S+B: Your third strategy, arbitrage, is usually associated with getting more labor for less money.
GHEMAWAT: I think of arbitrage as involving a broader range of factors. You can build arbitrage strategies around all four types of distances: cultural, administrative, geographic, and economic.
For instance, the Benihana company has one restaurant in Japan and a couple hundred in other parts of the world, primarily the U.S. The Japanese restaurant is in Tokyo, and it primarily serves Westerners who visit there. It’s really a form of performance art, customized to the U.S. market, wrapped up in a somewhat deceptive mantle of Japanese cooking. To most Japanese, there’s nothing Japanese about Benihana.
But at least there’s a connection, however tenuous, with Japan. The Häagen-Dazs brand was invented in the Bronx; its name is a sheer play on a fictitious cultural association. “It sounds Scandinavian, from a cold country; it must be pure stuff.” The brand was so successful that competitors like Frusen Glädjé followed, also with no direct Scandinavian link. That’s pure cultural arbitrage; it’s commanding a premium price through association with another culture, even though there’s no substantive connection with that culture.
Administrative arbitrage encompasses all the measures that companies take regarding taxes and regulations, including environmental regulations. Tax planning shows up, in anonymous surveys of multinational corporations, as a major factor in their geographic decisions — which is understandable given the huge variations in tax rates around the world. It’s also understandable when, say, tanneries move to less-developed countries because the environmental or health and safety regulations aren’t as strict. I don’t want to celebrate tax dodging or sweatshops, but just to point out that there’s still an awful lot of arbitrage around variations in regulations, both within countries and internationally.
S+B: Is administrative arbitrage feasible as a long-term strategy?
GHEMAWAT: There are some real “dos” and “don’ts” for companies. A multinational from an advanced country has to be particularly careful when running operations in countries where the health, safety, and environmental standards are more lax, not necessarily because it’ll get into trouble in that jurisdiction, but because of the reaction it may face at home.
An executive at a major manufacturer was telling me about the big problem they have in China: To compete cost-effectively, they have to ignore emissions. This company has spent 20 years trying to burnish its environmental credentials. The blowback to its worldwide reputation could be significant. And yet it feels it can’t afford to ignore China, because the market is so large.
Such considerations are, incidentally, one of the reasons for discounting the argument that established brands from industrial countries will tend to win. An India-based foundry is in a better position to take advantage of variations in environmental regulations than a Europe-based company that might be subject to massive challenges in its home market.
S+B: But couldn’t a European company up and move its headquarters to India?
GHEMAWAT: Well, there have been a few examples of companies moving to other nations. And companies may often threaten to move as a way of bargaining for lower tax rates or less onerous regulations. But actually moving is hard. The notion of the utterly footloose corporation is at variance with any careful look at the historical record.
When Accenture moved its headquarters to Bermuda, it must have seemed like a good idea. But if you’ve just relocated to a tax haven, you can’t bid as easily on government contracts. In 2004, a [US]$10 billion Homeland Security contract was held up for precisely this reason. Halliburton is currently moving its headquarters from Texas to Dubai, which makes sense given the number of Middle Eastern clients it has. But it will be interesting to see what negative repercussions arise in the U.S., especially given Halliburton’s high-level political connections.