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4.3 Global Strategy Implications

4.3.1 Institutional Voids

The difficulty of managing a global business in emerging countries arises because the local institutions in their respective economic systems are very different from those of the developed nations. As discussed in the previous section, China and India have great differences in their institutions. We stated that Indian institutions are built on the foundation of market mechanisms, but that the effectiveness of these mechanisms in the country is not even close to that of developed nations. On the other hand, China's economic system is unique with the government's direct involvement in every aspect of economic activity; however, it has more efficient markets than those in India, such as the product and labor markets. The institutional differences by country strongly correlate to the level of efficiencies in diverse markets such as product, capital, and labor markets. We term nonfunctioning market mechanisms as “institutional voids,” and introduce a methodology for analyzing global strategies on the basis of this term.

“Institutional voids” are economic institutions such as product, capital, or labor markets that have matured in developed nations, but have not reached a sufficient level of maturity in emerging markets, thus creating a void (Khanna and Palpu 2010). These researchers define the difference between emerging and developing countries by the degree of void. The emerging countries are countries like India and China that have immature economic institutions compared with developed nations, but have somewhat of an institutional foundation, thereby limiting the size of the void. On the other hand, developing countries are countries that do not have an institutional base, where the institutional void is so excessively large that companies accustomed to operating in developed nations with no institutional voids must use completely different business models to succeed there.

We use the above definition in our discussion of “emerging countries,” but must provide clarity into certain institutional voids. We have created four classifications of voids:

1. Voids in product markets

2. Voids in capital markets

3. Voids in labor markets

4. Macroenvironments related to institutions

First, we discuss the voids in product markets, which are determined by the following two factors: the extent products and services can be purchased by consumers on the basis of correct information, and whether market thickness can be secured with sufficiently functioning competitive markets containing many buyers and sellers. Thus, the efficiency of sales channels of wholesalers and retailers as well as the state of logistics and infrastructures are related to this type of void. When comparing China and India on these points, China might be said to have relatively smaller voids (i.e., more efficient). The restrictions on foreign capital in the distribution industry have been significantly relaxed in China, resulting in companies such as Carrefour and Walmart entering the Chinese market. However, India still has strict regulations on that industry. China also has more advanced infrastructure, making logistics more efficient.

In the case of voids in capital markets, India has smaller voids, thus more efficient markets. As noted above with regard to bank lending, in China, government organizations exert heavy-handed control over lending by financial institutions. In stock markets, China's publicly traded corporations have only a portion of their shares available to the market and often more than half are owned by governmentrelated entities (i.e., nonpublic enterprises). As a result, the true state of a publicly traded company is unclear based on the available financial information, making information asymmetry between companies and investors a big concern. On the other hand, India has had bank financing and stock trading since its colonial era, and as such, issues like the ones observed in China are relatively small.

Third, we discuss the voids in labor markets. This type of void is determined by how efficiently labor demand (corporations) is matched with supply (i.e., workers). On this point, the void in China is relatively smaller. India has extremely strict labor regulations, and it is practically impossible for corporations of a certain size to sack employees. In addition, unions are very active and there are many selection biases when hiring employees. Differences in language depending on the region and lack of women entering the workforce also negatively affect labor market efficiency. China has relatively higher worker mobility, and while there are heightened sense of worker entitlement and stronger regulations protecting workers, these issues are small in comparison with India.

Finally, macro environments relating to institutions encompass many areas including foreign capital regulations, broadcasting regulations, and regulations on the activities of foreign firms. We briefly discuss Chinese media regulations. The content of newspapers, magazines, and other forms of media in the country are checked stringently. It is possible now for individuals to publish their own information on the Internet in the form of blogs or similar formats, but cyber-cops keep a close watch on Internet discussions, and objectionable opinions are censored on a daily basis. However, these information regulations apply to politically sensitive content, so economic information such as corporate financials and product information is not impacted as much, making the impact of this factor on China's institutional voids minimal.

Having listed these voids, the global strategy based on Khanna's “institutional voids” is to select one of the following, depending on the circumstances: (1) replicating domestic business or (2) adapting to the local environment. This is similar to the discussion of “aggregate” and “adapt” in the AAA framework discussed in Chap. 2. The former should be selected to achieve economies of scale or to leverage a global brand; the latter should be selected when voids are too large and a strategy of replication is unrealistic.

In addition, we have discussed the model of using voids as business opportunities (the model that could be called “arbitration” in the AAA framework). As an example of this, the German retail firm Metro Group has a cash-wholesale business in India called “Metro Cash and Carry,” which provides a wealth of clues as to how to accomplish the goal of this model. Metro Group's business exploits India's institutional void of an inefficient distribution system. The business was started as a cash and carry service in Bangalore in 2003, and has since expanded throughout India. However, India has regulations on the trade of agricultural products (trade on these products within India must be conducted in government-authorized markets called “mandis”), making it impossible for Metro Group to deal in agricultural products. This law was created during the 1950s to protect farmers, but is currently an impediment to improving agricultural distribution. Agricultural products in India must be fresh, but a large amount of product goes waste during distribution, and even the government acknowledges the need to revise the law. At present, movements are afoot in some states to do so, but they have met with opposition in multiple states, especially from masses of individual businessmen who buy and sell under the system of mandis. Metro Group is working hard in appealing to both farmers and consumers that eliminating the law will be beneficial for both. When institutional voids become business opportunities, local systems are established in response to such voids; however, these local systems can also become large barriers. Businesses must assess the viability of conducting business by understanding these types of risks, and must be prepared to make long-term investments for the success of that business.

In addition, businesses have strategically important options of whether to tackle institutional voids alone or jointly with a local business. As deduced from the Metro Group example, businesses do not necessarily need to embrace voids; rather, it can be effective to work with local firms in making a long-term investment to reduce local voids. Other companies have entered the cash and carry business in India, for example, Tesco in the UK announced its intentions of partnering with the Tata Group to join the market. From the perspective of foreign firms, China and India are full of institutional defects, but companies are doing business within the confines of these local institutions. If a company recognizes a defect it believes will be difficult to overcome independently, there is value in considering a partnership with a local firm before conceding defeat entirely.

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