Qn1 (two questions are problems)Qn2: Spot and forward exchange
rate def's, you ll get in investopedia, u have detailed examples
online.300 Part Four Global Money System,
Spot Exchange Rates When two parties agree to exchange currency
and executethe deal immediately, the transaction is referred to as
a spot exchange . Exchange ratesgoverning such on the spot trades
are referred to as spot exchange rates. The spotexchange rate is
the rate at which a foreign exchange dealer converts one currency
intoanother currency on a particular day. Thus, when our U.S.
tourist in Edinburgh goes toa bank to convert her dollars into
pounds, the exchange rate is the spot rate for that day.Spot
exchange rates are reported on a real-time basis on many financial
web sites.Table 9.1 shows the exchange rates for a selection of
currencies traded in theNew York foreign exchange market as of 2:25
p.m., on March 27, 2006. An exchangerate can be quoted in two ways:
as the amount of foreign currency one U.S. dollar willbuy, or as
the value in dollars of one unit of foreign currency. Thus, one
U.S. dollar bought0.8327 on March 27, 2006, and one euro bought
$1.2009 US dollars.Spot rates change continually, often on a
minute-by-minute basis (although the magnitudeof changes over such
short periods is usually small). The value of a currency
isdetermined by the interaction between the demand and supply of
that currency relativeto the demand and supply of other currencies.
For example, if lots of people want U.S.
HedgingThe process of insuring ones business against foreign
exchange risk byusing forward exchanges or currency swaps.
Understand what is meant by spot exchange rates.
Spot Exchange Rate:-
The rate at which a foreign exchange dealer converts currency on
any particular day.Using insurance to protect against forward
exchange rates helps companies hedge against financial risk.
Daisuke Morita/Getty Images/DIL
Currency U.S. $ en Euro Can $ UK AU $ Swiss Franc
1 U.S. $ _ 1 116.6800 0.8327 1.1694 0.5723 1.4180 1.30921 en _
0.008570 1 0.007137 0.010022 0.004905 0.012153 0.0112211 euro _
1.2009 140.1210 1 1.4043 0.6873 1.7029 1.57231 Can $ _ 0.8551
99.7777 0.7121 1 0.4894 1.2126 1.11961 UK _ 1.7474 203.8809 1.4550
2.0434 1 2.4778 2.28771 AU $ _ 0.7052 82.2827 0.5872 0.8247 0.4036
1 0.92331 Swiss franc _ 0.7638 89.1197 0.6360 0.8932 0.4371 1.0831
1
Spot Exchange Rates at 2:25 p.m., March 27, 2006Source: Yahoo!
Finance.300 Part Four Global Money System
dollars and dollars are in short supply, and few people want
British pounds and poundsare in plentiful supply, the spot exchange
rate for converting dollars into pounds willchange. The dollar is
likely to appreciate against the pound (or the pound will
depreciateagainst the dollar). Imagine the spot exchange rate is 1
_ $1.50 when the market opens.As the day progresses, dealers demand
more dollars and fewer pounds. By the end of theday, the spot
exchange rate might be 1 _ $1.48. Each pound now buys fewer
dollarsthan at the start of the day. The dollar has appreciated,
and the pound has depreciated.
Forward Exchange Rates As we saw in the opening case, changes in
spot exchangerates can be problematic for an international
business. For example, a U.S. company thatimports laptop computers
from Japan knows that in 30 days it must pay yen to a
Japanesesupplier when a shipment arrives. The company will pay the
Japanese supplier 200,000for each laptop computer, and the current
dollar/yen spot exchange rate is $1 _ 120. Atthis rate, each
computer costs the importer $1,667 (i.e., 1,667 _ 200,000_120). The
importerknows she can sell the computers the day they arrive for
$2,000 each, which yieldsa gross profit of $333 on each computer
($2,000 _ $1,667). However, the importer willnot have the funds to
pay the Japanese supplier until the computers have been sold.
