Modes of entry into foreign market

It is a strategic decision, its implications will have long term effect on the growth and profitability of firm The company may have to adopt different modes to enter in different foreign markets These modes can be trade mode, contractual entry mode or investment mode

Factors affecting entry modes

Corporate objective
If co. wants complete control over production then trade mode is suitable If co. wants to expand its production activities to other nations to get the benefit of cheap factors of production then investment mode is better

Resources of parent company

If resources of the company are sufficiently large then investment mode is suitable Resources includes financial resources, human resources, managerial capability, technology, R&D, brand image etc.

 Environment of host nation

Political , cultural, legal, economic environment affects mode of entry If environment of host nation is supportive then investment mode is selected If market of host nation is small then trade mode is suitable

Cost of factors of production

Factors of production includes raw material, labour, machines etc If it is low then investment mode is better If raw material is cheap in host nation then investment mode is better

 Infrastructure of host nation

It includes roads, railways, ports, electricity, warehouses, intermediaries etc If infrastructure is good then investment mode is better China has highly developed infrastructure

Level of risk
Risk is more in investment mode as compared to trade mode If company can bear risk than it should go for investment mode otherwise trade mode is suitable

Modes of entry in foreign market

Modes of entry

Trade mode

Contractual entry mode

Investment mode

Trade mode
Direct and Indirect export
In direct export company sells its product directly to the consumers on its own or through agent Exporter bears the risk It is suitable when products are industrial goods or are costly In indirect export product is not sold to end users It is sold to distributors or middlemen In indirect export middlemen bears the risk Export management company

 Counter trade
Import as a condition of export Goods of equal value are exported and imported between two nations Bilateral trade agreement that other country will also import products of same value This does not require foreign exchange It is a type of barter trade

Types of counter trade

Types of counter trade

Barter Trade

Counter Purchase

Offset

Compensation

Switch trading

Clearing agreement

 Barter Trade
Simplest form of counter trade Export and import takes place simultaneously or within a specific time period Some nations may have to import goods which are not of much significance

Counter purchase
A firm agrees to purchase specific goods from country to which sales are made in a specific time period Money exchange takes place in accounting books only, in reality money doesnt change hands

 Offset
In this agreement a firm agrees to purchase goods from the country to which sales are made It is similar to counter purchase agreement except that in counter purchase agreement the exporter has to buy specific goods only In offset the exporter is free to import any goods It provides flexibility to the exporter

Compensation
It is also known as buy-back agreement Business unit of one nation helps to build a factory in other nation by providing capital or technology or both In return the exporter agrees to accept a specific percentage of output of the same factory

 Switch trading
Exporter is given counter purchase credits in consideration of goods sold by him These credits can be sold to any third party at some discount The third party can use these credits to import something

Clearing agreement
Exporter and importer maintains clearing accounts in the central banks of two nations The export and import takes place with no currency transactions The exporter doesnt receive any payment from importer, rather it receives payment from its central bank in its domestic currency The importer makes payment to its central bank in his own currency The central banks acts as clearing houses

Contractual Mode
When a company has developed technology through its own efforts, it can sell technology to other nations to cover R & D cost or to earn profit Technology can be sold by charging lump sum or through royalty These contracts are for specific period and for specific geographical location This mode is adopted when company having technology doesnt have sufficient funds/ size of host market is small or direct investment is banned

Types of contractual modes

Types of contractual modes

Licensing and
Franchising

Management
Contracting

Turnkey
Projects

Licensing and Franchising

Licensing
Business unit of one nation (licensor) allows the business unit of other nation (licensee) to use its technological know how for a given time period Licensor charges royalty for this which may vary from 5% - 8% of sales Licensor makes maximum utilization of intellectual property Licensee too makes profit

 Franchising
Business unit of one nation (Franchisor) grants rights to do business in a particular manner to the business unit of other nation (Franchisee) It may include selling the product in the name of franchisor, the key components are provided by franchisor Example Pepsi & Coca Cola

 Management Contracting
Parent organisation of one country sets up management agencies in host nation Parent organisation manages the business unit of host country without any ownership or capital investment Some fee can be charged for this purpose either in the form of percentage of profit or in lump sum

 Turnkey Project
Business unit of one nation (licensor) agrees to construct entire plant for the business unit of other country (licensee) Licensor possesses the technical skills, expertise and experience in constructing such plants Licensor either charges in lump sum or a fixed percentage of the total cost of project Licensee gets the benefit of world class design Licensee also gets technological support if needed in future

Investment Mode
Investment Mode

Foreign Direct Investment

Mergers & Acquisitions

Strategic Alliance

Foreign Direct Investment (FDI)

FDI is made by foreign companies in order to establish wholly owned companies in other country Company can buy shares of host company for the purpose of managing the host company New companies may be set up in host nation by foreign company (wholly owned subsidiary) New company may be set up jointly by foreign company and host company

 FDI can be horizontal or vertical In horizontal FDI parent company invests in same type of industry in the foreign nation Vertical FDI can be backward (supplies) or forward (using the end product)

Mergers & Acquisitions

Business unit of parent company joins hands with the existing company operating in host nation It helps in getting better knowledge of business environment of host nation Mergers can be horizontal, vertical or conglomerate In case of horizontal merger a company performing similar activities, producing almost similar products collaborate with each other It allows large scale production and hence economies of scale

 Vertical mergers and acquisition occur when business unit collaborate with suppliers of inputs or components It reduces uncertainty in supply of inputs or components In conglomerate merger two business units engaged in different unrelated activities collaborate with each other It reduces risk through diversification

 Strategic Alliance
Entered between two business units for achieving a specific goal like setting up common R & D unit, providing training to employees, common customer service center Sometimes strategic alliance is done to enter foreign market Both business units maintain their identity Little interference in working of each other This mode provides easy exit Toyota and General Motors

Advantages of Investment mode

Overcoming tariff and non tariff barriers Benefit of cheap local resources Saving in transportation cost Benefit of polycentric mode
Setting up different production centers in different nations Consumer choices are heterogeneous worldwide Through investment mode products that suits local tastes and preferences can be made

Risk diversification Strengthens political ties Long term investment

Advantages of trade mode

Economies of scale Needs lesser resources
Trade mode doesnt require investment in other nations

Suitable for universal products

Calculators, watches, printers, computers etc Such products can be manufactured at one place

Suitable in nations where business environment is unpredictable Easy exit Entry for short period Control over technology Employment generation in home country