1. ADDING Value1 Pankaj Ghemawat This note introduces the ADDING value scorecard and uses it to identify and calibrate the levers through which global strategy can create (or destroy) value, and to assess alternative strategy options. Some of the levers are likely to be familiar from singlecountry strategy but others are new or applied in rather different ways. The ADDING Value Scorecard The late C. Northcote Parkinson noted in one of his less famous laws that businesspeople tend to do detailed cost-benefit analyses of relatively small decisions but simply throw up their hands and surrender to animal spirits when making large ones.2 There is a sense in some quarters that global strategic moves are so complex and so subject to uncertainty that they essentially become matters of faith. The ADDING value scorecard presented here is intended as an antidote to this kind of thinking.3 ADDING is an acronym that parses the assessment of international business strategy into the individual levers via which value is created, each of which is amenable to careful (and in many cases quantitative) analysis: Adding volume, Decreasing costs, Differentiating or increasing willingness to pay, Improving industry attractiveness, Normalizing risks, and Generating knowledge and other resources. The components of the ADDING value scorecard are meant to be commensurable, and to add up to determine overall value addition or subtraction. The first four components should be familiar from single-country strategy: adding volume (or, with a more dynamic frame, growth), decreasing costs, differentiating or increasing willingness to pay, and increasing industry attractiveness. They reflect what might be called the fundamental equation of business strategy: Your margin = industry margin + your competitive advantage Michael Porter’s famous five-forces framework for the structural analysis of industries has explored the strategic determinants of industry profitability (the first term on the right side of the equation).4 Porter and other strategists, notably Adam Brandenburger and Gus Stuart, have probed the determinants of competitive advantage (the second term on the right side of the equation), and emphasized characterizing it in terms of willingness to pay and (opportunity) costs:5 Your competitive advantage = [willingness to pay – cost] for your company – [willingness to pay – cost] for your competitor = your relative willingness to pay – your relative cost.

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In other words, in single-country strategy a company is said to have created competitive advantage over its rivals if it has driven a wider wedge between willingness to pay and cost than its competitors have done. The final two components of ADDING value—normalizing risk and generation of knowledge and other resources—reflect the large differences that persist across countries. Thus, they are customary add-ons in global strategy. The relationships among the components are summarized in exhibit 1-1. Exhibit 1-1. The Components of the ADDING Value Scorecard

Volume Economic Value

Competitive Advantage • Costs • Differentiation

Margin

+ Uncertainty/ Risk

Industry Attractiveness/ Leverage

Knowledge/ Resources

Applying the ADDING Value Scorecard When applying the ADDING value scorecard, it is useful to begin by quickly thinking through the list of value components and brainstorming about the ways that economic value could be increased or decreased under each heading. Then, go back and review the lists to figure out elements that might still be added and to begin to think through the impact of each. It is generally very helpful to quantify numerically (at least to a rough order of magnitude) those elements that are amenable to quantification. For what cannot be quantified, note the direction of the impact and your general assessment of its magnitude (e.g., “++” for a large positive impact or “–” for a small negative one). Then, add up the quantified impacts and weigh them against the collective impact of the elements that could not be quantified. While complete quantification is rarely possible, partial quantification makes clear how much positive or negative impact the remaining elements must have to sway the decision, improving the ultimate conclusion. The following sections offer specific suggestions to consider when analyzing each component of the ADDING value scorecard.

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Adding Volume or Growth Assess the economic profitability of incremental volume—that is, determine accounting profits minus capital recovery costs. While this may seem like an obvious requirement for a value-focused analysis, it is worth noting that research indicates many large companies maintain significant country operations that generate negative economic returns over long periods of time. Understand the level at which economies of scale or scope really matter and calibrate their magnitudes. While it is often assumed in global strategy that global scale is what counts, there are many other possibilities: national scale, plant scale, share of customer wallet, and so on. Economies of scale or scope should ideally be calibrated rather than just identified since their strength varies substantially across industries and can be dependent on other aspects of a firm’s strategy. Assess the other effects of incremental volume. The previous point focused on economies of scale, particularly on the cost side. But incremental volume can also have other effects—not all of them positive—on a company’s economics. If a key input is in short supply, for instance, additional volume may raise rather than lower costs. Decreasing Costs Unbundle cost and price effects. Expressing costs as a percentage of revenues can obscure the true effects of cross-border moves on a company’s cost structure. Instead, think about other ways to normalize costs. In some cases, it is useful to analyze cost per unit of output to clearly separate volume and price effects. In other cases, it can also be useful to normalize cost per unit of a key input, such as capital or labor. Unbundle costs into subcategories. Cross-border moves typically have different impacts on various line items within a company’s cost structure, so it is important to analyze each of the major cost components separately. Don’t forget to consider capital costs in addition to operating costs. Fixed and variable costs also represent another key distinction, particularly for purposes such as breakeven analyses. Consider cost increases as well as decreases. This point, already made briefly, is worth reiterating. Consider, for example, takeover premiums and transaction costs involved with cross-border mergers. Remember that increases in complexity may impact not only production costs but also selling, general, and administrative costs. Look at cost drivers other than scale and scope. Strategists know that there are many other potential drivers of costs beyond scale and scope: location (particularly important in a cross-border context), capacity utilization, vertical integration, timing (e.g., early-mover advantages), functional policies, and institutional factors (e.g., unionization and governmental regulations such as tariffs). Relate the potential for absolute cost reductions to labor intensity or the intensity of other inputs. Labor is just one avenue for potential economic arbitrage; capital, natural resources and specialized inputs represent others. Arbitrage opportunities will be elaborated on in section 5.