Ifover the next 30 days the dollar unexpectedly depreciates against
the yen, say, to $1 _95, the importer will still have to pay the
Japanese company 200,000 per computer, butin dollar terms that
would be equivalent to $2,105 per computer, which is more than
shecan sell the computers for. A depreciation in the value of the
dollar against the yen from$1 _ 120 to $1 _ 95 would transform a
profitable deal into an unprofitable one.To insure or hedge against
this risk, the U.S. importer might want to engage in a
forwardexchange. A forward exchange occurs when two parties agree
to exchangecurrency and execute the deal at some specific date in
the future. Exchange rates governingsuch future transactions are
referred to as forward exchange rates. For most majorcurrencies,
forward exchange rates are quoted for 30 days, 90 days, and 180
days into thefuture. In some cases, it is possible to get forward
exchange rates for several years intothe future. Returning to our
computer importer example, let us assume the 30-dayforward exchange
rate for converting dollars into yen is $1 _ 110. The importer
entersinto a 30-day forward exchange transaction with a foreign
exchange dealer at this rateand is guaranteed that she will have to
pay no more than $1,818 for each computer(1,818 _ 200,000_110).
This guarantees her a profit of $182 per computer ($2,000 _$1,818).
She also insures herself against the possibility that an
unanticipated change inthe dollar/yen exchange rate will turn a
profitable deal into an unprofitable one.In this example, the spot
exchange rate ($1 _ 120) and the 30-day forward rate($1 _ 110)
differ. Such differences are normal; they reflect the expectations
of theforeign exchange market about future currency movements. In
our example, the factthat $1 bought more yen with a spot exchange
than with a 30-day forward exchangeindicates foreign exchange
dealers expected the dollar to depreciate against the yen inthe
next 30 days. When this occurs, we say the dollar is selling at a
discount on the30-day forward market (i.e., it is worth less than
on the spot market). Of course, theopposite can also occur. If the
30-day forward exchange rate were $1 _ 130, for example,$1 would
buy more yen with a forward exchange than with a spot exchange.
Insuch a case, we say the dollar is selling at a premium on the
30-day forward market.This reflects the foreign exchange dealers
expectations that the dollar will appreciateagainst the yen over
the next 30 days.In sum, when a firm enters into a forward exchange
contract, it is taking out insuranceagainst the possibility that
future exchange rate movements will make a transactionunprofitable
by the time that transaction has been executed. Although many firms
routinelyenter into forward exchange contracts to hedge their
foreign exchange risk, thereare some spectacular examples of what
happens when firms dont take out this insurance.
LEARNING OBJECTIVE 3
Appreciate the role that forward exchange rates play in insuring
against foreign exchange risk.
Forward Exchange Rate
The exchange rate governing forward exchange transactions,
calculated at the time ofthe exchange but based on future
expectations.
Forward ExchangeWhen two parties agree to exchange currency and
execute a deal at some specific date in the future.
Chapter Nine The Foreign Exchange Market 301
One such example was given in the opening case, which looked at
STMicro. Another isgiven in the Management Focus box above, which
explains how a failure to fully insureagainst foreign exchange risk
cost South African Airlines $1.05 billion.
Qn3: Value creation can be googled Value Creation 362Value
CreationPerforming activities that increase the value of goods or
services to consumers.
VALUE CREATION The way to increase the profitability of a firm
is to createmore value. The amount of value a firm creates is
measured by the difference betweenits costs of production and the
value that consumers perceive in its products. See theAnother
Perspective box below. In general, the more value customers place
on a firmsproducts, the higher the price the firm can charge for
those products. However, theprice a firm charges for a good or
service is typically less than the value placed on thatgood or
service by the customer. This is because the customer captures some
of thatvalue in the form of what economists call a consumer surplus
. 3 The customer is able todo this because the firm is competing
with other firms for the customers business, sothe firm must charge
a lower price than it could were it a monopoly supplier. Also, itis
normally impossible to segment the market tosuch a degree that the
firm can charge eachcustomer a price that reflects that
individualsassessment of the value of a product, whicheconomists
refer to as a customers reservation price .For these reasons, the
price that gets chargedtends to be less than the value placed on
theproduct by many customers.Figure 11.2 illustrates these
concepts. Thevalue of a product to an average consumer is V;the
average price that the firm can charge aconsumer for that product
given competitivepressures and its ability to segment the market
isP; and the average unit cost of producing thatproduct is C (C
comprises all relevant costs,including the firms cost of capital).
