Over the years, internationalization has been increasingly mentioned as the outward movement in an individual firm’s or larger corporation’s international operations. Enterprises no longer conduct their business activities just within their own country; they gradually reach the international market. However, in the process of penetrating foreign markets, they often face challenges and barriers that are not easily to overcome, such as language, regulation, currency, polity, or economic size. These barriers significantly impact on the activities of a business in a foreign country.
Pankaj Ghemawat categorized all barriers into four distances: cultural, geographic, political, and economic distances, which form CAGE framework. He emphasizes that the types of distances influence different businesses in different ways. For example, culture distance determines consumers’ product preferences while geographic distance influences the costs of transportation. Obviously, the future and the success of internationalization in any company depend heavily on the company’s ability to master and reduce barriers, specifically, the four distances. Any company that underestimates their importance or simply ignores the distances may incur a big loss, yet failure. In the retail industry, the failure of Wal-Mart in South Korea is a typical example.
After eight years of disappointing sales in South Korea, in 2005, the America’s largest retailer, Wal-Mart, announced to leave the country. A year later, the company quietly transferred all 16 of its South Korean stores to Shinsegae Group, a domestic retailer, for $882 million and officially withdrew from Kimchi (Olsen, 2006). While Wal-Mart has had impressive success in other foreign markets such as Canada, the United Kingdom, and Mexico, Wal-Mart experienced a shameful failure in South Korea, which is mainly because of its neglect in cultural and administrative distances.
Since the early 1990s, Wal-Mart has promoted its international expansion strategy to spread its power through the world. From the first appearance in the international market in 1991, the number of Wal-Mart stores outside of the United States increased to 1,587 in 2005, and reached to 5, 651 in January 2012 (Wal-Mart, 2012). In the late 1990s, South Korea, one of the world’s largest economies with a very large-growing retail sector, was absolutely one of Wal-Mart’s targets. In1998, Wal-Mart officially entered the South Korean market with a big hope to continue its successful dominance in the world’s retail industry. The company acquired four domestic retail stores, Makro and quickly opened up six new Wal-Mart stores. Joe Hatfield, Wal-Mart’s Asia CEO confidently stated: “Wal-Mart is committed to the Korean market for the long-term.”
Sadly, during eight years in South Korea, Wal-Mart was never on the top 4 of the national retail industry. By 2005, Wal-Mart accounted for only 4 percent, far less than the E-Mart chain of Shinsegae Group with 30 percent (Hun, 2006). For the retailers ranked by market share’s specification, see Appendix A. Unlike other industries, retail industry is still dominated by local players in most countries (Corstjens & La, 2012). South Korea is not an exception. Appendix B is another example of retailers’ sales by market shares in two years, 2003 and 2004. Not surprisingly, Wal-Mart was on the bottom of this list in which majority is domestic retailers such as, Lotte Mart, E Mart, and Hanaro. Wal-Mart’s growth rate was negative 2.4 percent, indicating a declining company. By 2005, Wal-Mart South Korea generated only $787 million in sales, which led to a big loss of $10 million (Olsen, 2006). On the last day in South Korea, Wal-Mart’s vice president, Michael Duke mentioned: “As we continue to focus on our effort where we can have the greatest impact on our growth strategy, it became increasingly clear that in South Korea’s current environment it would be difficult for us to reach the scale we desired.” The losses of Wal-Mart in the Korean market were very clear, but the company never publicly admitted the failure. Wal-Mart’s executives excused that the withdrawal from South Korea was to focus on the Chinese market (Hun, 2006). For many people, that was simply a failure. The company failed to adapt to a new environment, to realize social norms, and to connect social networks. Eight years in South Korea are long enough for Wal-Mart to realize that there are many administrative and cultural differences between South Korea and the United States, and that it should have localized its business sufficiently to be more suitable with Koreans. Clearly, ignoring cultural and administrative distance is the biggest mistake Wal-Mart made in South Korea, hence resulting to the failure.