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Differentiating or Increasing Willingness to Pay Relate the potential for differentiation to R&D-to-sales and advertising-to-sales ratios for your industry. These ratios are the most robust markers of multinational presence, which is why product differentiation is considered key to strategies that seek to tap scale economies by expanding across borders. R&D expenditures equal to 0.9 percent of sales revenues define the bottom quartile of U.S. manufacturing, 2.0 percent of revenues the median, and 3.5 percent of revenues the top quartile. The corresponding cutoff points for advertising-to-sales ratios are 0.8 percent, 1.7 percent, and 3.5 percent. Compare a company’s and industry’s ratios versus these benchmarks to quickly check the scope for differentiation that it is likely to afford. Focus on willingness to pay rather than prices paid. There are at least two problems with using price as a proxy for the benefits for which buyers are willing to pay. First, prices mix a number of other influences related to industry attractiveness and bargaining power. Second, a focus on willingness to pay encourages envisioning things as they might be rather than as they actually are—supporting development of a more creative range of strategy options. Think through how globality affects willingness to pay. There are some cases of cross-border presence directly boosting willingness to pay—for instance, for individual customers who travel internationally or want to belong to a global community, or for companies that are themselves global and value consistent products and services across locations. But especially in consumer businesses, cross-border appeal is more often rooted in specific country-of-origin advantages (e.g., French wine). Analyze how cross-border heterogeneity in preferences affects willingness to pay for the products offered. In the next section, the CAGE distance framework will be introduced to help discern more precisely the cross-country differences that firms must account for in their strategies. For now, lets just say that while differences sometimes support country-of-origin advantages, they more often reduce willingness to pay for foreign products or services. Even subtle differences can render a product that works well in one country inferior or entirely unsalable in another. Segment the market appropriately. Segmentation obviously picks up on differences in willingness to pay (and, sometimes, differences in costs). Typically, the number of segments to be considered increases with diversity in customer needs and ease in customizing the firm’s products or services. The greater diversity companies face operating internationally increases the benefits of market segmentation. Improving Industry Attractiveness or Bargaining Power Account for international differences in industry profitability. Substantial differences in average firm profitability across countries, even within the same industry, are often overlooked. Be sure to understand these patterns when assessing markets. Understand concentration dynamics in your industry. Contrary to what many assume, global integration does not necessarily increase global concentration.6 Analyze the concentration dynamics of an industry at the global, regional, and country levels for a basic check of the current competitive context and how it is likely to evolve.

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Look broadly at other changes in industry structure. Consider how the factors in Michael Porter’s five-forces framework are changing. For example, are shifts in sales or production to emerging markets changing the bargaining power of buyers or suppliers? Think through how you can de-escalate or escalate the degree of rivalry. Conduct detailed structural and competitor analysis to figure out competitors’ likely responses to strategic moves. Recognize the implications of your actions for rivals’ costs or willingness to pay for their products. Raising rivals’ costs or reducing their willingness to pay can do as much for a company’s profits as improving its own position in absolute terms. Attend to regulatory, or nonmarket, restraints—and ethics. Behavior aimed at building up bargaining power is always a sensitive matter, and the legal status of the strategies listed under the preceding two headings, in particular, varies across countries. Be careful of the legal and ethical considerations that may arise around these types of strategies. Normalizing Risk Characterize the extent of key sources of risk in a business (capital intensity, demand volatility, etc.). A useful way of summarizing risks is in terms of the learn-to-burn rate: a ratio that looks at how quickly information resolving key uncertainties comes in versus the rate at which money is (irreversibly) being spent. Assess how much cross-border operations reduce risk—or increase it. International operations can provide geographic risk pooling, but can also create new sources of risk. For example, a company reliant on cross-border supply chains faces very different risks from one with more localized production. Recognize any benefits that might accrue from increasing risk. Risk can, given optionality, be valuable for the same reason that financial options are more valuable in the presence of greater (price) volatility. Thus, some multinationals think of emerging markets as strategic options rather than just as risk traps. Consider multiple modes of managing exposure to risk or exploitation of optionality. For example, a company may enter a foreign market with a fully owned greenfield operation, make an acquisition, work with a joint venture partner, or simply export there. Or, given widely diversified shareholders, it may make more sense to rely on shareholders to eliminate industry-specific risks and, given that possibility, to discount them in formulating company strategy. Generating Knowledge—and Other Resources or Capabilities Assess to what extent knowledge is location-specific versus mobile and the implications for knowledge transfer. Cross-country differences may require explicit attention to knowledge decontextualization and recontextualization. Otherwise, knowledge transfer can make matters worse rather than better. Consider multiple modes of managing the generation and diffusion of knowledge. In addition to formal mechanisms, don’t forget about informal ways that knowledge diffuses across borders: through personal interactions; working with buyers, suppliers, or consultants; open innovation; imitation; contracting for use of knowledge; and so forth.