The firmsprofit per unit sold (_) is equal to P _ C, whileSell More
inExisting MarketsAdd Value andRaise PricesProfitabilityProfit
GrowthEnterpriseValuationReduce CostsEnter NewMarketsAnother
PerspectiveEducation as a Part of Your Value ChainThe concept of
value chain can be used to examine therole your undergraduate
education plays in your life plans.If you look closely at your
personal development plans(education, internship, physical and
emotional/spiritualfitness, extracurricular activities) and think
about themin terms of primary and support activities, how does
yourchoice of major fit into your personal development strategy?How
do your choices of how you spend your time fitinto your value
chain? Do you ever spend time doing thingsthat dont support the
strategic goals of your personalvalue chain?figure 11.1Determinates
of Enterprise ValueChapter Eleven The Strategy of International
Business 363the consumer surplus per unit is equal to V _ P
(another way of thinking of theconsumer surplus is as value for the
money; the greater the consumer surplus, thegreater the value for
the money the consumer gets). The firm makes a profit solong as P
is greater than C, and its profit will be greater the lower C is
relative to P.The difference between V and P is in part determined
by the intensity of competitivepressure in the marketplace; the
lower the intensity of competitive pressure,the higher the price
charged relative to V. 4 In general, the higher the firms profitper
unit sold is, the greater its profitability will be, all else being
equal.The firms value creation is measured by the difference
between V and C (V _ C);a company creates value by converting
inputs that cost C into a product on whichconsumers place a value
of V. A company can create more value (V _ C) either bylowering
production costs, C, or by making the product more attractive
throughsuperior design, styling, functionality, features,
reliability, after-sales service, and thelike, so that consumers
place a greater value on it (V increases) and, consequently,
arewilling to pay a higher price (P increases). This discussion
suggests that a firm has highprofits when it creates more value for
its customers and does so at a lower cost. We refer to astrategy
that focuses primarily on lowering production costs as a low-cost
strategy. Werefer to a strategy that focuses primarily on
increasing the attractiveness of a productas a differentiation
strategy. 5 MTV primarily focuses on the differentiation side of
thisequation; it tried to differentiate itself from rivals through
more compellingprogramming.Michael Porter has argued that low cost
and differentiation are two basic strategies forcreating value and
attaining a competitive advantage in an industry. 6 According
toPorter, superior profitability goes to those firms that can
create superior value, and theway to create superior value is to
drive down the cost structure of the business ordifferentiate the
product in some way so that consumers value it more and are
preparedto pay a premium price. Superior value creation relative to
rivals does not necessarilyrequire a firm to have the lowest cost
structure in an industry, or to create the mostvaluable product in
the eyes of consumers. However, it does require that the gapbetween
value (V) and cost of production (C) be greater than the gap
attained bycompetitors.Qn4: Countertrade is like a barter system.
Sell goods and you ll get goods in return. google
Chapter Thirteen Exporting, Importing, and Countertrade 437
CountertradeCountertrade is an alternative means of structuring
an international sale when conventionalmeans of payment are
difficult, costly, or nonexistent. We first encounteredcountertrade
in Chapter 9 in our discussion of currency convertibility. A
governmentmay restrict the convertibility of its currency to
preserve its foreign exchange reservesso they can be used to
service international debt commitments and purchase crucialimports.
