in the EU 126

1.3 Fighting Counterfeit Motion Pictures 128

1.4 Brazil’s Embraer: From State-Owned Enterprise to Global Leader 131

1.5 Microsoft in China 136

Part 2 Acquiring Tools 139

Chapter 5: Trading Internationally 140

Why Do Nations Trade? 143

Theories of International Trade 145

Realities of International Trade 158

Debates and Extensions 163

Management Savvy 166

Chapter 6: Investing Abroad Directly 174

Understanding the FDI Vocabulary 176

Why Do Firms Become MNEs by Engaging in FDI? 180

Realities of FDI 186

How MNEs and Host Governments Bargain 190

Debates and Extensions 192

Management Savvy 195

Chapter 7: Dealing with Foreign Exchange 204

What Determines Foreign Exchange Rates? 206

Evolution of the International Monetary System 214

Strategic Responses to Foreign Exchange Movements 218

Debates and Extensions 221

Management Savvy 225

Table of Contents

Chapter 11: Managing Global Competitive Dynamics 336

Competition, Cooperation, and Collusion 339

Institutions Governing Domestic and International Competition 343

Resources Influencing Competitive Dynamics 346

Attacks, Counterattacks, and Signaling 350

Local Firms versus Multinational Enterprises 351

Debates and Extensions 352

Management Savvy 356

Chapter 12: Making Alliances and Acquisitions Work 364

Defining Alliances and Acquisitions 367

Institutions, Resources, Alliances, and Acquisitions 368

Formation of Alliances 374

Evolution and Dissolution of Alliances 376

Performance of Alliances 378

Motives for Acquisitions 379

Performance of Acquisitions 383

Debates and Extensions 384

Management Savvy 386

Chapter 13: Strategizing, Structuring, and Learning around the World 394

Multinational Strategies and Structures 396

How Institutions and Resources Affect Multinational Strategies, Structures, and Learning 404

Worldwide Learning, Innovation, and Knowledge Management 408

Debates and Extensions 412

Management Savvy 415

Part 3 Integrative Cases 428

3.1 Wikimart: Building a Russian Version of Amazon 428

3.2 Private Military Companies 431

3.3 Amazon, Bookoff, and the Japanese Bookselling Industry 435

3.4 Huawei’s Intellectual Property War 438

3.5 Is A Diamond (Cartel) Forever? 446

3.6 The TNK-BP Joint Venture 452

Chapter 8: Capitalizing on Global and Regional Integration 232

Global Economic Integration 234

Organizing World Trade 237

Regional Economic Integration 240

Regional Economic Integration in Europe 242

Regional Economic Integration in the Americas 248

Regional Economic Integration in the Asia Pacific 250

Regional Economic Integration in Africa 252

Debates and Extensions 253

Management Savvy 256

Part 2 Integrative Cases 270

2.1 Canada and the United States Fight Over Pigs 270

2.2 Foreign Direct Investment in the Indian Retail Industry 272

2.3 The Fate of Opel 274

2.4 Jobek do Brasil’s Foreign Exchange Challenges 276

2.5 The EU–Korea Free Trade Agreement 279

Part 3 Strategizing around the Globe 285

Chapter 9: Growing and Internationalizing the Entrepreneurial Firm 286

Entrepreneurship and Entrepreneurial Firms 289

Institutions, Resources, and Entrepreneurship 289

Growing the Entrepreneurial Firm 293

Internationalizing the Entrepreneurial Firm 298

Debates and Extensions 301

Management Savvy 303

Chapter 10: Entering Foreign Markets 310

Overcoming the Liability of Foreignness 312

Where to Enter? 315

When to Enter? 318

How to Enter? 320

Debates and Extensions 326

Management Savvy 329

Contents vii

3.7 Geely’s Acquisition of Volvo 455

3.8 Hilton Welcomes Chinese Travelers at Home and Abroad 459

Part 4 Building Functional Excellence 465

Chapter 14: Competing on Marketing and Supply Chain Management 466

Three of the Four Ps in Marketing 468

From Distribution Channel to Supply Chain Management 474

The Triple As in Supply Chain Management 475

How Institutions and Resources Affect Marketing and Supply Chain Management 478

Debates and Extensions 481

Management Savvy 483

Chapter 15: Managing Human Resources Globally 492

Staffing 495

Training and Development 500

Compensation and Performance Appraisal 502

Labor Relations 505

Institutions, Resources, and Human Resource Management 506

Debates and Extensions 511

Management Savvy 513

Chapter 16: Financing and Governing the Corporation Globally 522

Financing Decisions 525

Owners 526

Managers 528

Board of Directors 532

Governance Mechanisms as a Package 534

A Global Perspective 536

Institutions, Resources, and Corporate Finance and Governance 538

Debates and Extensions 543

Management Savvy 544

Chapter 17: Managing Corporate Social Responsibility Globally 552

A Stakeholder View of the Firm 555

Institutions, Resources, and Corporate Social Responsibility 561

Debates and Extensions 568

Management Savvy 569

Part 4 Integrative Cases 582

4.1 ESET: From a “Living-Room” Firm to a Global Player in the Antivirus Software Industry 582

4.2 Dallas Versus Delhi 586

4.3 Microfinance: Macro Success or Global Mess? 587

4.4 Sino Iron: Engaging Stakeholders in Australia 589

4.5 Foxconn 595

Glossary 598

Name Index 607

Organization Index 617

Subject Index 621

viii Contents

Preface

The first two editions of Global Business aspired to set a new standard for interna- tional business (IB) textbooks. Based on the enthusiastic support from students and instructors in Australia, Brazil, Britain, Canada, China, Egypt, France, Hong Kong, India, Indonesia, Ireland, Israel, Lithuania, Malaysia, Puerto Rico, Russia, Slovenia, South Africa, South Korea, Taiwan, Thailand, and the United States, the first two editions achieved unprecedented success. A Chinese translation is now available and a European adaptation (coauthored with Klaus Meyer) has been suc- cessfully launched. In short, Global Business is global.

The third edition aspires to do even better. It continues the market-winning framework centered on one big question and two core perspectives pioneered in the first edition, and has been thoroughly updated to capture the rapidly moving research and events of the past few years. Written for undergraduate and MBA students around the world, the third edition will continue to make IB teaching and learning more (1) engaging, (2) comprehensive, (3) fun, and (4) relevant.

More Engaging As an innovation in IB textbooks, a unified framework integrates all chapters. Given the wide range of topics in IB, most textbooks present the discipline in a fashion that “Today is Tuesday, it must be Luxembourg.” Very rarely do authors address: “Why Luxembourg today?” More important, why IB? What is the big ques- tion in IB? Our unified framework suggests that the discipline can be united by one big question and two core perspectives. The big question is: What deter- mines the success and failure of firms around the globe? To address this question, Global Business introduces two core perspectives, (1) the institution-based view and (2) the resource-based view, in all chapters. It is this relentless focus on our big question and core perspectives that enables this book to engage a variety of IB topics in an integrated fashion. This provides unparalleled continuity in the learning process.

Global Business further engages readers through an evidence-based approach. I have endeavored to draw on the latest research rather than the latest fads. As an active researcher myself, I have developed the unified framework not because it just popped up in my head when I wrote the book. Rather, this is an extension of my own research that consistently takes on the big question and leverages the two core perspectives.1

1 For the big question, see M. W. Peng, 2004, Identifying the big question in international business research, Journal of International Business Studies, 35: 99–108. For the institution-based view, see M. W. Peng, S. L. Sun, B. Pinkham, & H. Chen, 2009, The institution-based view as a third leg for a strategy tripod, Academy of Management Perspectives, 23(3): 63–81; M. W. Peng, D. Wang, & Y. Jiang, 2008, An institution-based view of international business strategy: A focus on emerging economies, Journal of International Business Studies, 39: 920–936. For the resource-based view, see M. W. Peng, 2001, The resource-based view and international business, Journal of Management, 27: 803–829.

x Preface

Another vehicle to engage students is debates. Most textbooks present knowledge “as is” and ignore debates. But obviously our field has no shortage of debates. It is the responsibility of textbook authors to engage students by introducing cutting- edge debates. Thus, I have written a beefy “Debates and Extensions” section for every chapter.

