Entering Foreign Markets

McGraw-Hill/Irwin Global Business Today, 5e

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Entering Foreign Markets

INTRODUCTION
A firm expanding internationally must decide: which markets to enter when to enter them and on what scale how to enter them (the choice of entry mode)

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Entering Foreign Markets

There are several options including:
exporting

licensing or franchising to host country firms

setting up a joint venture with a host country firm setting up a wholly owned subsidiary in the host country to serve that market

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Entering Foreign Markets

The advantages and disadvantages associated with each entry mode is determined by:
transport costs and trade barriers political and economic risks firm strategy While it may make sense for some firms to serve a market by exporting, other firms might set up a wholly owned subsidiary, or utilize some other entry mode.

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Entering Foreign Markets

BASIC ENTRY DECISIONS
There are three basic decisions that a firm contemplating foreign expansion must make: which markets to enter when to enter those markets on what scale

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Entering Foreign Markets

Which Foreign Markets?
The choice between different foreign markets is based on an assessment of their long run profit potential. Typically, the most favorable markets are those that are politically stable developed and developing nations that have free market systems, and where there is not a dramatic upsurge in either inflation rates, or private sector debt Those that are less desirable are politically unstable developing nations that operate with a mixed or command economy, or developing nations where speculative financial bubbles have led to excess borrowing Firms are more likely to be successful if they offer a product that has not been widely available in a market and that satisfies an unmet need

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Entering Foreign Markets

Timing of Entry
With regard to the timing of entry, we say that entry is early when an international business enters a foreign market before other foreign firms, and late when it enters after other international businesses have already established themselves in the market

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Entering Foreign Markets

The advantages associated with entering a market early are called first mover advantages, and include: the ability to pre-empt rivals and capture demand by establishing a strong brand name the ability to build up sales volume in that country and ride down the experience curve ahead of rivals and gain a cost advantage over later entrants the ability to create switching costs that tie customers into their products or services making it difficult for later entrants to win business
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Entering Foreign Markets

Disadvantages associated with entering a foreign market before other international businesses are referred to as first mover disadvantages and include:
Pioneering costs (costs that an early entrant has to bear that a later entrant can avoid)

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Entering Foreign Markets

Pioneering costs arise when a business system in a foreign country is so different from that in a firms home market that the enterprise has to devote considerable time, effort and expense to learning the rules of the game, and include:
the costs of business failure if the firm, due to its ignorance of the foreign environment, makes some major mistakes the costs of promoting and establishing a product offering, including the cost of educating the customers
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Entering Foreign Markets

Summary It is important to realize that there are no right decisions here, just decisions that are associated with different levels of risk and reward

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Entering Foreign Markets

Scale of Entry and Strategic Commitments The consequences of entering a market on a significant scale are associated with the value of the resulting strategic commitments (decisions that have a long term impact and are difficult to reverse) Deciding to enter a foreign market on a significant scale is a major strategic commitment that changes the competitive playing field Small-scale entry has the advantage of allowing a firm to learn about a foreign market while simultaneously limiting the firms exposure to that market
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Entering Foreign Markets

ENTRY MODES
These are six different ways to enter a foreign market. Exporting Most manufacturing firms begin their global expansion as exporters and only later switch to another mode for servicing a foreign market

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Entering Foreign Markets

Advantages Exporting avoids the substantial cost of establishing manufacturing operations in the host country Exporting may also help a firm achieve experience curve location economies

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Entering Foreign Markets

Disadvantages
There may be lower-cost locations for manufacturing abroad High transport costs can make exporting uneconomical Tariff barriers can make exporting uneconomical Agents in a foreign country may not act in exporters best interest

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Entering Foreign Markets

Turnkey Projects In a turnkey project, the contractor agrees to handle every detail of the project for a foreign client, including the training of operating personnel

At completion of the contract, the foreign client is handed the "key" to a plant that is ready for full operation

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Entering Foreign Markets

Advantages
Turnkey projects are a way of earning great economic returns from the know-how required to assemble and run a technologically complex process Turnkey projects make sense in a country where the political and economic environment is such that a longer-term investment might expose the firm to unacceptable political and/or economic risk
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Entering Foreign Markets

Disadvantages
By definition, the firm that enters into a turnkey deal will have no long-term interest in the foreign country The firm that enters into a turnkey project may create a competitor If the firm's process technology is a source of competitive advantage, then selling this technology through a turnkey project is also selling competitive advantage to potential and/or actual competitors
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Entering Foreign Markets

Licensing
A licensing agreement is an arrangement whereby a licensor grants the rights to intangible property to another entity (the licensee) for a specified time period, and in return, the licensor receives a royalty fee from the licensee