17 This is problematic for exporters. Nonconvertibility implies
that theexporter may not be paid in his or her home currency; and
few exporters would desirepayment in a currency that is not
convertible. Countertrade is a common solution. 18Countertrade
denotes a whole range of barterlike agreements; its principle is to
tradegoods and services for other goods and services when they
cannot be traded for money.Some examples of countertrade are An
Italian company that manufactures power-generating equipment, ABB
SAESadelmi SpA, was awarded a 720 million baht ($17.7 million)
contract by theElectricity Generating Authority of Thailand. The
contract specified that thecompany had to accept 218 million baht
($5.4 million) of Thai farm products aspart of the payment. Saudi
Arabia agreed to buy 10 747 jets from Boeing with payment in crude
oil,discounted at 10 percent below posted world oil prices. General
Electric won a contract for a $150 million electric generator
project inRomania by agreeing to market $150 million of Romanian
products in markets towhich Romania did not have access. The
Venezuelan government negotiated a contract with Caterpillar under
whichVenezuela would trade 350,000 tons of iron ore for Caterpillar
earthmovingequipment. Albania offered such items as spring water,
tomato juice, and chrome ore inexchange for a $60 million
fertilizer and methanol complex. Philip Morris ships cigarettes to
Russia, for which it receives chemicals that can beused to make
fertilizer. Philip Morris ships the chemicals to China, and in
return,China ships glassware to North America for retail sale by
Philip Morris. 19THE INCIDENCE OF COUNTERTRADE In the modern era,
countertradearose in the 1960s as a way for the Soviet Union and
the Communist states of EasternEurope, whose currencies were
generally nonconvertible, to purchase imports. Duringthe 1980s, the
technique grew in popularity among many developing nations
thatlacked the foreign exchange reserves required to purchase
necessary imports. Today,reflecting their own shortages of foreign
exchange reserves, some successor states tothe former Soviet Union
and the Eastern European Communist nations periodicallyengage in
countertrade to purchase their imports. Estimates of the percentage
ofworld trade covered by some sort of countertrade agreement range
from highs of8 and 10 percent by value to lows of around 2 percent.
20 The precise figure is unknown,but it may well be at the low end
of these estimates given the increasing liquidity ofinternational
financial markets and wider currency convertibility. However,
periodicfinancial crises can be followed by short-term spikes in
the volume of countertrade.For example, countertrade activity
increased notably after the Asian financial crisis of1997. That
crisis left many Asian nations with little hard currency to
financeinternational trade. In the tight monetary regime that
followed the crisis in 1997,many Asian firms found it difficult to
get access to export credits to finance their owninternational
trade. Thus, they turned to the only option available to
them:countertrade.
LEARNING OBJECTIVE 5
Define countertrade and its three major types.
Countertrade
The trade of goods and services for other goods and services via
a whole range of barter like agreements.
Chapter Thirteen Exporting, Importing, and Countertrade 439
Given that countertrade is a means of financinginternational
trade, albeit a relatively minor one,prospective exporters may have
to engage in thistechnique from time to time to gain access
tocertain international markets. The governmentsof developing
nations sometimes insist on a certainamount of countertrade. 21 For
example, all foreigncompanies contracted by Thai state agenciesfor
work costing more than 500 million baht($12.3 million) are required
to accept at least30 percent of their payment in Thai
agriculturalproducts. Between 1994 and mid-1998, foreignfirms
purchased 21 billion baht ($517 million) inThai goods under
countertrade deals. 22
TYPES OF COUNTERTRADE With itsroots in the simple trading of
goods and servicesfor other goods and services, countertrade
hasevolved into a diverse set of activities that can becategorized
as five distinct types of trading arrangements:barter,
counterpurchase, offset, switchtrading, and compensation or
buyback. 23 Manycountertrade deals involve not just one
arrangement, but elements of two or more.Barter Barter is the
direct exchange of goods or services between two parties withouta
cash transaction. Although barter is the simplest arrangement, it
is not common.Its problems are twofold. First, if goods are not
exchanged simultaneously, one partyends up financing the other for
a period. Second, firms engaged in barter run the riskof having to
accept goods they do not want, cannot use, or have difficulty
