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Why Uber Lost $1 Billion In China

Robert Salomon, Uber

With Robert Salomon, Professor at NYU Stern School of Business and author of Global Vision: How Companies Can Overcome the Pitfalls of Globalization

Today’s international marketplace, often perceived as operating in a “flat world,” actually contains many hills and valleys.  Robert Salomon, Professor at NYU Stern School of Business and author of Global Vision: How Companies Can Overcome the Pitfalls of Globalization, addresses these issues in this engaging interview with Steve.

Many high profile and successful companies, such as Ikea, Walmart, and Starbucks, have struggled to make a profit in foreign countries in large part because of cultural, political, and economic differences, which Professor Salomon refers to as “institutional distance”.  Uber’s enormous losses in China, France, and Spain are testament to this idea. Much greater than geographical distance, the concept of “institutional distance” explains why American companies fare better in Australia than in Mexico, in most cases.

The idea of a “flat world,” coined a few years ago by columnist Thomas Friedman, has turned out to have lost its validity since the inception of the global marketplace. Setting up a company in a foreign land without knowledge of that country’s practices—legal, cultural, and economic—is like planting an olive tree from the soil of Tuscany into the Sahara Desert.  It just won’t flourish.

Professor Salomon explains how the study and measurement of the differences inherent in any country led him to create global acumen, which is an algorithm allowing a company to assess risk to investment evaluation.

Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital.  Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.  Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances.  The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.

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Steve Pomeranz: Today’s international marketplace is now estimated to be in excess of $30 trillion a year.  Surprisingly, some of today’s most respected companies like Ikea, Walmart, and Starbucks have struggled to be profitable overseas.

How could companies with such highly successful and proven business models have so much trouble operating in foreign countries?

Robert Salomon, Professor of International Management, Faculty Scholar at NYU Stern School of Business has addressed this in his latest book.  It’s entitled Global Vision: How Companies Can Overcome the Pitfalls of Globalization.  Robert joins me.  Hi, Robert.  Welcome to the show.

Robert Salomon: Thanks for having me, Steve.

Steve Pomeranz: Let’s talk about some of the case studies in your book, specifically Ikea.  Let’s start with Ikea.  Ikea’s been in China for a pretty long time, or rather Russia for over 15 years.  What did they encounter there?

Robert Salomon: Yeah, just broadly, to kick off a discussion, the kinds of challenges that companies face in global markets tend to be cultural challenges, political challenges, and economic challenges.  For Ikea, the challenge that they encountered in Russia was one of corruption, one that is not just endemic to the business society, and endemic to the political environment, but it’s endemic to society at large.

When Ikea entered Russia, Ikea, being a Swedish company, they’re used to acting, or behaving very transparently as is the custom in the Swedish culture.  What they didn’t realize was just how much corruption there was in Russia and how much that would affect their business there.

Steve Pomeranz: You give an example of the utility company that was servicing Ikea.  Take us through that quickly.

Robert Salomon: Yeah, what had happened was it’s well known that in Russia that the energy supplies aren’t very reliable.  The electricity is often controlled by groups that are attached to some darker kinds of forces.  Let’s call them mafia kinds of sources, or sources in which corruption is rife.

Ikea thought, “Hey, look, we’re going to take care of this problem by getting generators.  This way, our generators will be able to power our stores and we won’t have any problems with the electric company should people try and hold us up for bribes.”

That’s what they went up and did.  What they found out was that 1 of their own employees, the employee who was in charge of purchasing the gas for their generators was actually involved in a kickback scheme and was caught up in corruption as well.

They were held up not in the electricity side, but in the gas side, in buying gas for their generators.  In trying to outsmart the system, they actually discovered that they were caught up with the problem in another way.

Steve Pomeranz: A local judge ruled against them and slapped them with a fine for breach of contract with the generator company.  What is Ikea’s hard-earned lesson here?

Robert Salomon: The hard-earned lesson here is that A, countries are very, very different around the world.  You have to understand the political, economic, and cultural environments that you’re going to operate in.

Not only that, but, in particular, you mentioned the judge that ruled against Ikea and forced them to pay a fine.  Realize that the rules, the laws are stacked against foreigners.  They’re stacked against you.  When you operate in a foreign environment, you are at a disadvantage.

Steve Pomeranz: What is the thinking?  I can just see managers and companies and boards looking at vast potential of customers.  You’re entering China, there’s billions of new purchasers.  There’s a rising middle class.  Let’s go into China and let’s partake in some of that growth.  They see the revenue side then they can figure out the cost side, the hard cost side.

I mean a factory’s going to cost this and that and this.  They’re missing another level of costs.  I think you’ve alluded to it before, the cultural costs.  Tell us about those.