Finally, this book engages students by packing rigor with accessibility. There is no “dumbing down.” No other competing IB textbook exposes students to an article on how to save Europe by the Managing Director of the International Monetary Fund (In Focus 8.1), a commentary on China’s ten years in the World Trade Organization by the US Ambassador to China (Emerging Markets 8.1), and a Harvard Business Review article on China’s outward foreign direct investment (authored by me—Emerging Markets 6.1). These are not excerpts but full-blown, original articles—the first in an IB (and, in fact, in any management) textbook. These highly readable short pieces directly give students a flavor of the original insights.

More Comprehensive Global Business offers the most comprehensive and innovative coverage of IB topics available on the market. Unique chapters not found in other IB textbooks are:

Chapter 9 on entrepreneurship and small firms’ internationalization. Chapter 11 on global competitive dynamics. Chapter 16 on corporate finance and governance. Chapter 17 on corporate social responsibility (in addition to one full-blown

chapter on ethics, cultures, and norms, Chapter 3). Half of Chapter 12 (alliances and acquisitions) deals with the inadequately

covered topic of acquisitions. Approximately 70% of market entries based on foreign direct investment (FDI) around the world use acquisitions. Yet, none of the other IB textbooks has a chapter on acquisitions—clearly, a missing gap.

The most comprehensive topical coverage is made possible by drawing on the latest and most comprehensive range of the research literature. Specifically, I have accelerated my own research, publishing a total of 30 articles since 2010 after I finished the second edition.2 I have drawn on such latest research to inject cutting- edge thinking into the third edition.

In addition, I have also endeavored to consult numerous specialty journals. For example, the trade and finance chapters (Chapters 5–7) draw on the American Eco- nomic Review, Journal of Economic Literature, and Quarterly Journal of Economics. The entrepreneurship chapter (Chapter 9) consults with the Journal of Business Venturing and Entrepreneurship Theory and Practice. The marketing and supply chain chapter (Chapter 14) draws heavily from the Journal of Marketing, Journal of International Mar- keting, and Journal of Operations Management. The corporate finance and governance chapter (Chapter 16) is visibly guided by research published in the Journal of Finance and Journal of Financial Economics.

The end result is the unparalleled, most comprehensive set of evidence-based insights on the IB market. While citing every article is not possible, I am confident

2 All my articles are listed at www.mikepeng.com and www.utdallas.edu/~mikepeng. Go to “Journal Articles.”

Preface xi

that I have left no major streams of research untouched. Feel free to check the Name Index to verify this claim.

Finally, the third edition of Global Business continues to have a global set of cases contributed by scholars around the world—an innovation on the IB market. Virtually all other IB textbooks have cases written by book authors. In comparison, this book has been blessed by a global community of case contributors who are based in Austria, Brazil, China, France, Germany, Hong Kong, India, and the United States. Many are experts who are located in, or are from, the countries in which the cases take place. For example, we now have a Brazil case penned by a Brazil-based author (see the Integrative Case on Jobek do Brasil), and two China cases written by China-based authors (see the Integrative Cases on Geely’s acquisition of Volvo and Sino Iron in Australia). This edition also features a Russia case contributed by the world’s top two leading experts on Russian management (see the Integrative Case on Wikimart). The end result is an unparalleled, diverse collection of case materials that will significantly enhance IB teaching and learning around the world.

More Fun If you fear that this book must be very boring because it draws so heavily on cur- rent research, you are wrong. I have used a clear, engaging, conversational style to tell the “story.” Relative to rival books, my chapters are generally more lively and shorter. Some reviewers have commented that reading Global Business is like read- ing a “good magazine.” A large number of interesting anecdotes have been woven into the text. In addition to examples from the business world, non-traditional (“outside-the-box”) examples range from ancient Chinese military writings to mu- tually assured destruction (MAD) strategy during the Cold War, from Shakespeare’s The Merchant of Venice to Tolstoy’s Anna Karenina. Popular movies such as A Few Good Men, Devil’s Advocate, and Legally Blonde are also featured. In addition, numerous Opening Cases, Closing Cases, and In Focus boxes spice up the book. Check out the following fun-filled features:

Partying in Saudi Arabia (Chapter 3 Opening Case) Adding value to the dirtiest job online (In Focus 4.2) Why are US exports so competitive? (Chapter 5 Opening Case) A sticky business in Singapore (In Focus 5.1) Cry for me, Argentina (Chapter 6 Closing Case) The Greek tragedy (Chapter 8 Closing Case) The world’s best place to make Viagra (In Focus 10.1) A fox in the hen house (In Focus 11.2) Brazil’s Whopper deal (Emerging Markets 12.2) Mickey goes to Shanghai (Chapter 13 Opening Case) Wolf wars (Chapter 17 Closing Case) Milton Friedman goes global (Emerging Markets 17.1)

There is one Video Case from BBC News to support every chapter. While vir- tually all competing books have some videos, none has a video package that is so integrated with the learning objectives of every chapter.

Finally, as a new feature introduced since the second edition, PengAtlas allows you to conduct IB research using informative maps and other geographic and cultural literacy tools to enhance your learning.

xii Preface

More Relevant So what? Chapters in most textbooks leave students to figure out the crucial “So what?” question for themselves. In contrast, I conclude every chapter with an action-packed section titled “Management Savvy.” Each section has at least one table (or one teachable slide) that clearly summarizes the key learning points from a practical standpoint. No other competing IB book is so savvy and so relevant.

Further, ethics is a theme that cuts through the book, with at least one “Ethical Dilemma” feature and a series of Critical Discussion Questions on ethics in each chapter. Finally, many chapters offer career advice for students. For example:

Chapter 1 In Focus 1.3 directly addresses a question many students would ask: What language and what fields should I study?

Chapter 4 develops a resource-based view of the individual—that is, about you, the student. The upshot? You want to make yourself into an “untouch- able” who adds valuable, rare, and hard-to-imitate capabilities indispensable to an organization. In other words, you want to make sure your job cannot be outsourced.

Chapter 15 offers tips on how to strategically and proactively invest in your career now—as a student—for future international career opportunities.

What’s New in the Third Edition? Most importantly, the third edition has (1) highlighted the executive voice by draw- ing more heavily from CEOs and other business leaders, (2) dedicated more space to emerging economies, and (3) enhanced the quantity and variety of cases.

First, since Global Business aims to train a new generation of global business lead- ers, the third edition has featured more extensive quotes and perspectives from global business leaders. These are longer and more visibly prominent break-out quotes—not merely single quotes typically embedded (or “buried”) in paragraphs. In Chapter 1 alone, you will enjoy such insightful quotes from (1) GE’s current chairman and CEO and (2) GE’s former chairman and CEO. In later chapters, the following global business leaders will share their thoughts with you:

Applied Materials’ human resource executive Argentina’s president Bayer North America’s CEO Dow Chemical’s CEO IBM’s CEO IBM’s chief procurement officer IMF’s managing director—a full article TNK-BP’s chairman and CEO and Alfa Group’s founder US Ambassador to China—a full article US Secretary of Justice (representing the Department of Justice’s challenge of AT&T’s proposed merger with T- Mobile) US Secretary of Treasury (on the US-China Strategic and Economic Dialogue) Whole Foods’ co-founder and CEO WTO’s director-general

Second, this edition builds on Global Business’s previous strengths by more prom- inently highlighting global business challenges in and out of emerging economies. This is both a reflection of the global realities in which emerging economies have

Preface xiii

played a more prominent role and a reflection of my own strong research interest in emerging economies. Specifically, in the third edition, (1) a new Emerging Markets in- chapter feature is launched in every chapter, and (2) 18 out of 23 (78%) of the longer Integrative Cases deal with emerging economies (including one case on Central and Eastern Europe, two cases each on Africa, Brazil, Russia, and India, and six on China).