reselling ata reasonable price. For these reasons, barter is viewed
as the most restrictive countertradearrangement. It is primarily
used for one-time-only deals in transactions withtrading partners
who are not creditworthy or trustworthy. See the Another
Perspectiveabove for bartering in charitable giving.Counterpurchase
Counterpurchase is a reciprocal buying agreement. It occurswhen a
firm agrees to purchase a certain amount of materials back from a
country towhich it made a sale. Suppose a U.S. firm sells some
products to China. China paysthe U.S. firm in dollars, but in
exchange, the U.S. firm agrees to spend some of itsproceeds from
the sale on textiles produced by China. Thus, although China
mustdraw on its foreign exchange reserves to pay the U.S. firm, it
knows it will receivesome of those dollars back because of the
counterpurchase agreement. In one counterpurchaseagreement,
Rolls-Royce sold jet parts to Finland. As part of the
deal,Rolls-Royce agreed to use some of the proceeds from the sale
to purchase FinnishmanufacturedTV sets that it would then sell in
Great Britain.Offset An offset is similar to a counterpurchase
insofar as one party agrees topurchase goods or services with a
specified percentage of the proceeds from the originalsale. The
difference is that this party can fulfill the obligation with any
firm in thecountry to which it made the sale. From an exporters
perspective, this is moreattractive than a straight counter
purchase agreement because it gives the exportergreater flexibility
to choose the goods that it wishes to purchase.Switch Trading The
term switch trading refers to the use of a specializedthird-party
trading house in a countertrade arrangement. When a firm enters
a
Another Perspective
Corporate America Takes to Barter in Making
Charitable ContributionsWe all know and hear about corporations
giving away theirproducts to communities, nonprofit organizations,
schools,colleges, charities, and religious groups, and we see it
asthem fulfilling their corporate social responsibility or
perhapsas a way to enhance and promote their corporateimage.
According to a recent survey by the ConferenceBoard, a New York
business research think tank, for thefirst time ever, a bit more
than half of all charitable contributions54.2 percentwere in
merchandise, not cash.Why merchandise and not cash? Answer:
Congress passeda tax provision in 1976 that allows major
corporations todeduct up to double their manufacturing costs when
theirproducts go to organizations that serve the ill, needy,
orminor children. Also, it is a method to reduce inventories
ofunwanted goods. Thus, product philanthropy was
born.(www.barternews.com/archive/12_13_05.htm)BarterThe direct
exchange of goods or services between two parties without a
cashtransaction.Counte rpurchaseWhen a firm agrees to purchase a
certain amount of materials back from a country to which it made a
sale.OffsetWhen a firm agrees to purchase goods or services from
any firm within the country to which it made a sale.Switch
TradingUsing a specialized third-party trading house in a
countertrade agreement.
440 Part Five Competing in the Global Marketplace
Counter purchase or offset agreement with a country, it often
ends up with what arecalled counter purchase credits , which can be
used to purchase goods from that country.Switch trading occurs when
a third-party trading house buys the firms counter purchasecredits
and sells them to another firm that can better use them. For
example, aU.S. firm concludes a counter purchase agreement with
Poland for which it receivessome number of counter purchase credits
for purchasing Polish goods. The U.S. firmcannot use and does not
want any Polish goods, however, so it sells the credits to
athird-party trading house at a discount. The trading house finds a
firm that can usethe credits and sells them at a profit.In one
example of switch trading, Poland and Greece had a counter
purchaseagreement that called for Poland to buy the same
U.S.-dollar value of goods fromGreece that it sold to Greece.
However, Poland could not find enough Greek goodsthat it required,
so it ended up with a dollar-denominated counter purchase balance
inGreece that it was unwilling to use. A switch trader bought the
right to 250,000Counter purchase dollars from Poland for $225,000
and sold them to a European sultana(grape) merchant for $235,000,
who used them to purchase sultanas from Greece.
Compensation or Buybacks A buyback occurs when a firm builds a
plant in acountryor supplies technology, equipment, training, or
other services to the countryand agrees to take a certain
percentage of the plants output as partial paymentfor the contract.
For example, Occidental Petroleum negotiated a deal with
Russiaunder which Occidental would build several ammonia plants in
Russia and as partialpayment receive ammonia over a 20-year
period.