Robert Salomon: Yeah, it’s exactly what you said, which is that when companies, and I speak to managers all the time.  I speak to executives who tell me, “Wow, how am I going to grow this business?  How am I going to meet Wall Street growth targets if I don’t grow internationally?”

That’s where the growth is.  They look to markets like China, as you mentioned, because they have over 1 billion consumers.  That promises the potential of massive growth rates.  The trouble is is that they tend to overestimate the benefits of that growth potential and underestimate the costs.

They know how much factories cost.  They know how much it costs to acquire land.  What they miss is all the cultural, political, and economic soft costs that go along with just educating yourself about this economy.

They don’t know how to deal with the right politicians, who the right politicians are.  They don’t have the right lawyers.  They don’t know how to deal with customers.  Their customers are different.  They don’t understand the culture of their customers.  They don’t understand the culture of their employees, how to motivate employees in this particular environment.

As I mentioned before, as with Ikea, they’re at a disadvantage in the political and legal environment as well.  All these things, all these costs add up.  A lot of executives, a lot of managers underestimate just how large those costs are.

Steve Pomeranz: I remember many, many years ago when Japanese cars were first coming in to the US, one of the cases that you always heard about was how they would come in slowly.  They’d learn their lesson sometimes the hard way, but they got to understand what the American consumer really wanted.  They were able to inculcate their culture and their product to fit that.

What I seem to be hearing here is that companies really are just barreling in and thinking, “Because I have a brand name like Walmart or Starbucks that I’m just going to be able to do business as usual.” Is that a correct assessment?

Robert Salomon:Yeah, that’s right.  I think a perfect example of that is Uber.  Uber has rolled out its business model almost intact from the United States into foreign markets, into China, into Europe without really thinking about, “What do we need to do?  How do we need to adapt our business model to this particular environment so that it fits this environment?  How can we learn over time?”

Uber just announced it’s losing more than $1 billion per year in China.  It’s been banned from France.  It’s been banned from several cities in Spain.

It’s funny you talked about the Japanese automobile manufacturers.  One of the things that they did particularly well when they entered the United States is that they entered at the low end of the market.

They entered with prices that were so much lower than the US automobile manufacturers because there was a incredible cost advantage that they had that they had time to make money and learn about the US environment along the way.

Steve Pomeranz: My guest is Robert Salomon.  He’s Professor of International Management and Faculty Scholar at NYU Stern School of Business.  His book is Global Vision; How Companies Can Overcome the Pitfalls of Globalization.

Another factor you bring up in your book is the case of Starbucks.  Starbucks is successful in Japan.  As a matter of fact, I think it’s Starbucks’ second largest market.  Their profits are significantly lower there.  This is another aspect.  They are able to do business, but they’re not as profitable.  What’s going on there?

Robert Salomon: Yeah, the interesting thing is that even those companies that do well in foreign markets generate lower levels of profitability in those foreign markets than they do in the United States.

Steve Pomeranz: Why?

Robert Salomon: There are these fantastic studies that show, for example, that operating margins for domestic companies in the United States are about 2 to 3 percentage points higher than for similar foreign companies.

The question, of course, you asked is why.  The why is for all those reasons that I talk about in the book.  It is costly to adapt your product for cultures you don’t understand.

It’s very, very costly to adapt to an economic environment that you don’t understand.  You have higher start up costs.  You have higher operational costs.  You have to tailor the products which make manufacturing the product more expensive for that local market.

In the case of Starbucks, like you mentioned, one result, an example in the context of Starbucks, is that they have average profitability 50% of what it is in the United States in Japan.

Steve Pomeranz: I thought the world was flat.  Remember Tom Friedman’s book saying because of technology, all places in the world, everybody was going to compete equally.  The world is flat, but I don’t think that’s the picture you’re painting here.

Robert Salomon: No.  I think that the more we learn, research is starting to tell us that the world isn’t nearly as flat as Thomas Friedman tends to suggest that it is.

One of my colleagues, in fact, shows that it’s so far from flat, in fact, that Thomas Friedman’s entire thesis really doesn’t hold up.  There’s tremendous difference across the world, differences in cultures, differences in languages, differences in religions, differences in economies, differences in law, and regulation, and politics.

Just look at what’s happening in the world right now.  All of the conflict that you see, for example, in the Middle East can be tied in one way, or some of it anyway, to religious differences.  There is tremendous difference that still exists throughout the world.  The world is far from flat.

Steve Pomeranz: You speak about something called institutional distance.  Some countries, there is the distance institutionally is small.  You wrote about Canada and the United States, Spain and Mexico, the United Kingdom and Australia.  In some countries the distance is great like China and the United States, India, Brazil, and Indonesia and Spain.  Take us through that a little bit.