Intangible property includes patents, inventions, formulas, processes, designs, copyrights, and trademarks

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Entering Foreign Markets

Advantages
The firm does not have to bear the development costs and risks associated with opening a foreign market The firm avoids barriers to investment It allows a firm with intangible property that might have business applications, but which doesnt want to develop those applications itself, to capitalize on market opportunities

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Entering Foreign Markets

Disadvantages
The firm doesnt have the tight control over manufacturing, marketing, and strategy that is required for realizing experience curve and location economies Licensing limits a firms ability to coordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another There is the potential for loss of proprietary (or intangible) technology or property One way of reducing this risk is through the use of cross-licensing agreements where a firm might license intangible property to a foreign partner, but requests that the foreign partner license some of its valuable knowhow to the firm in addition to a royalty payment

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Entering Foreign Markets

Franchising
Franchising is basically a specialized form of licensing in which the franchisor not only sells intangible property to the franchisee, but also insists that the franchisee agree to abide by strict rules as to how it does business

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Chapter 12: Entering Foreign Markets

Advantages
The firm avoids many costs and risks of opening up a foreign market

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Entering Foreign Markets

Disadvantages Franchising may inhibit the firm's ability to take profits out of one country to support competitive attacks in another The geographic distance of the firm from its foreign franchisees can make poor quality difficult for the franchisor to detect

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Entering Foreign Markets

Joint Ventures A joint venture is the establishment of a firm that is jointly owned by two or more otherwise independent firms

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Entering Foreign Markets

Advantages
A firm can benefit from a local partner's knowledge of the host country's competitive conditions, culture, language, political systems, and business systems The costs and risks of opening a foreign market are shared with the partner Political considerations may make joint ventures the only feasible entry mode

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Entering Foreign Markets

Disadvantages
A firm risks giving control of its technology to its partner The firm may not have the tight control over subsidiaries that it might need to realize experience curve or location economies

Shared ownership can lead to conflicts and battles for control if goals and objectives differ or change over time

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Entering Foreign Markets

Wholly Owned Subsidiaries
In a wholly owned subsidiary, the firm owns 100 percent of the stock. Establishing a wholly owned subsidiary in a foreign market can be done two ways:

the firm can set up a new operation in that country the firm can acquire an established firm

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Entering Foreign Markets

Advantages
A wholly owned subsidiary reduces the risk of losing control over core competencies A wholly owned subsidiary gives a firm the tight control over operations in different countries that is necessary for engaging in global strategic coordination (i.e., using profits from one country to support competitive attacks in another) A wholly owned subsidiary maybe required if a firm is trying to realize location and experience curve economies
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Entering Foreign Markets

Disadvantage Firms bear the full costs and risks of setting up overseas operations

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Entering Foreign Markets

SELECTING AN ENTRY MODE
The optimal choice of entry mode involves trade-offs. Core Competencies and Entry Mode The optimal entry mode depends to some degree on the nature of a firms core competencies

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Entering Foreign Markets

The advantages and disadvantages of the various entry modes are shown in Table 1.

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Entering Foreign Markets

Technological Know-How
A firm with a competitive advantage based on proprietary technological know-how should avoid licensing and joint venture arrangements in order to minimize the risk of losing control over the technology If a firm believes its technological advantage is only transitory, or the firm can establish its technology as the dominant design in the industry, then licensing may be appropriate even if it does involve the loss of know-how
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Entering Foreign Markets

Management Know-How The competitive advantage of many service firms is based upon management know-how The risk of losing control over the management skills to franchisees or joint venture partners is not high, and the benefits from getting greater use of brand names is significant

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Entering Foreign Markets

Pressures for Cost Reductions and Entry Mode
The greater the pressures for cost reductions, the more likely a firm will want to pursue some combination of exporting and wholly owned subsidiaries This will allow it to achieve location and scale economies as well as retain some degree of control over its worldwide product manufacturing and distribution

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Entering Foreign Markets

GREENFIELD VENTURE OR ACQUISITION?
Should a firm establish a wholly owned subsidiary in a country by building a subsidiary from the ground up (greenfield strategy), or should it acquire an established enterprise in the target market (acquisition strategy)?