Third, in response to students’ and professors’ enthusiasm about the wide- ranging and globally relevant cases in previous editions, the third edition has fur- ther enhanced the quantity and variety of cases. The number of Integrative Cases has increased from 15 to 23—a 53% increase. The variety has also been enhanced not only in terms of the geographic diversity noted above, but also in terms of the mix of longer cases and shorter cases. In addition, I have pushed myself to partici- pate more actively in case writing. Therefore, I am very proud to report that of the 23 Integrative Cases in the third edition, I personally wrote 10 (43%). This com- pares very favorably to the one Integrative Case out of a total of 15 that I personally authored in the second edition (representing a mere 7%).

Of course, in addition to these new features, every chapter has been thoroughly updated. Of the 23 Integrative Cases, 19 (83%) are new to this edition. PengAtlas maps have also been updated to capture the latest statistics.

The new BBC News Video Cases provide current, real-world examples of key course topics. The set covers such diverse countries as Brazil, China, Cuba, Dubai, India, Thailand, and Uruguay, and features a broad array of industries from high- tech manufacturing to goat farming.

Support Materials A full set of supplements is available for students and adopting instructors, all de- signed to facilitate ease of learning, teaching, and testing.

Global Business CourseMate. Cengage Learning’s Global Business CourseMate brings course concepts to life with interactive learning, study, and exam prepara- tion tools that support the printed textbook. Through this website, available for an additional fee, students will have access to their own set of PowerPoint® slides, flashcards, and games, as well as the Learning Objectives and Glossary for quick reviews. A set of auto-gradable, interactive quizzes (prepared by Timothy R. Muth of Florida Institute of Technology) will allow students to instantly gauge their comprehension of the material. The quizzes are all tagged to the book’s Learn- ing Objectives, Bloom’s taxonomy, and national standards. Finally, Global Business CourseMate includes interactive maps that delve more deeply into key concepts presented in the book.

Product Support Website. The flashcards, Learning Objectives, and Glossary are available for quick reference on our complimentary student product support website.

Webtutor on BlackBoard® and Webtutor on WebCT.™ Available on two differ- ent platforms, Global Business Webtutor enhances students’ understanding of the material by featuring the Opening Cases and Video Cases, as well as the Glossary, study flashcards, and interactive maps that delve more deeply into key concepts presented in the book.

CengageNOW™ Course Management System. Designed by instructors for instructors, CengageNOW™ mirrors the natural teaching workflow with an

xiv Preface

easy-to-use online suite of services and resources, all in one program. With this system, instructors can easily plan their courses, manage student assignments, automatically grade, teach with dynamic technology, and assess student progress with pre- and post-tests tagged to course outcomes and national standards. For students, study tools include flashcards, PowerPoint® slides, media quizzes, guided cases, and a set of quizzes based on interactive maps that enhance comprehen- sion of the material and develop cultural and geographic literacy. Diagnostic tools create a personalized study plan for each student that focuses their study efforts. CengageNOW™ operates seamlessly with WebCT™, Blackboard®, and other course management tools.

Global Economic Watch. Cengage Learning’s Global Economic Watch helps instructors bring these pivotal current events into the classroom through a powerful, continuously updated online suite of content, discussion forums, testing tools, and more. The Watch, a first-of-its-kind resource, stimulates discussion and understanding of the global downturn with easily integrated teaching solutions:

A thorough overview and timeline of events leading up to the global economic crisis are included in the ebook module, Impact of the Global Economic Crisis on Small Business

A content-rich blog of breaking news, expert analysis, and commentary— updated multiple times daily—plus links to many other blogs

A powerful real-time database of hundreds of relevant and vetted journal, newspaper, and periodical articles, videos, and podcasts—updated four times every day

Discussion and testing content, PowerPoint® slides on key topics, sample syllabi, and other teaching resources

History is happening now, so bring it into the classroom with The Watch at www.cengage.com/thewatch.

Instructor’s Resource CD (IRCD). Instructors will find all of the teaching resources they need to plan, teach, grade, and assess student understanding and progress at their fingertips with this all-in-one resource for Global Business. The IRCD contains:

Instructor’s Manual—This valuable, time-saving Instructor’s Manual in- cludes comprehensive resources to streamline course preparation, including teaching suggestions, lecture notes, answers to all chapter questions, and Integrative Case discussion guides. Also included are discussion guidelines and answers for the Video Cases, prepared by Carol Decker.

Test Bank—The Global Business Test Bank in ExamView® software allows instructors to create customized texts by choosing from 35 True/False, 35 Multiple Choice, and at least 8 short answer/essay questions for each of the 17 chapters. Ranging in difficulty, all questions have been tagged to the text’s Learning Objectives, Bloom’s taxonomy, and other national standards to ensure that students are meeting the course criteria.

PowerPoint® Slides—This comprehensive set of more than 250 Powerpoint® slides will assist instructors in the presentation of the chapter material, en- abling students to synthesize key global concepts.

Global Business DVD. Perhaps one of the most exciting and compelling bonus features of this program, these 17 short and powerful video clips, produced by BBC

Preface xv

News, provide current and relevant real-world examples. The set covers such di- verse countries as Brazil, China, Cuba, Dubai, India, Thailand, and Uruguay, and features a broad array of industries from high-tech manufacturing to goat farming.

Instructor Product Support Website. For those instructors who prefer to access supplements online, the Instructor’s Manual, PowerPoint® slides, and Test Bank are also available through the instructor’s product support website.

Acknowledgments As Global Business launches its third edition, I first want to thank all the customers— professors, instructors, and students around the world who have made the book’s success possible. A special thank-you goes to my friend and colleague, Klaus Meyer (China Europe International Business School), who spearheaded the develop- ment of International Business, which was tailored for European (or, more broadly, European, Middle Eastern, and African [EMEA]) students. Klaus has made Global Business more global.

At UT Dallas, I thank my colleagues Dan Bochsler, Larry Chasteen, Tev Dalgic, Van Dam, Greg Dess, Dave Ford, Richard Harrison, Maria Hasenhuttl, Charlie Hazzard, Marilyn Kaplan, Seung-Hyun Lee, Elizabeth Lim, John Lin, Livia Markóczy, Joe Picken, Roberto Ragozzino, Orlando Richard, Jane Salk, Mary Vice, Eric Tsang, and Habte Woldu, as well as the supportive leadership team—Hasan Pirkul (dean), Varghese Jacob (associate dean), and Greg Dess (area coordinator). I also thank my two PhD students, Brian Pinkham (now at Texas Christian University) and Steve Sauerwald, for their research assistance. Three PhD students (Canan Mutlu, Brian Pinkham, and Weichieh Su) and five MBA students (Simon Ebenezer, Matthew Lafever, Katie Metzler, Katie Ryan, and Chris Spartz) authored excellent case materials.

At South-Western Cengage Learning, I thank the “Peng team:” Erin Joyner, Publisher; Michele Rhoades, Senior Acquisitions Editor; Jennifer King, Developmen- tal Editor; Emily Nesheim and Tamborah Moore, Senior Content Project Managers; Jonathan Monahan, Marketing Manager; Stacy Shirley, Senior Art Director; and Tamara Grega, Editorial Assistant.

