A third generic strategy for creating a global advantage is arbitrage (see Figure 3.1). Arbitrage is a way of exploiting differences, rather than adapting to them or bridging them, and defines the original global strategy: buy low in one market and sell high in another. Outsourcing and offshoring are modern day equivalents. Wal-Mart saves billions of dollars a year by buying goods from China. Less visible but equally important absolute economies are created by greater differentiation with customers and partners, improved corporate bargaining power with suppliers or local authorities, reduced supply chain and other market and nonmarket risks, and through the local creation and sharing of knowledge.
Since arbitrage focuses on exploiting differences between regions, the CAGE framework described in Competing in a Global World is of particular relevance and helps define a set of substrategies for this generic approach to global value creation.
Favorable effects related to country or place of origin have long supplied a basis for cultural arbitrage. For example, an association with French culture has long been an international success factor for fashion items, perfumes, wines, and foods. Similarly, fast-food products and drive-through restaurants are mainly associated with U.S. culture. Another example of cultural arbitrage—real or perceived—is provided by Benihana of Tokyo, the “Japanese steakhouse.” Although heavily American—the company has only one outlet in Japan out of more than 100 worldwide—it serves up a theatrical version of teppanyaki cooking that the company describes as “Japanese” and “eatertainment.”
Legal, institutional, and political differences between countries or regions create opportunities for administrative arbitrage. Ghemawat cites the actions taken by Rupert Murdoch’s News Corporation in the 1990s. By placing its U.S. acquisitions into holding companies in the Cayman Islands, the company could deduct interest payments on the debt used to finance the deals against the profits generated by its newspaper operations in Britain. Through this and other similar actions, it successfully lowered its tax liabilities to an average rate of less than 10%, rather than the statutory 30% to 36% of the three main countries in which it operated: Britain, the United States, and Australia. By comparison, major competitors such as Disney were paying close to the official rates. 1
With steep drops in transportation and communication costs in the last 25 years, the scope for geographic arbitrage—the leveraging of geographic differences—has been diminished but not fully eliminated. Consider what is happening in medicine, for example. It is quite common today for doctors in the United States to take X-rays during the day, send them electronically to radiologists in India for interpretation overnight, and for the report to be available the next morning in the United States. In fact, reduced transportation costs sometimes create new opportunities for geographic arbitrage. Every day, for instance, at the international flower market in Aalsmeer, the Netherlands, more than 20 million flowers and 2 million plants are auctioned off and flown to customers in the United States.
As Ghemawat notes, in a sense, all arbitrage strategies that add value are “economic.” Here, the term economic arbitrage is used to describe strategies that do not directly exploit cultural, administrative, or geographicdifferences. Rather, they are focused on leveraging differences in the costs of labor and capital, as well as variations in more industry-specific inputs (such as knowledge) or in the availability of complementary products. 2
Exploiting differences in labor costs—through outsourcing and offshoring—is probably the most common form of economic arbitrage. This strategy is widely used in labor-intensive (garments) as well as high- technology (flat-screen TV) industries. Economic arbitrage is not limited to leveraging differences in labor costs alone, however. Capital cost differentials can be an equally rich source of opportunity.
Minicase: Indian Companies Investing in Latin America? To Serve U.S. Customers?
3Indian investment in Latin America is relatively small but growing quickly. Indian firms have invested about $7 billion in the region over the last decade, according to figures released by the Latin American division of India’s Ministry of External Affairs in New Delhi. The report projects that this amount will easily double in the next few years.
As India has become a magnet for foreign investment, Indian companies themselves are looking abroad for opportunities, motivated by declining global trade barriers and fierce competition at home. Their current focus is on Latin America, where hyperinflation and currency devaluation no longer dominate headlines.
Like China, India is trying to lock up supplies of energy and minerals to feed its rapidly growing economy. Indian firms have stakes in oil and natural gas ventures in Colombia, Venezuela, and Cuba. In 2006, Bolivia signed a deal with New Delhi-based Jindal Steel and Power, Ltd., which plans to invest $2.3 billion to extract iron ore and to build a steel mill in that South American nation.
At the same time, Indian information technology companies are setting up outsourcing facilities to be closer to their customers in the West. Tata Consultancy Services is the leader, employing 5,000 tech workers in more than a dozen Latin American countries.
Indian manufacturing firms, accustomed to catering to low-income consumers at home, are finding Latin America a natural market. Mumbai-based Tata Motors, Ltd., has formed a joint venture with Italy’s Fiat to produce small pickup trucks in Argentina. Generic drug makers, such as Dr. Reddy’s, are offering low-cost alternatives in a region where U.S. and European multinationals have long dominated.
The Indian government has carefully positioned India as a partner, rather than a rival out to steal the region’s resources and jobs, a common worry about China. Mexico has been particularly hard-hit by China’s rise. The Asian nation’s export of textiles, shoes, electronics, and other consumer goods has cost Mexico tens of thousands of manufacturing jobs, displaced it as the second-largest trading partner with the United States, and flooded its domestic market with imported merchandise. In 2006, Mexico’s trade deficit with China was a record $22.7 billion, but China has invested less than $100 million in the country since 1994, according to the Bank of Mexico.
Mexico’s trading relationship with India, albeit small, is much more balanced. Mexico’s trade deficit with India was just under half a billion dollars in 2006, and Indian companies have invested $1.6 billion here since 1994—or about 17 times more than China—according to Mexico’s central bank.
Some of that investment is in basic industries and traditional maquiladorafactories making goods for export. For example, Mexico’s biggest steel plant is owned by ArcelorMittal. Indian pharmaceutical companies, too, are finding Latin America to be attractive for expansion. Firms including Ranbaxy Laboratories, Ltd., Aurobindo Pharma, Ltd., and Cadila Pharmaceuticals, Ltd., have sales or manufacturing operations in the region.
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