If I’m a manager of a company, and I’m trying to go overseas, how do I know what the institutional distance is between myself and the country I want to do business in?

Robert Salomon: That’s a good question.  All these differences that I’ve been talking about, cultural differences, economic differences, political differences, all those combined make up what I like to call institutional differences.  When you look at countries, they are made up basically of cultural, political, and economic institutions.

If we look at countries as made up of these institutions, you can compare countries on those institutions and say, “How far is one country, or how different is one country in its institutional makeup from another?”

When you start to look at the world in that way, what you start to notice is things like the United States and Australia are actually institutionally very, very close even though they are geographically very far apart.  Why?  They have a common colonizer in the United Kingdom.  We both, the United States and Australia, we inherited a lot of institutions from the United Kingdom.

Even though Mexico is our neighbor to the south, the United States actually shares more institutionally, by that again I mean culturally, economically, and politically.  They share more in common with the UK and Australia than with Mexico.  That’s what I talk about in the book.  That’s what I mean by institutional distance.

The second part of that then is, “If we know that it’s these institutions on which countries differ, we can actually measure it.” There are measures out there for how much countries differ in language, in religion, in their social structure, which make up culture.

If you have measures on these things, you can actually take those measures and compare them across countries.  Once you do that, you can start now to have a mathematical expression of those institutional differences.  That’s what I call institutional distance.

Ultimately, what you can do is you can convert that into a risk spread that then can help managers price it, or take it into account; how that will affect their profitability in their global operations.

Steve Pomeranz: Yeah, that was listed in the book.  That was really quite good.  You also write about, I think you’re referring to global acumen which is the software you created.  I want to get to that in a minute.

I want to come back a little bit though, to those companies that have achieved success over the years.  One that comes to mind is Coca-Cola.  I think GM has attained some success in China.  What are those companies doing differently?

Robert Salomon: Yeah, when you look at companies, certainly there are companies that have been successful globally, no doubt.  Coca-Cola is one.  Coca-Cola, what it has going for it is its tremendously valuable and powerful brand name.  That’s one.

Another thing that it really has going for it is a marketing prowess that is almost second to none.  It knows how to manage relationships with vendors.  It can leverage those relationships in multiple countries.

When you look at General Motors, it’s slightly different.  General Motors’ success, for example, in China has a lot to do with the relationships that it struck in the Chinese market when it entered.  It struck very important relationships with local municipalities and political leaders, and with SAIC, which was a state-owned automobile manufacturer.

If I contrast GM with Uber, GM entered China the right way by building the right kinds of relationships.  Uber went into China thinking, “We can do this on our own.  We’re going to export our entire business model to China and we’re going to conquer the world.” It didn’t quite work out well for them.  GM knew that in order to do well in China, it needed local support.  It really went out and built relationships locally.

Steve Pomeranz: I guess companies go with the idea, “We’re going to change the world.” which is something you can actually pretty much do here in the States.  In a lot of cases, the world just really doesn’t want to change.  There are planted institutions and old relationships going back that are going to be extremely resistant to change.

My guest is Robert Salomon.  The book is Global Vision; How Companies Can Overcome the Pitfalls of Globalization.  To hear this audio and to also read the transcript of this interview, don’t forget to go to onthemoneyradio.org.

We’ve got about two minutes left, Robert.  What is global acumen?  How can people access it and use it?

Robert Salomon: Coming back to what we discussed before about institutional distance and how you can calculate it, global acumen is an algorithm that I created about 10 years ago that takes cultural, political, and economic measures from various countries all over the world and uses those measures to create a risk spread that is expressed in interest rate equivalents.

Steve Pomeranz: What does that mean, a risk spread?

Robert Salomon:  What it would tell you, for example, is that the risk between the United States and China is, let’s say 14% based on its institutional makeup.  What you would do is you can use that risk spread to apply to your investments and say, “If I am a corporation investing in China, I need an additional 14% return on investment in order to make this worthwhile given the risks.”

The algorithm was developed 10 years ago.  The user interface has just been built out in the last year or so.  In order to get access to it, or to learn more about it, people can feel free to contact me either via Twitter, which is @Robert Salomon.  That’s spelled S-A-L-O-M-O-N, or at my email, which is rsalomon@stern.nyu.edu.

Steve Pomeranz: The book is Global Vision; How Companies Can Overcome the Pitfalls of Globalization.  My guest, Robert Salomon.  As I said before, to hear this interview again, or to read the transcripts, don’t forget to go to onthemoneyradio.org.

Robert, it’s been a pleasure.  Thank you so much for sharing with us.

Robert Salomon: Thanks, Steve.  I really appreciate it.