THE PROS AND CONS OF COUNTERTRADE Countertrades mainattraction
is that it can give a firm a way to finance an export deal when
other meansare not available. Given the problems that many
developing nations have in raising theforeign exchange necessary to
pay for imports, countertrade may be the only optionavailable when
doing business in these countries. Even when countertrade is not
theonly option for structuring an export transaction, many
countries prefer it to cashdeals. Thus, if a firm is unwilling to
enter a countertrade agreement, it may lose anexport opportunity to
a competitor that is willing to make a countertrade agreement.In
addition, a countertrade agreement may be required by the
government of acountry to which a firm is exporting goods or
services. Boeing often has to agree tocounter purchase agreements
to capture orders for its commercial jet aircraft. Forexample, in
exchange for gaining an order from Air India, Boeing may be
required topurchase certain component parts, such as aircraft
doors, from an Indian company.Taking this one step further, Boeing
can use its willingness to enter into aCounter purchase agreement
as a way of winning orders in the face of intensecompetition from
its global rival Airbus Industrie. Thus, countertrade can become
astrategic marketing weapon.However, the drawbacks of countertrade
agreements are substantial. Other thingsbeing equal, firms would
normally prefer to be paid in hard currency. Countertradecontracts
may involve the exchange of unusable or poor-quality goods that the
firm cannotdispose of profitably. For example, a few years ago, one
U.S. firm got burned when50 percent of the television sets it
received in a countertrade agreement with Hungarywere defective and
could not be sold. In addition, even if the goods it receives are
of highquality, the firm still needs to dispose of them profitably.
To do this, countertrade requiresthe firm to invest in an in-house
trading department dedicated to arranging andmanaging countertrade
deals. This can be expensive and time-consuming.Given these
drawbacks, countertrade is most attractive to large, diverse
multinationalenterprises that can use their worldwide network of
contacts to dispose of goods
Buyback
When a firm builds a plant in a country and agrees to take a
certain percentage of the plants output as partial payment of the
contract.
LEARNING OBJECTIVE 6
Articulate how countertrade can be used to facilitate
exporting.
Chapter Thirteen Exporting, Importing, and Countertrade 441
acquired in countertrading. The masters of countertrade are
Japans giant tradingfirms, the sogo shosha, which use their vast
networks of affiliated companies to profitablydispose of goods
acquired through countertrade agreements. The trading firm ofMitsui
& Company, for example, has about 120 affiliated companies in
almost everysector of the manufacturing and service industries. If
one of Mitsuis affiliates receivesgoods in a countertrade agreement
that it cannot consume, Mitsui & Company willnormally be able
to find another affiliate that can profitably use them. Firms
affiliatedwith one of Japans sogo shosha often have a competitive
advantage in countries wherecountertrade agreements are
preferred.Large, diverse Western firms that have a global reach
(e.g., General Electric, PhilipMorris, and 3M) have similar profit
advantages from countertrade agreements. Indeed,3M has established
its own trading company3M Global Trading, Inc.to developand manage
the companys international countertrade programs. Unless there is
noalternative, small and medium-sized exporters should probably try
to avoid countertradedeals because they lack the worldwide network
of operations that may berequired to profitably utilize or dispose
of goods acquired through them.
Qn6: Staffing policies are three types, they are:
Ethnocentric, Polycentric and geocentric. Define them, write
advantages and disadvantages
Staffing policiescomparison, 514, 515definition,
512ethnocentric, 512513, 514geocentric, 514, 524525goals,
511512polycentric, 513514--Staffing PolicyStaffing policy is
concerned with the selection of employees for particular jobs.