In the academic community, I thank Ben Kedia (University of Memphis) for inviting me to conduct faculty training workshops in Memphis every year since 1999, and Michael Pustay (Texas A&M University) for co-teaching these workshops with me—widely known as the “M&M Show” in the IB field. Discussions with over 200 colleagues who came to these faculty workshops over the last decade have helped shape this book into a better product. I also appreciate the meticulous and excellent comments from the reviewers:

Nadeem M. Firoz (Montclair State University) Andrew Fleck (Fox Valley Technical College) Anna Helm (George Washington University) P. Michael McLain (Hampton University) Mark Quinn (Xavier University of Louisiana) Al Saber (Friends University) Sudhir Sachdev (Farmingdale State College)

Continued thanks to the reviewers of the previous editions:

Syed Ahmed (Cameron University) Richard Ajayi (University of Central Florida, Orlando)

xvi Preface

Basil Al-Hashimi (Mesa Community College) Verl Anderson (Dixie State College of Utah) Peter L. Banfe (Ohio Northern University) Lawrence A. Beer (Arizona State University) Tefvik Dalgic (University of Texas at Dallas) Tim R. Davis (Cleveland State University) George DeFeis (Monroe College, Bronx) Ping Deng (Maryville University) Norb Elbert (Eastern Kentucky University) Joe Horton (University of Central Arkansas) Samira Hussein (Johnson County Community College) Ann L. Langlois (Palm Beach Atlantic University) Lianlian Lin (California State Polytechnic University, Pomona, California) Ted London (University of Michigan) Martin Meznar (Arizona State University, West) Dilip Mirchandani (Rowan University) Timothy R. Muth (Florida Institute of Technology) Don A. Okhomina (Fayetteville State University) William Piper (Alcorn State University) Charles A. Rarick (Barry University) Tom Roehl (Western Washington University) Bala Subramanian (Morgan State University) Gladys Torres-Baumgarten (Kean University) Susan Trussler (University of Scranton) William R. Wilkerson (University of Virginia) Attila Yaprak (Wayne State University)

In addition, I thank many colleagues who provided informal feedback to me on the book. Space constraints here force me to only acknowledge colleagues who wrote me since the second edition, since colleagues who wrote me earlier were thanked in earlier editions.

Paul Beamish (University of Western Ontario, Canada) Santanu Borah (University of North Alabama, USA) Thierry Brusselle (Chaffey Community College, USA) Lauren Carey (University of Miami, USA) Ping Deng (Maryville University, USA) Todd Fitzgerald (Saint Joseph’s University, USA) Dennis Garvis (Washington and Lee University, USA) John Gerace (Chestnut Hill College, USA) Mike Geringer (Ohio University, USA) C. Gopinath (Suffolk University, USA) Charlie Hazzard (University of Texas at Dallas, USA) Chad Hilton (University of Alabama, USA) Anisul Islam (University of Houston, USA) Basil Janavaras (Minnesota State University, USA) Marshall Shibing Jiang (Brock University, Canada) Somnath Lahiri (Illinois State University, USA) Ann Langlois (Palm Beach Atlantic University, USA) Lianlian Lin (California State Polytechnic University, USA) Dong Liu (Georgia Institute of Technology, USA)

Preface xvii

David Liu (George Fox University, USA) Ted London (University of Michigan, USA) Charles Mambula (Langston University, USA) Daniel McCarthy (Northeastern University, USA) Hemant Merchant (Florida Atlantic University, USA) Debmalya Mukherjee (University of Akron, USA) Asmat Nizam (Universiti Utara, Malaysia) Kenny Oh (University of Missouri at St. Louis, USA) Eydis Olsen (Drexel University, USA) Sheila Puffer (Northeastern University, USA) Gongming Qian (Chinese University of Hong Kong, China) David Reid (Seattle University, USA) Surekha Rao (Indiana University Northwest, USA) Al Rosenbloom (Dominican University, USA) Anne Smith (University of Tennessee, USA) Clyde Stoltenberg (Wichita State University, USA) Steve Strombeck (Azusa Pacific University, USA) Sunny Li Sun (University of Missouri at Kansas City, USA) Qingjiu (Tom) Tao (James Madison University, USA) Vas Taras (University of North Carolina at Greensboro, USA) Rajaram Veliyath (Kennesaw State University, USA) Jose Vargas-Hernandez (Universidad de Guadalajara, Mexico) Loren Vickery (Western Oregon University, USA) George White (Old Dominion University, USA) Habte Woldu (University of Texas at Dallas, USA) Richard Young (Minnesota State University, USA) Wu Zhan (University of Sydney, Australia)

I also want to thank three very special colleagues: Liu Yi (Shanghai Jiaotong University), Xie En, and Wang Longwei (Xi’an Jiaotong University) in China. They loved the book so much that they were willing to endure the pain of translating it into Chinese. Their hard work has enabled Global Business to reach wider audiences globally. For the third edition, 28 colleagues graciously contributed cases:

Christoph Barmeyer (Passau University, Germany) Dirk Michael Boehe (Insper Institute of Education and Research, Brazil) Charles Byles (Virginia Commonwealth University, USA) Peggy Chaudhry (Villanova University, USA) Jessica Chelekis (University of Southern Denmark, Denmark) Yuan Yi Chen (Hong Kong Baptist University, China) Zhu Chen (PFC Energy, Beijing, China) Simon Ebenezer (University of Texas at Dallas, USA) Juan España (National University, USA) Steven Globerman (Western Washington University, USA) Matthew Lafever (University of Texas at Dallas, USA) Ulrike Mayrhoder (University Lyon 3, France) Daniel McCarthy (Northeastern University, USA) Katie Metzler (University of Texas at Dallas, USA) Klaus Meyer (China Europe International Business School, China) Susan Mudambi (Temple University, USA) Canan Mutlu (University of Texas at Dallas, USA)

xviii Preface

Brian Pinkham (Texas Christian University, USA) Sheila Puffer (Northeastern University, USA) Katie Ryan (University of Texas at Dallas, USA) Arnold Schuh (Vienna University of Economics and Business, Austria) Chris Spartz (University of Texas at Dallas, USA) Charles Stevens (University of Wyoming, USA) Weichieh Su (University of Texas at Dallas, USA) Sunny Li Sun (University of Missouri at Kansas City, USA) Michael Young (Hong Kong Baptist University, China) Yanli Zhang (Montclair State University, USA) Alan Zimmerman (City University of New York, USA)

In addition, the work of the following prominent authors was reprinted to grace the pages of this book:

Rohit Deshpande (Harvard Business School) and Anjali Raina (HBS India Research Center, India)—coauthor of “The Ordinary Heroes of the Taj” Mikhail Fridman (TNK-BP and Alfa Group, Russia)—chairman and CEO of TNK-BP and founder of Alfa Group Vijay Govindarajan and Chris Trimble (Dartmouth College)—coauthor of Reverse Innovation Christine Lagarde (International Monetary Fund)—Managing Director of the IMF Gary Locke (US Embassy, Beijing, China)—US Ambassador to China Michael Porter (Harvard Business School) and Mark Kramer (FSG)—coauthor of “Creating Shared Value” Jack Welch and Suzy Welch (BusinessWeek)—Jack is the retired chairman and CEO of GE and Suzy is a former editor of Harvard Business Review

Last, but by no means least, I thank my wife Agnes, my daughter Grace, and my son James—to whom this book is dedicated. I have named Agnes CEO, CFO, CIO, CTO, and CPO for our family, the last of which is coined by me, which stands for “chief parenting officer.” When the first edition was conceived, Grace was three, and James one. When the second edition came out, Grace declared a career inter- est in being a rock star, and James a race car driver. Now my ten-year-old Grace, already a voracious reader and writer, can help me edit, and my eight-year-old James can help me enter grades. Grace is writing and editing her 17th short story, called My Magic Life, and James is very interested in creating Lego models. For now, Grace wants to be a lawyer, and James a banker. As a third-generation professor in my family, I can’t help but wonder whether one (or both) of them will become a fourth-generation professor. To all of you, my thanks and my love.

MWP

December 1, 2012

About the Author

Mike W. Peng is the Jindal Chair of Global Business Strategy at the Jindal School of Management, University of Texas at Dallas, a National Science Foundation CAREER Award winner, and a Fellow of the Academy of International Business. He is also Executive Director of the Center for Global Business, which he founded. At UT Dallas, he has been the number-one contributor to the 45 top journals tracked by Financial Times, which has ranked UT Dallas as a top-20 school in research world- wide and its MBA and EMBA programs increasingly in the top tier.