Geographic distance and time difference used to be considered as the biggest barriers in international business. However, in the CAGE distance framework, Pankaj Chemawat pointed that cultural distance produces even larger effects on trade in recent years (Ghemawat, 2001). Cultural distance is defined “as the sum of factors creating, on the one hand, a need for knowledge, and on the other hand, barriers to the knowledge flow and hence also for other flow between the home and target country” (Buckley, 1999). In other words, it is differences in language, ethnicity, religious beliefs, and social norms.
In the case of Wal-Mart, the company clearly neglected Korean social norms and customs when doing business there. Most Korean shoppers are visual-oriented customers who appreciate well-organized flows, sophisticated atmosphere, eye-catching displays and shopping environment. To create a real market atmosphere, which is what Koreans like, many domestic stores even hired clerks to hawk new products with megaphones and offer samples to their customers (Hun, 2006). On the contrary, all 16 Wal-Mart stores in South Korea were much simpler; they were still warehouse format stores with concrete blocks, gray concrete floors, and wooden shelves like any Wal-Mart store in the United States. Apparently, applying its Western retail model to South Korea did not work simply because “Koreans hate warehouse format” (Chung Yong Jin, vice president of Shinsegae Group). It was not suitable for Korean tastes.
Not surprisingly, Wal-Mart was behind the local retailers in the knowledge of taste. Even in America, the style of Wal-Mart stores is not attractive to many customers as Conan O’Brien once said: “Wal-Mart’s in the news, Wal-Mart announced it is remodeling its stores to attract more upscale customers. Yeah. That’s right. Step one to attract upscale customers is take down the signs that say ‘Wal-Mart’.”
Ghemawat pointed that social norms, part of culture, are the deeply rooted system of unspoken principles that guide individuals in their everyday choices and interactions (Ghemawat, 2001). Understanding of a country’s social norms helps business to meet customers’ needs, which is crucial in the retail industry. In the United States, people usually go grocery shopping once or twice per week, thus they will buy in bulk. Korean shoppers, in contrast, have a habit of doing it daily to buy a smaller quantity, reflecting a social norm common in South Korea where the freshness and cleanliness of food are highly considered. Again, Wal-Mart ignored it. In all its stores, Korean consumers were offered a lot of dry and frozen food in larger packages. Perhaps, Wal-Mart believed that Koreans would do the same way like Americans do. It failed to understand Korean’s social norms. “The South Korean culture is very tied into markets; it is one of the largest countries that is deeply involved in local markets” (Gandolfi & Braun, 2008). That explains why most Korean consumers go to small local stores to purchase small units of fresh food rather than Wal-Mart stores.
The CAGE framework shows that products foods, beverages, and electrical appliances are strongly affected by cultural distance (Ghemawat, 2001). These products are also main products carried by Wal-Mart. Nevertheless, entering the Korean market with a degree of cultural arrogance, Wal-Mart mistakenly assumed that retail industry in general was not sensitive to culture. It expected Korean consumers to change their lifestyles and shopping habits while it might have been able to adapt to this country’s culture. Even though culture is not innate and can be learned, especially the current globalization tends to obscure a national culture; it does not mean that all cultural values of a country can be changed. For Koreans, food or shopping culture has been around for years and hence, may not be changed easily.
Even the Every Day Low Price strategy that has helped Wal-Mart increase sales in many countries, it was not attractive to Koreans. This is simply because of cultural distance. Indeed, business strategies in a country are culturally dependent, and what works in one country does not necessarily work in another. Korean consumers consider the quality of products. They believed: “a discount store meant that you sold cheap products at cheap prices” (Masao Kiuchi, Seiyu’s CEO). In Korean culture, high price is often associated with better quality. Moreover, they are very brand-loyal; thus, they will not switch to different brands easily. This strategy of Wal-Mart was just attractive to price-sensitive consumers in other countries, but definitely not in South Korea.
There is an old saying, “When in Rome, do as the Romans do.” But, for Wal-Mart, the global business model could be applied to everywhere, including South Korea. The failure of Wal-Mart mainly resulted from believing that there was a global culture to apply its global model. However, differences in lifestyle, beliefs, customs, and social norms still exist between American and South Korea. Of course, one-size cannot fit all and cultural distance still matters. If Wal-Mart had taken cultural distance into account, acted more locally, and had extensive adaptions to the cultural norms, it would have succeeded in the Korean market.