Atone level, this involves selecting individuals who have the
skills required to do particularjobs. At another level, staffing
policy can be a tool for developing and promotingthe desired
corporate culture of the firm. 5 By corporate culture , we mean the
organizationsnorms and value systems. A strong corporate culture
can help a firm to implementits strategy. General Electric, for
example, is not just concerned with hiringpeople who have the
skills required for performing particular jobs; it wants to
hireindividuals whose behavioral styles, beliefs, and value systems
are consistent with thoseof GE. This is true whether an American is
being hired, an Italian, a German, or anThe HRM function
isresponsible for theseaspects of organizationarchitectureProcesses
Incentives &ControlsCulturePeopleStructurefigure 16.1The Role
of HumanResources in ShapingOrganization ArchitectureLEARNING
OBJECTIVE 2Discuss the pros and consof different approaches
tostaffing policy in aninternational business.512 Part Five
Competing in the Global MarketplaceAustralian and whether the
hiring is for a U.S. operation or a foreign operation. Thebelief is
that if employees are predisposed toward the organizations norms
and valuesystems by their personality type, the firm will be able
to attain higher performance.TYPES OF STAFFING POLICY Research has
identified three types of staffingpolicies in international
businesses: the ethnocentric approach, the polycentric approach,and
the geocentric approach. 6 We will review each policy and link it
to thestrategy pursued by the firm. The most attractive staffing
policy is probably the geocentricapproach, although there are
several impediments to adopting it.The Ethnocentric Approach An
ethnocentric staffing policy is one in whichall key management
positions are filled by parent country nationals. This practice
waswidespread at one time. Firms such as Procter & Gamble,
Philips NV, and Matsushitaoriginally followed it. In the Dutch firm
Philips, for example, all important positionsin most foreign
subsidiaries were at one time held by Dutch nationals, who were
referredto by their non-Dutch colleagues as the Dutch Mafia. In
many Japanese andSouth Korean firms, such as Toyota, Matsushita,
and Samsung, key positions in internationaloperations have often
been held by home-country nationals. According to theJapanese
Overseas Enterprise Association, in 1996 only 29 percent of foreign
subsidiariesof Japanese companies had presidents who were not
Japanese. In contrast,66 percent of the Japanese subsidiaries of
foreign companies had Japanese presidents. 7Firms pursue an
ethnocentric staffing policy for three reasons. First, the firm
maybelieve the host country lacks qualified individuals to fill
senior management positions.This argument is heard most often when
the firm has operations in less developedcountries. Second, the
firm may see an ethnocentric staffing policy as the bestway to
maintain a unified corporate culture. Many Japanese firms, for
example, prefertheir foreign operations to be headed by expatriate
Japanese managers because thesemanagers will have been socialized
into the firms culture while employed in Japan. 8Procter &
Gamble until recently preferred to staff important management
positionsin its foreign subsidiaries with U.S. nationals who had
been socialized into P&Gscorporate culture by years of
employment in its U.S. operations. Such reasoning tendsto
predominate when a firm places a high value on its corporate
culture.Third, if the firm is trying to create value by
transferring core competencies to aforeign operation, as firms
pursuing an international strategy are, it may believe that thebest
way to do this is to transfer parent-country nationals who have
knowledge of thatcompetency to the foreign operation. Imagine what
might occur if a firm tried to transfera core competency in
marketing to a foreign subsidiary without a correspondingtransfer
of home-country marketing management personnel. The transfer would
probablyfail to produce the anticipated benefits because the
knowledge underlying a corecompetency cannot easily be articulated
and written down. Such knowledge often has asignificant tacit
dimension; it is acquired through experience. Just like the great
tennisplayer who cannot instruct others how to become great tennis
players simply by writinga handbook, the firm that has a core
competency in marketing, or anything else, cannotjust write a
handbook that tells a foreign subsidiary how to build the firms
core competencyanew in a foreign setting. It must also transfer
management personnel to the foreignoperation to show foreign
managers how to become good marketers, for example.The need to
transfer managers overseas arises because the knowledge that
underlies thefirms core competency resides in the heads of its
domestic managers and was acquiredthrough years of experience, not
by reading a handbook. Thus, if a firm is to transfer acore
competency to a foreign subsidiary, it must also transfer the
appropriate managers.Despite this rationale for pursuing an
ethnocentric staffing policy, the policy is nowon the wane in most
international businesses for two reasons. First, an
ethnocentricStaffing PolicyAn organizationsstrategy concerning
theselection of employeesfor particular jobs.Corporate CultureAn
organizations normsand value systems.EthnocentricStaffing PolicyA
staffing approach inwhich all keymanagement positionsare filled by
parentcountrynationals.Chapter Sixteen Global Human Resource
Management 513staffing policy limits advancement opportunities for
host-country nationals. This canlead to resentment, lower
productivity, and increased turnover among that group.