Professor Peng holds a bachelor’s degree from Winona State University, Minnesota, and a PhD degree from the University of Washington, Seattle. Between 2005 and 2011, he was the first Provost’s Distinguished Professor at UT Dallas, a chair position that was created to attract him to join the faculty. He had previously been an associate professor (with tenure) at the Ohio State University. Prior to that, he had served on the faculty at the Chinese University of Hong Kong and the University of Hawaii. He has taught in five states in the United States (Hawaii, Ohio, Tennessee, Texas, and Washington) as well as China, Hong Kong, and Vietnam. He has also held visiting or courtesy appointments in Australia, Britain, China, Denmark, Hong Kong, and the United States. In addition to these countries, he has presented papers in Austria, Brazil, France, Germany, Japan, Macau, Puerto Rico, Singapore, South Korea, Switzerland, and Taiwan.

Professor Peng is one of the most prolific and most influential scholars in inter- national business (IB). During the decade 1996–2006, he was the top-seven con- tributor to IB’s number-one premier outlet: Journal of International Business Studies. His research is also among some of the most widely cited—both the United Nations and the World Bank have cited his work. A Journal of Management article found him to be among the top 65 most widely cited management scholars, and an Academy of Management Perspectives study found him to be the fourth most influential manage- ment scholar both inside and outside of academia (measured by academic citations and non-edu Google webpages) among professors who obtained their PhD since 1991. Overall, Professor Peng has published over 100 articles in leading journals, over 30 pieces in non-refereed outlets, and five books. Since the launch of Global Business’s second edition, he has published not only in top IB journals, such as the Academy of Management Journal, Journal of International Business Studies, Journal of World Business, and Strategic Management Journal, but also in leading outlets in op- erations ( Journal of Operations Management), entrepreneurship ( Journal of Business Venturing and Entrepreneurship Theory and Practice), and human resources (Interna- tional Journal of Human Resource Management).

Professor Peng’s market leading textbooks, Global Business, Global Strategy, and GLOBAL, are studied in over 30 countries and have been translated into Chinese, Spanish, and Portuguese. A European adaptation, International Business (with Klaus Meyer), has been successfully launched.

Professor Peng is active in leadership positions. He has served on the edito- rial boards of AMJ, AMR, JIBS, JMS, JWB, and SMJ, and guest-edited a special

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issue for the JMS. At the Academy of International Business (AIB), he co-chaired the AIB/JIBS Frontiers Conference in San Diego (2006), guest-edited a JIBS special issue (2010), chaired the Emerging and Transition Economies track for the Nagoya conference (2011), and chaired the Richard Farmer Best Disserta- tion Award Committee for the Washington conference (2012). In 2012, he was elected to be a Fellow of the AIB, joining a distinguished group of about 80 senior scholars who made most significant contributions to IB. At the Strategic Manage- ment Society (SMS), he was elected to chair the Global Strategy Interest Group. He also co-chaired the SMS Special Conference on China in Shanghai (2007). He served one term as Editor-in-Chief of the Asia Pacific Journal of Management. During his editorial tenure, he managed the doubling of submission numbers and the successful bid to enter the Social Sciences Citation Index (SSCI), which reported APJM’s first citation impact to be 3.36 and rated it as the top 18 among 140 management journals for 2010.

Professor Peng is also an active consultant, trainer, and keynote speaker. He has provided on-the-job training to over 300 professors. He has consulted and been a keynote speaker for multinational enterprises (such as AstraZeneca, Berlitz, KOSTA, Nationwide, SAFRAN, and Texas Instruments), non-profit organiza- tions (such as Greater Dallas Asian American Chamber of Commerce and World Affairs Council of Dallas-Fort Worth), educational and funding organizations (such as Harvard University Kennedy School of Government, Hong Kong Research Grants Council, National Science Foundation of the United States, Social Sciences and Humanities Research Council of Canada, and the University of Memphis), and national and international organizations (such as the US-China Business Council, US Navy, and World Bank).

Professor Peng has attracted close to $1 million in external funding. His hon- ors include a National Science Foundation CAREER Grant, a US Small Business Administration Best Paper Award, a (lifetime) Distinguished Scholar Award from the Southwestern Academy of Management, and a (lifetime) Scholarly Contribu- tion Award from the International Association for Chinese Management Research. He has been quoted in The Economist, Newsweek, Dallas Morning News, Smart Business Dallas, Atlanta Journal-Constitution, The Exporter Magazine, The World Journal, Business Times (Singapore), Sing Tao Daily (Vancouver), and Brasil Econômico (São Paulo), and on the Voice of America.

Laying Foundations

Chapters 1 Globalizing Business

2 Understanding Formal Institutions: Politics, Laws, and Economics

3 Emphasizing Informal Institutions: Cultures, Ethics, and Norms

4 Leveraging Resources and Capabilities

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Learning Objectives

After studying this chapter, you should be able to

1-1 explain the concepts of international business and global business, with a focus on emerging economies.

1-2 give three reasons why it is important to study global business.

1-3 articulate one fundamental question and two core perspectives in the study of global business.

1-4 identify three ways of understanding what globalization is.

1-5 state the size of the global economy and its broad trends and understand your likely bias in the globalization debate.

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Globalizing Business

In 1994, when Mahindra & Mahindra (M&M) arrived in the United States, it was already a powerhouse in its native India. The company, founded as a steelmaker in 1945, had entered the agriculture market nearly 20 years later, partnering with International Harvester to manufacture a line of sturdy 35-horsepower tractors under the Mahindra name.

The Mahindra tractors became very popular in India. They were affordably priced and fuel efficient, two qualities highly valued by thrifty Indian farmers, and the machines were sized appropriately for small Indian farms. Over the years, M&M continued to in- novate to perfect its offerings, and its tractors prolif- erated throughout India’s vast agricultural regions. The Mahindra brand became well established and respected. By the mid-1990s, the company was one of India’s top tractor manufacturers—and it was ready for new challenges. The lucrative US market beckoned.

When Mahindra USA (MUSA) opened for busi- ness, Deere & Company—famous for its John Deere brand—was the dominant player. Deere’s bread and butter were enormous machines ranging as high as 600 horsepower for industrial-scale agribusiness. Rather than trying to develop a product that could com- pete head-on with Deere, M&M aimed for a smaller agricultural niche, one in which it could grow and make the most of its strengths.

Mahindra figured its little tractor would be perfect for hobby farmers, landscapers, and building contractors. The machine was sturdy, extremely reliable, and priced to sell. With a few modifications for the US market—such as supersized seats and larger brake pedals to accommo- date larger American bodies—Mahindra was good to go.

But the company was far from home and hardly a household name. The few Americans who had heard of the brand thought of it variously as “red,” “foreign,” or “cheap.” Even domestic competitors were barely aware of the newcomer. Deere gave more of its atten- tion to Case and New Holland than to Mahindra. Fly- ing below the radar, MUSA decided to make its mark through personalized service.

MUSA built close relationships with small dealer- ships, particular family-run operations. Rather than saddle dealers with expensive inventory, MUSA allowed them to run on a just-in-time basis, offering to deliver a tractor within 24 to 48 hours of receiving the order. MUSA also facilitated financing. In return, Mahindra benefited from the trust the dealers enjoyed in their communities.

MUSA also built close relationships with custom- ers. Some 10% to 15% of M&M tractor buyers got phone calls from the company’s president, who asked whether they were pleased with the buying experience and their new tractors. The company also offered special incentives—horticultural scholarships,

O p e n i n g C a s e

EmErging markEts: Mahindra & Mahindra versus John Deere

4 Part One Laying Foundations

for example—to neglected market segments such as female hobby farmers.

This high-touch strategy paid off handsomely. MUSA’s US sales growth averaged 40% per year from 1999 to 2006. This prompted David C. Everitt, president of Deere’s agricultural division, to remark that Mahindra “could someday pass Deere in global unit sales.”

