adding value

How to add value to business

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1. ADDING Value
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Pankaj Ghemawat

The introduction explains that international or global strategy requires distinctive content
because the state of the world is one of semiglobalization, in which the differences
between countries continue to be substantial. Global strategy requires dealing with this
complex reality, in which neither the interactions between countries nor the differences
that continue to divide them can be ignored, in order to create and claim more value
across borders than a collection of single-country enterprises could do on their own. In
other words, the fundamental objective of global strategy is to account for differences so
as to produce a whole that exceeds the sum of its national parts by as large a measure as
possible.

This section 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 single-
country strategy but others are new or applied in rather different ways, as discussed in
this section. The next section, on the CAGE distance framework, identifies and explores
the effects of cross-country differences of various sorts on international economic
interactions. Taken together, sections 1 and 2 supply the basic tools necessary to pursue
the objective articulated in the introduction: applying a firm-centric, value-focused
perspective to a substrate of cross-country differences.

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.
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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.
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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:

SAMPLE

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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).
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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:
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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.

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















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
Economic
Value
Volume
Margin
Competitive
Advantage
•Costs
•Differentiation
Industry
Attractiveness/
LeverageUncertainty/
Risk
Knowledge/
Resources
+

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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.

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.

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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.

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.

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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.
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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.
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.

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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.
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


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.

Components
of Value

Guidelines
Adding Volume
/ Growth
 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
Decreasing
Costs
 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)
Differentiating /
Increasing
Willingness-to-
Pay
 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
Improving
Industry
Attractiveness /
Bargaining
Power
 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
Normalizing (or
Optimizing)
Risk
 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
Generating
Knowledge (and
other Resources
or Capabilities)
 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

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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).
5
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.