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Entering Foreign Markets

Pros and Cons of Acquisition
Benefits of Acquisitions Acquisitions have three major points in their favor: they are quick to execute acquisitions enable firms to preempt their competitors managers may believe acquisitions are less risky than greenfield ventures

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Entering Foreign Markets

Why Do Acquisitions Fail?
Acquisitions fail for several reasons: the acquiring firms often overpay for the assets of the acquired firm there may be a clash between the cultures of the acquiring and acquired firm attempts to realize synergies by integrating the operations of the acquired and acquiring entities often run into roadblocks and take much longer than forecast there is inadequate pre-acquisition screening
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Entering Foreign Markets

Reducing the Risks of Failure Problems can minimized: through careful screening of the firm to be acquired by moving rapidly once the firm is acquired to implement an integration plan

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Entering Foreign Markets

Pros and Cons of Greenfield Ventures
The main advantage of a greenfield venture is that it gives the firm a greater ability to build the kind of subsidiary company that it wants However, greenfield ventures are slower to establish Greenfield ventures are also risky

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Entering Foreign Markets

CRITICAL THINKING AND DISCUSSION QUESTIONS 1. Review the Management Focus on ING. ING chose to enter the U.S. financial services market via acquisitions rather than greenfield ventures. What do you think are the advantages to ING of doing this? What might the drawbacks be? Does this strategy make sense? Why?

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Answer
Answer: Most students will probably agree that INGs strategy of acquiring firms with a strong local presence makes sense. The company maintains the local management team and products, yet sells its own ING products as well. This strategy allows the company to act locally, while building a global name.

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Entering Foreign Markets

CRITICAL THINKING AND DISCUSSION QUESTIONS
2. Licensing propriety technology to foreign competitors is the best way to give up a firm's competitive advantage. Discuss.

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Answer
Answer: The statement is basically correct - licensing proprietary technology to foreign competitors does significantly increase the risk of losing the technology. Therefore licensing should generally be avoided in these situations. Yet licensing still may be a good choice in some instances. When a licensing arrangement can be structured in such a way as to reduce the risks of a firm's technological know-how being expropriated by licensees, then licensing may be appropriate. A further example is when a firm perceives its technological advantage as being only transitory, and it considers rapid imitation of its core technology by competitors to be likely. In such a case, the firm might want to license its technology as rapidly as possible to foreign firms in order to gain global acceptance for its technology before imitation occurs. Such a strategy has some advantages. By licensing its technology to competitors, the firm may deter them from developing their own, possibly superior, technology. And by licensing its technology the firm may be able to establish its technology as the dominant design in the industry. In turn, this may ensure a steady stream of royalty payments. Such situations apart, however, the attractions of licensing are probably outweighed by the risks of losing control over technology, and licensing should be avoided

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Entering Foreign Markets

CRITICAL THINKING AND DISCUSSION QUESTIONS 3. Discuss how the need for control over foreign operations varies with firms strategies and core competencies. What are the implications for the choice of entry mode?

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Answer
Answer: If a firms competitive advantage (its core competence) is based on control over proprietary technological know-how, licensing and joint venture arrangements should be avoided if possible so that the risk of losing control over that technology is minimized. For firms with a competitive advantage based on management know-how, the risk of losing control over the management skills to franchisees or joint venture partners is not that great. Consequently, many service firms favor a combination of franchising and subsidiaries to control the franchises within particular countries or regions. The subsidiaries may be wholly owned or joint ventures, but most service firms have found that joint ventures with local partners work best for controlling subsidiaries.
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Entering Foreign Markets

CRITICAL THINKING AND DISCUSSION QUESTIONS 4. A small Canadian firm that has developed some valuable new medical products using its unique biotechnology know-how is trying to decide how best to serve the European Community market. Its choices are given below. The cost of investment in manufacturing facilities will be a major one for the Canadian firm, but it is not outside its reach. If these are the firms only options, which one would you advise it to choose? Why? Manufacture the product at home and let foreign sales agents handle marketing. Manufacture the products at home but set up a wholly owned subsidiary in Europe to handle marketing. Enter into a strategic alliance with a large European pharmaceutical firm. The product would be manufactured in Europe by a 50/50 joint venture, and marketed by the European firm.
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Answer
Answer: If there were no significant barriers to exporting, then option (iii) would seem unnecessarily risky and expensive. After all, the transportation costs required to ship drugs are small relative to the value of the product. Both options (i) and (ii) would expose the firm to less risk of technological loss, and would allow the firm to maintain much tighter control over the quality and costs of the drug. The only other reason to consider option (iii) would be if an existing pharmaceutical firm could also give it much better access to the market and potentially access to its products and technology, and that this same firm would insist on the 50/50 manufacturing joint venture rather than agreeing to be a foreign sales agent. The choice between (i) and (ii) boils down to a question of which way will be the most effective in attacking the market. If a foreign sales agent can be found that is already quite familiar with the market and who will agree to aggressively market the product, the agent may be able to increase market share more quickly than a wholly owned marketing subsidiary that will take some time to get going. On the other hand, in the long run the firm will learn a great deal more about the market and will likely earn greater profits if sets up its own sales force.

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