Deere responded with short-lived—and seemingly desperate—cash incentives to induce Mahindra buy- ers to trade for a Deere. This had the unintended effect of promoting M&M’s brand (“And we didn’t even pay for it,” said Anjou Choudhari, CEO of M&M’s farm equipment sector from 2005 to 2010). Mahindra fired back with an ad featuring the headline: “Deere John, I have found someone new.”

As Mahindra enjoyed growing success in America, Deere struggled to gain a foothold in India. Unlike

Mahindra, which had innovated both its product and its processes for the US market, Deere tried to tempt Indian farmers with the same product that had under- written its success at home. The strategy did not work, and Deere was forced to re-engineer its thinking as well as its product.

“We gave a wake-up call to John Deere,” noted Choudhari. “Our global threat was one of the motiva- tions for Deere to design a low-horsepower tractor—in India and for India.”

In the meantime, M&M has become the number- one tractor maker worldwide, as measured by units sold.

Source: This case was written by Professors Vijay Govindarajan and Chris Trimble (both at the Tuck School of Business, Dartmouth College). It was an excerpt from V. Govindarajan & C. Trimble, 2012, Reverse Innova- tion (pp. 10–11), Boston: Harvard Business Review Press.

How do firms such as Mahindra & Mahindra and Deere compete in India, the United States, and elsewhere? What determines the success and failure of these firms—and numerous others—around the world? This book will address these and other impor- tant questions on global business.

1-1 What Is Global Business? 1-1a Defining International Business and Global Business Traditionally, international business (IB) is defined as a business (or firm) that en- gages in international (cross-border) economic activities. It can also refer to the action of doing business abroad. The previous generation of IB textbooks almost always takes the foreign entrant’s perspective. Consequently, such books deal with issues such as how to enter foreign markets and how to select alliance partners. The most frequently discussed foreign entrant is the multinational enterprise (MNE), de- fined as a firm that engages in foreign direct investment (FDI) by directly investing in, controlling, and managing value-added activities in other countries.1 Using our Opening Case, traditional IB textbooks would focus on how MNEs such as Deere enter India by undertaking FDI there. MNEs and their cross-border activities are, of course, important, but they only cover one side of IB—the foreign side. Students educated by these books often come away with the impression that the other side of IB—namely, domestic firms—does not exist. Of course, that is not true. Do- mestic firms such as Mahindra & Mahindra do not just sit around in the face of foreign entrants. Domestic firms actively compete and/or collaborate with foreign entrants such as International Harvester. Sometimes strong domestic firms such as Mahindra & Mahindra have also gone overseas themselves. Overall, focusing on the foreign entrant side captures only one side of the coin at best.2

There are two key words in IB: international (I) and business (B).3 However, many previous textbooks focus on the international aspect (the foreign entrant) to such an extent that the business part (which also includes domestic business) almost

Learning Objective Explain the concepts of international business and global business, with a focus on emerging economies.

1-1

International business (IB)

(1) A business (or firm) that engages in international (cross- border) economic activities and/ or (2) the action of doing busi- ness abroad.

Multinational enterprise (MNE)

A firm that engages in foreign direct investment (FDI).

Foreign direct investment (FDI)

Investment in, controlling, and managing value-added activities in other countries.

Chapter 1 Globalizing Business 5

disappears. This is unfortunate, because IB is fundamentally about B in addition to being I. To put it differently, the IB course in the undergraduate and MBA curri- cula at numerous business schools is probably the only one with the word “business” in its title. All other courses you take are labeled management, marketing, finance, and so on, representing one functional area but not the overall picture of business. Does it matter? Of course! It means that your IB course is an integrative course that has the potential to provide you with an overall business perspective (rather than a functional view) grounded in a global environment. Consequently, it makes sense that your textbook should give you both the I and B parts, not just the I part.

To cover both the I and the B parts, global business is defined in this book as business around the globe—thus, the title of this book is Global Business (not IB). In other words, global business includes both (1) international (cross-border) busi- ness activities covered by traditional IB books and (2) domestic business activities. Such deliberate blurring of the traditional boundaries separating international and domestic business is increasingly important today, because many previously national (domestic) markets are now globalized.

Consider the competition in college textbooks, such as this Global Business book you are studying now. Not long ago, competition among college business textbook publishers was primarily on a nation-by-nation basis. The Big Three—South-Western Cengage Learning (our publisher, which is the biggest in the college business textbook market), Prentice Hall, and McGraw-Hill—primarily competed in the United States. A different set of publishers competed in other countries. As a result, most textbooks studied by British students would be authored by British professors and published by British publishers, most textbooks studied by Brazilian students would be authored by Brazilian professors and published by Brazilian publishers, and so on. Now South- Western Cengage Learning (under British and Canadian ownership), Pearson Pren- tice Hall (under British ownership), and McGraw-Hill (still under US ownership) have significantly globalized their competition, thanks to the rising demand for high- quality business textbooks in English. Around the globe, they are competing against each other in many markets, publishing in multiple languages and versions. For in- stance, Global Business and its sister books, Global Strategy, GLOBAL (paperback), and International Business (an adaptation for the European market), are published by dif- ferent subsidiaries in Chinese, Spanish, and Portuguese in addition to English, reach- ing customers in over 30 countries. Despite such worldwide spread of competition, in each market—down to each school—textbook publishers have to compete locally. In other words, no professor teaches globally, and all students study locally. This means that Global Business has to win adoption from every class, every semester. Overall, it becomes difficult to tell in this competition what is international and what is domestic. Thus, “global” seems to be a better word to capture the essence of this competition.

1-1b Global Business and Emerging Economies Global Business also differs from other books on IB because most focus on competi- tion in developed economies. Here, by contrast, we devote extensive space to com- petitive battles waged throughout emerging economies, a term that has gradually replaced the term “developing countries” since the 1990s. Another commonly used term is emerging markets (see PengAtlas Map 1.1). How important are emerging economies? Collectively, they now contribute approximately 45% of the global gross domestic product (GDP), as shown in Figure 1.1. Note that this percentage is adjusted for purchasing power parity (PPP), which is an adjustment to reflect the dif- ferences in cost of living (see In Focus 1.1). Using official (nominal) exchange rates

Global business

Business around the globe.

Emerging economies

A term that has gradually re- placed the term “developing countries” since the 1990s.

Emerging markets

A term that is often used in- terchangeably with “emerging economies.”

Gross domestic product (GDP)

The sum of value added by resident firms, households, and governments operating in an economy.

Purchasing power parity (PPP)

A conversion that determines the equivalent amount of goods and services that different currencies can purchase.

6 Part One Laying Foundations

Figure 1.1 The Contributions of Emerging Economies Relative to Developed Economies (World %)

80 90 10060 7050403020100

Developed economies

FDI outflows

GDP (nominal exchange rates)

Exports of goods and services

FDI inflows

GDP (purchasing power parity)

Population

BRIC Emerging economies excluding BRIC

Sources: Data extracted from (1) United Nations, 2011, World Investment Report 2011, New York and Geneva: UN; (2) World Bank, 2012, World Development Indicators database, Washington: World Bank. All data refer to 2011.

GDP, GNP, GNI, PPP—there is a bewildering variety of acronyms that are used to measure economic develop- ment. It is useful to set these terms straight before pro- ceeding. Gross domestic product (GDP) is measured as the sum of value added by resident firms, households, and governments operating in an economy. For exam- ple, the value added by foreign-owned firms operating in Mexico would be counted as part of Mexico’s GDP. However, the earnings of non-resident sources that are sent back to Mexico (such as earnings of Mexicans who do not live and work in Mexico and dividends received by Mexicans who own non-Mexican stocks) are not in- cluded in Mexico’s GDP. One measure that captures this is gross national product (GNP). More recently, the World Bank and other international organizations have used a new term, gross national income (GNI), to supersede GNP. Conceptually, there is no difference between GNI and GNP. What exactly is GNI/GNP? It comprises GDP plus income from non-resident sources abroad.

While GDP, GNP, and now GNI are often used as yardsticks of economic development, differences in cost of living make such a direct comparison less mean- ingful. A dollar of spending in, say, Thailand can buy a lot more than in Japan. Therefore, conversion based on purchasing power parity (PPP) is often necessary.