Beside cultural distance, a great administrative distance was another important barrier that significantly impacted Wal-Mart in South Korea. Administrative (or political) distance relates essentially to history, membership of different political, economic or monetary unions, government policies, and potential hostility (Ghemawat, 2001). Wal-Mart appeared not to seriously consider administrative distance.
Wal-Mart’s huge mistake was underestimating the power of small and medium scale local manufacturers as well as ignoring administrative and political issues.
One of the decisive factors for Wal-Mart’s move into the Korean market was the establishment of the Foreign Investment Promotion Act in 1998. The South Korean government claimed that the Act would provide foreign investors supports, and special benefits. By doing so, the government hoped to promote foreign investment and to control the consequences of the 1997 financial crisis. Initially, the policies made positive signs. For example, from $25 billion in1962-1997, the country’s total volume of FDI remarkably increased to $40 billion in 1998-2000 (Ahn, 2008).
Since the liberalization of FDI started, more global retailers came to South Korean, making the national retail market more competitive. Many small and medium scale manufacturers became more concerned about the increased bargaining power and unfair trade practices of large-scale food retailers. In 2001, the Fair Trade Commission of Korea ordered these retailers to stop the unfair trade practices and fined many of them. Wal-Mart alone was imposed $1.6 million fine and ordered to publicly announce that it had violated the fair trade law (Dodd, 2008).
Also, the lack of transparency and the inefficiency of the Korean government policies in the late of 1990s increased administrative distance. According to economists Jeffrey Frankel and Andrew Rose, a common government policy increases trade by 300 percent (Ghemawat, 2001). Truly, a company will find difficult to conduct cross-border economic activities in a foreign country that has different government policies. That was what happened to Wal-Mart. The Korean government insisted that it would give tax incentives such as, reduction on corporation income tax, income tax exemption, and reduction on taxes relating to the registration of assets, in fact, foreign businesses paid many unreasonable taxes. According to a 1998 survey by the Korean Chamber of Commerce and Industry, several foreign retailers, including Wal-Mart complained about the inefficiency of local taxation policy that levied huge amounts of taxes on real estates in Seoul.
Undoubtedly, administrative distance will be larger if the institutional environment of a country is weak. This can be a source of uncertainty, which will significantly impact the choice of investment (Angue & Mayrhofer, 2010). In the early 2000s, the institutional environment of South Korea was not strong as it is today. Laws, regulations, administrative procedures, and policies developed by the government back then were complex and ineffective. When Wal-Mart sold products at low prices, some domestic retailer followed by lowering their product prices. However, the government had very little involvement in stopping it. The government still favored domestic competitors. It is also necessary to say that the domestic retailers lowered prices and aggressively protected their business culturally. Even if the government had intervened by more strict regulations, there would not have had many improvements. Laws, regulations, or rules can control social problems but not easily change cultural issues.
Moreover, the Korean government did not create a fair competitive business environment for foreign companies. The liberalization of foreign direct investment process was implemented in 1998. In fact, the government had started it in 1989. Between 1989 and 1998, it allowed domestic companies to secure lands at good prices for their future plans (Ramstad, 2006). By the time foreign companies like Wal-Mart entered the Korean market, the retail market in this country had been already saturated. In an international market, a company will not avoid facing barriers. There is no doubt that they significantly affect a company’s business activities. It does not mean that there is no way to overcome them. Ghemawat suggested three solutions to add value in a world where differences still matter: adaptation, aggregation, and arbitrage. Indeed, if Wal-Mart had adapted to local culture, it would probably have satisfied Korean consumers. And if Wal-Mart had had an administrative arbitrage strategy that encompasses all measures related to taxes, regulations, and policies, it could have minimized the losses (Ghemawat). The failure of Wal-Mart in South Korea is a valuable lesson for any company that is doing or plans to expand business internationally.

References

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