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Think of other resources in similar terms. Knowledge transfer is sometimes thought of purely technically—a tendency reinforced by the ease with which patents can be counted. But other kinds of information, such as business-model or management innovations, can also be transferred across borders. Even more generally, other organizational resources/capabilities with broad effects might be analyzed in similar ways. Avoid double-counting. While it is important to avoid double-counting in all of the components of the scorecard, be aware that it is particularly likely to arise here. If you have already accounted for the effects of generating (or depleting) a resource on cost, willingness to pay, and so on—which is generally recommended—do not repeat them here. Conclusion The ADDING value scorecard parses cross-border value addition (or subtraction) in manageable, commensurable components to facilitate robust and meaningful analysis of international strategies. By applying the scorecard, one can avoid typical strategic errors such as “sizeism” that may result, for example, from focusing on narrow metrics like the percentage of a company’s revenues earned outside its home country. The scorecard may also be used outside-in to assess a competitor’s global strategy and to try to predict its future moves. More broadly, it is also useful to think about the sustainability of each of the sources of value addition or subtraction to add a dynamic perspective to the analysis. Exhibit 1-2 summarizes the guidelines presented here for applying the ADDING value scorecard.

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Exhibit 1-2 Applying the ADDING Value Scorecard Components of Value Adding Volume / Growth

Guidelines   

Decreasing Costs

Differentiating / Increasing Willingness-toPay

Improving Industry Attractiveness / Bargaining Power

Normalizing (or Optimizing) Risk

Generating Knowledge (and other Resources or Capabilities)

                        

Look at the true economic profitability of incremental volume (taking into account cost of capital) Probe the level at which additional volume yields economics of scale (or scope): globally, nationally, at the plant or customer level, etc. Calibrate the strength of scale effects (slope, percentage of costs/revenues affected) Assess the other effects of volume Unbundle price effects and cost effects Unbundle costs into subcategories Consider cost increases (e.g., due to complexity, adaptation, etc.) as well as decreases and net them out Look at cost drivers other than scale/scope Look at labor cost/sales ratios for your industry (or company) Look at R&D/sales and advertising/sales ratios for your industry Focus on willingness to pay rather than prices paid Think through how globality affects willingness to pay Analyze, in particular, how cross-country (CAGE) heterogeneity in preferences affects willingness to pay for products on offer Segment the market appropriately Account for international differences in industry profitability Understand the structural dynamics of your industry Look broadly at the impact of trends and moves in changing important elements of industry structure In particular, think through how you can deescalate/escalate rivalry Recognize the implications of what you do for rivals’ costs or willingness to pay for their products (worsening their positions can do as much for added value as improving your own) Attend to regulatory/nonmarket restraints—and ethics Characterize the extent and key sources of risk in your business (capital intensity, other irreversibility correlates, demand volatility, etc.) Assess how much cross border operations reduce or increase risk Recognize any benefits that might accrue from increasing risk Consider multiple modes of managing risk or optionality Assess how location-specific versus mobile knowledge is, and the implications for knowledge transfer Consider multiple modes of generating (and diffusing) knowledge Think of other resources/capabilities in similar terms Avoid double-counting

Working through the ADDING value scorecard also helps surface some of the opportunities and challenges that result from semiglobalization and the reality of persistent cross-country differences. The CAGE distance framework is introduced in section 2 to sharpen the analysis of such differences.

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1 Pankaj Ghemawat And Jordan I. Siegel, “Cases on Redefining Global Strategy” , (Harvard Business Review Press, 2011):1-10 2

C. Northcote Parkinson, Parkinson’s Law and Other Studies in Administration (Boston: Houghton Mifflin, 1956). 3 For more detail about the ADDING value scorecard and its application, see chapter 3 of Pankaj Ghemawat, Redefining Global Strategy (Boston: Harvard Business School Press, 2007); and for a general discussion of value creation and capture in a single-country context, see Pankaj Ghemawat, Strategy and the Business Landscape, 3rd ed. (Upper Saddle River, NJ: Pearson Prentice Hall, 2009). 4

Michael E. Porter, Competitive Strategy (New York: Free Press, 1980).

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Michael E. Porter, Competitive Advantage (New York: Free Press, 1985); and Adam M. Brandenburger and Harborne W. Stuart Jr., “Value-Based Business Strategy,” Journal of Economics & Management Strategy 5, no. 1 (1996): 5–24. 6

Pankaj Ghemawat and Fariborz Ghadar, “Global Integration ≠ Global Concentration,” Industrial and Corporate Change, August 2006, especially 597–603.

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