The PPP between two countries is the rate at which the currency of one country needs to be converted into that of a second country to ensure that a given amount of the first country’s currency will purchase the same volume of goods and services in the second country (see Chapter 7 for details). According to the In- ternational Monetary Fund (IMF), the Swiss per capita GDP is $81,161 based on official (nominal) exchange rates—higher than the US per capita GDP of $48,387. However, everything is more expensive in Switzerland. A Big Mac costs $6.81 in Switzerland versus $4.20 in the United States. Thus, Switzerland’s per capita GDP based on PPP becomes $43,370—lower than the US per capita GDP based on PPP, $48,387 (the IMF uses the United States as benchmark in PPP calculation). On a worldwide basis, measured at official exchange rates, emerging economies’ share of global GDP is approxi- mately 26%. However, measured at PPP, it is about 43% of the global GDP. Overall, when you read statis- tics about GDP, GNP, and GNI, always pay attention to whether these numbers are based on official exchange rates or PPP, which can make a huge difference.

Sources: Based on (1) Economist, 2012, Big Mac index, January 14: 93; (2) Economist, 2006, Grossly distorted picture, February 11: 72; (3) International Monetary Fund, 2012, World Economic Outlook, April, Washington, DC: IMF.

Setting the Terms Straight IN Focus 1.1

Gross national product (GNP)

GDP plus income from non- resident sources abroad.

Gross national income (GNI)

GDP plus income from non- resident sources abroad. GNI is the term used by the World Bank and other international organizations to supersede the term GNP.

Chapter 1 Globalizing Business 7

without adjusting for PPP, emerging economies contribute about 26% of the global GDP. Why is there such a huge difference between the two measures? Because the cost of living (such as housing and haircuts) in emerging economies tends to be lower than that in developed economies. For instance, one dollar spent in Mexico can buy a lot more than one dollar spent in the United States.

Table 1.1 lists the 33 countries that are classified as “developed economies.” The rest of the world (more than 150 countries) can be broadly labeled as “emerging economies.” Of these emerging economies, Brazil, Russia, India, and China—commonly referred to as BRIC—command more attention. As a group, they generate 17% of world exports, absorb 16% of FDI inflows, and contribute 28% of world GDP (on a PPP basis). Commanding a lion’s share, BRIC contrib- ute 62% of the GDP of all emerging economies (on a PPP basis). BRIC also generate 8% of world FDI outflows. MNEs from BRIC (such as Mahindra & Mahindra in the Opening Case) are increasingly visible in making investments and acquiring firms around the world.4 Clearly, major emerging economies (es- pecially BRIC) and their firms have become a force to be reckoned with in global business.5 In addition to BRIC, other interesting terms include BRICS (BRIC + South Africa), BRICM (BRIC + Mexico), and BRICET (BRIC + Eastern Europe and Turkey).

Does it make sense to group so many countries with tremendous diversity in terms of history, geography, politics, and economics together as “emerging economies”? As compared to developed economies, the label of “emerging econo- mies,” rightly or wrongly, has emphasized the presumably homogenous nature of so many different countries. While this single label has been useful, more recent research has endeavored to enrich it.6

Specifically, the two dimensions illustrated in Figure 1.2 can help us differenti- ate various emerging economies.7 Vertically, the development of market-supporting political, legal, and economic institutions has been noted as a crucial dimension of

BRIC

Brazil, Russia, India, and China.

Table 1.1 Classifying Developed Economies versus Emerging Economies

33 developed economies as classified by the International Monetary Fund (IMF)

Australia Hong Kong Portugal

Austria Iceland Singapore

Belgium Ireland Slovak Republic

Canada Israel Slovenia

Cyprus Italy South Korea

Czech Republic Japan Spain

Denmark Luxembourg Sweden

Finland Malta Switzerland

France Netherlands Taiwan

Germany New Zealand United Kingdom

Greece Norway United States

All the other 149 economies are classified by the IMF as emerging economies

Source: IMF, www.imf.org. The IMF recognizes 182 countries and economies. It labels developed economies “advanced economies” and labels emerging economies “emerging and developing economies.”

8 Part One Laying Foundations

institutional transitions in many emerging economies.8 Horizontally, the develop- ment of infrastructure and factor markets is also crucial.

Stereotypical or traditional emerging economies suffer from both the lack of institutional development and the lack of infrastructure and factor market development. Most emerging economies 20 years ago would have fit this descrip- tion. Today, some emerging economies that have made relatively little progress along these two dimensions (such as Belarus and Zimbabwe) still exist.

However, a lot has changed. A great deal of institutional development and in- frastructure and factor market development have taken place. Such wide-ranging development has resulted in the emergence of a class of mid-range emerging econo- mies that differ from both traditional emerging economies and developed econ- omies. For example, the top down approach to government found in China has facilitated infrastructure and factor market development. But China’s political and market institutions tend to be underdeveloped relative to physical infrastructure. Alternatively, India has strong political institutions supporting market institutions (although there is still significant corruption in government bureaucracies). While Indian government policy reforms have facilitated better market institutions and associated economic development, world-class physical infrastructure is lacking. In the middle area of Figure 1.2, Brazil and Russia can be placed as examples. In these mid-range emerging economies, there are some democratic political institutions (despite the recent setback in Russia—see Chapter 2 Opening Case) and some in- frastructure and factor market development. Finally, some economies have clearly graduated from the “emerging” phase and become what we call “newly developed economies.” South Korea may be an exemplar country as it has more balanced development in both institutional development and infrastructure/factor markets.

1-1c Base of the Pyramid and Reverse Innovation The global economy can be viewed as a pyramid (Figure 1.3). The top consists of about one billion people with per capita annual income of $20,000 or higher.

Mid-Range Emerging

Economies (e.g., INDIA)

Mid-Range Emerging

Economies (e.g., CHINA)

Traditional Emerging

Economies (e.g., BELARUS)

Less

Infrastructure and Factor Market Development In

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(e.g., SOUTH KOREA)

Figure 1.2 A Typology of Emerging Economies

Source: Adapted from R. Hoskisson, M. Wright, I. Filatotchev, & M. W. Peng, 2013, Emerging multinationals from mid-range economies: The influence of institutions and factor markets, Journal of Management Studies (in press).

Chapter 1 Globalizing Business 9

These are mostly people who live in the developed economies in the Triad, which consists of North America, Western Europe, and Japan. Another billion people earning $2,000 to $20,000 per year make up the second tier. The vast majority of humanity—about five billion people—earn less than $2,000 per year and com- prise the base of the pyramid (BOP). Most MNEs focus on the top and second tiers and end up ignoring the base of the pyramid.9 An increasing number of such low- income countries have shown a great deal of economic opportunities as income levels have risen (see the Closing Case). More Western MNEs, such as GE, are in- vesting aggressively in the base of the pyramid and leveraging their investment to tackle markets in both emerging and developed economies.

One interesting recent development out of emerging economies is reverse innovation—an innovation that is adopted first in emerging economies and then diffused around the world.10 Traditionally, innovations are generated by Triad-based multinationals with the needs and wants of rich customers at the top of the pyramid in mind. When such multinationals entered lower-income economies, they tended to simplify the product features and lower the prices. In other words, the innovation flow is top down. However, as Deere & Company found out in India, its large-horsepower tractors designed for American farmers were a poor fit for the very different needs and wants of Indian farmers. Despite Deere’s efforts to simplify the product and reduce the price, the price was still too high in India. Instead, Mahindra & Mahindra brought its widely popular small-horsepower tractors that were developed in India to the United States, and carved out a growing niche that eventually propelled it to be the world’s largest tractor maker by units sold (see the Opening Case). In response, Deere abandoned its US tractor designs and “went native” in India, by launching a local design team charged with developing something from scratch—with the needs and wants of farmers in India (or, more broadly, in emerging economies) in mind. The result was a 35-horsepower tractor that

Triad

North America, Western Europe, and Japan.

Base of the pyramid (BoP)

Economies where people make less than $2,000 per capita per year.

Reverse innovation

An innovation that is adopted first in emerging economies and is then diffused around the world.

Base of the Pyramid Per capita GDP/GNI < $2,000

Approximately five billion people

Second Tier Per capita GDP/GNI $2,000–$20,000

Approximately one billion people

Top Tier Per capita GDP/GNI > $20,000

Approximately one billion people

Sources: Adapted from (1) C. K. Prahalad & S. Hart, 2002, The fortune at the bottom of the pyramid, Strategy+Business, 26: 54-67; (2) S. Hart, 2005, Capitalism at the Crossroads (p. 111), Philadelphia: Wharton School Publishing.

Figure 1.3 The Global Economic Pyramid

10 Part One Laying Foundations

Table 1.2 Why Study Global Business?

Enhance your employability and advance your career in the global economy

Better preparation for possible expatriate assignments abroad

Stronger competence in interacting with foreign suppliers, partners, and competitors and in working for foreign-owned employers in your own country

was competitive not only with Mahindra in India, but also in the United States and elsewhere. In both cases, the origin of new innovations is from the base of the pyramid. The flow of innovation is bottom up—in other words, reverse innovation.

The reverse innovation movement suggests that emerging economies are no longer merely low-cost production locations or attractive new markets (hence the term “emerging markets”). They are also sources of new innovations that may not only grow out of BOP markets, but also have the potential to go uphill to penetrate into the top of the global economic pyramid. In a Harvard Business Review article, Jeff Immelt, chairman and CEO of a leading practitioner of reverse innovation, GE, noted:

To be honest, the company is also embracing reverse innovation for defensive rea- sons. If GE doesn’t come up with innovations in poor countries and take them glob- al, new competitors from the developing world—like Mindray, Suzlon, Goldwind, and Haier—will. . . GE has tremendous respect for traditional rivals like Siemens, Philips, and Rolls-Royce. But it knows how to compete with them; they will never destroy GE. By introducing products that create a new price-performance paradigm, however, the emerging giants very well could. Reverse innovation isn’t optional; it is oxygen.11

As advised by GE’s Immelt, today’s students—and tomorrow’s business leaders— will ignore the opportunities and challenges at the base of the pyramid at their own peril. This book will help ensure that you will not ignore these opportunities.

1-2 Why Study Global Business? Global business (or IB) is one of the most exciting, most challenging, and most relevant subjects offered by business schools. Why study it? There are at least three compelling reasons why you should study global business—and study hard (Table 1.2).

First, mastering global business knowledge helps advance your employability and career in an increasingly competitive global economy. Take a look at the Open- ing Day Quiz in Table 1.3. Can you answer all the questions correctly? If not, you will definitely benefit from studying global business.

The answer to Question 1 is empirical—that is, based on data. You should guess first and then look at the label of your shirt yourself or ask a friend to help you. The key here is international trade. Do you wear a shirt made in your own country or another country? Why?

In Question 2, smart students typically ask whether the mobile device (such as a smartphone or an iPad) means the motherboard or the components. My answer is: “I mean the whole device, all the production that went into making

Learning Objective Give three reasons why it is important to study global business.

1-2

Chapter 1 Globalizing Business 11

the machine.” Then some students would respond: “But they could be made in different countries!” My point exactly. Specifically, the point here is to appreciate the complexity of a global value chain, with different countries making different components and handling different tasks. Such a value chain is typically managed by an MNE, such as Apple, Dell, Foxconn, HP, Lenovo, or Samsung. The capabilities necessary to organize a global supply chain hints at the importance of resources and capabilities—one of the two key themes of this book.

Question 3 is deceptively simple. Unfortunately, 100% of my own students— ranging from undergraduates to PhDs—miss it. Surprise! The Group of 20 (G-20) only has 19 member countries. The 20th member is the European Union (EU)—a regional bloc, not a single country (see PengAtlas Map 1.1). Ideally, why the G-20 is formed in such an interesting way will make you more curious about how the rules of the game are made around the world. In this case, why are 19 countries in, but numerous others are out? What is special about the EU? Why are other regional blocs not included in the G-20? What about the G-7? What about other groups of countries (see Figure 1.4)? A focus on the rules of the game—more technically, institutions—is another key theme of the book.

Question 4 will really frighten you. Some students would typically clarify: “Do you mean the few security guards looking after the closed plant?” “Not necessarily,” I would point out. “The question is: How many jobs will be kept by the company?” Students would eventually get it: even adding a few jobs as security guards at the closed plant, the most optimistic estimates are that only 30 to 50 jobs may be kept. Yes, you guessed it, these jobs typically are high-level positions such as the CEO, CFO, CIO, factory director, and chief engineer. These managers will be sent by the MNE to start up operations in an emerging economy. You need to realize that in a 2,000-employee plant, even if you may be the 51st-highest-ranked employee, your fate may be the same as the 2,000th employee. You really need to work hard and work smart to position yourself as one of the top 50 (preferably one of the top 30). Doing well in this class and mastering global business knowledge may help make it happen.

Group of 20 (G-20)

The group of 19 major countries plus the European Union (EU) whose leaders meet on a biannual basis to solve global economic problems.

Table 1.3 Opening Day Quiz

1. Which country made the shirt you are wearing? 2. Which country made your mobile communication device? (A) China (A) China (B) Malaysia (B) Germany (C) Mexico (C) Singapore (D) Romania (D) Taiwan (E) US (E) US

3. How many countries does the G-20 have? 4. A 2,000-employee manufacturing plant is closing in a developed economy, and production is moving to an emerging economy. How many of the 2,000 jobs will the company keep?

(A) 0 (B) 5–10 (C) 10–20 (D) 20–30 (E) 30–50

(A) 20 (B) 21 (C) 22 (D) 19 (E) 18

12 Part One Laying Foundations

In addition to the first reason to equip you with relevant knowledge, the second compelling reason why you should study global business is related to Question 4. Because many ambitious students aspire to join the top ranks of large firms, expertise in global business is often a prerequisite. Today, it is increasingly difficult, if not impossible, to find top managers at large firms without significant global competence. Of course, eventually hands-on global experience, not merely knowledge acquired from this course, will be required. However, mastery of the knowledge of, and demonstration of interest in, global business during your education will set you apart as a more ideal candidate

to be selected as an expatriate manager (or “expat”)—a manager who works abroad—to gain such an experience (see Chapter 15 for details).

Thanks to globalization, low-level jobs not only command lower salaries but are also more vulnerable. However, high-level jobs, especially those held by expats, are both financially rewarding and relatively secure. Expats often command a signifi- cant international premium in compensa- tion—a significant pay raise when work- ing overseas. In US firms, an expat’s total compensation package is approximately $250,000 to $300,000 (including perks and benefits; not all is take-home pay). When they return to the United States after a tour of duty (usually two to three

Expatriate manager

A manager who works abroad, or “expat” for short.

International premium

A significant pay raise when working overseas.

Brazil

India

South Africa

Brunei Cambodia Indonesia

Laos Malaysia Myanmar

Philippines Singapore Thailand Vietnam

Italy France

Germany Japan

UK Canada

USA

Shanghai Co-op Organization

BRIC

IBSA ASEAN +3G7

Kazakhstan Kyrgyztan Tajikistan

Uzbekistan

Russia

China

Argentina Australia Mexico Turkey

European Union

G20

Japan

South Korea

Figure 1.4 Country Groupings in the 21st Century

Source: Adapted from C. Dhanaraj & T. Khanna, 2011, Transforming mental models on emerging markets (p. 696), Academy of Management Learning and Education, 10(4): 684-701. G7 = Group of Seven; G20 = Group of Twenty; BRIC = Brazil, Russia, India, and China; IBSA = India-Brazil-South Africa Dialogue Forum; Shanghai Co-op Orga- nization = Shanghai Co-operation Organization; ASEAN = Association of Southeast Asian Nations. © Academy of Management.

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