Resentmentcan be greater still if, as often occurs, expatriate
managers are paid significantlymore than home-country
nationals.Second, an ethnocentric policy can lead to cultural
myopia , the firms failure to understandhost-country cultural
differences that require different approaches to marketingand
management. The adaptation of expatriate managers can take a long
time,during which they may make major mistakes. For example,
expatriate managers mayfail to appreciate how product attributes,
distribution strategy, communications strategy,and pricing strategy
should be adapted to host-country conditions. The result maybe
costly blunders. They may also make decisions that are ethically
suspect simply becausethey do not understand the culture in which
they are managing. 9 In one highlypublicized case in the United
States, Mitsubishi Motors was sued by the federal EqualEmployment
Opportunity Commission for tolerating extensive and systematic
sexualharassment in a plant in Illinois. The plants top management,
all Japanese expatriates,denied the charges. The Japanese managers
may have failed to realize that behaviorthat would be viewed as
acceptable in Japan was not acceptable in the United States. 10The
Polycentric Approach A polycentric staffing policy requires
host-countrynationals to be recruited to manage subsidiaries, while
parent-country nationals occupykey positions at corporate
headquarters. In many respects, a polycentric approachis a response
to the shortcomings of an ethnocentric approach. One advantage
ofadopting a polycentric approach is that the firm is less likely
to suffer from culturalmyopia. Host-country managers are unlikely
to make the mistakes arising from culturalmisunderstandings to
which expatriate managers are vulnerable. A second advantageis that
a polycentric approach may be less expensive to implement, reducing
thecosts of value creation. Expatriate managers can be expensive to
maintain.A polycentric approach also has its drawbacks.
Host-country nationals have limitedopportunities to gain experience
outside their own country and thus cannot progressbeyond senior
positions in their own subsidiary. As in the case of an
ethnocentric policy,this may cause resentment. Perhaps the major
drawback with a polycentric approach,however, is the gap that can
form between host-country managers and parent-countrymanagers.
Language barriers, national loyalties, and a range of cultural
differences mayisolate the corporate headquarters staff from the
various foreign subsidiaries. The lack ofmanagement transfers from
home to host countries, and vice versa, can exacerbate
thisisolation and lead to a lack of integration between corporate
headquarters and foreignsubsidiaries. The result can be a
federation of largely independent national units withonly nominal
links to the corporate headquarters. Within such a federation,
thecoordination required to transfer core competencies or to pursue
experience curve andlocation economies may be difficult to achieve.
Thus, although a polycentric approachmay be effective for firms
pursuing a localization strategy, it is inappropriate forother
strategies.The federation that may result from a polycentric
approach can also be a force forinertia within the firm. After
decades of pursing a polycentric staffing policy, food
anddetergents giant Unilever found that shifting from a strategic
posture that emphasizedlocalization to a transnational posture was
very difficult. Unilevers foreign subsidiarieshad evolved into
quasi-autonomous operations, each with its own strong
nationalidentity. These little kingdoms objected strenuously to
corporate headquartersattempts to limit their autonomy and to
rationalize global manufacturing. 11The Geocentric Approach A
geocentric staffing policy seeks the bestpeople for key jobs
throughout the organization, regardless of nationality.
ThisPolycentricStaffing PolicyA staffing policy underwhich the firm
recruitshost-country nationals tomanage subsidiaries intheir own
country, whileparent-country nationalsoccupy key positions
atcorporate headquarters.GeocentricStaffing PolicyA staffing policy
underwhich the firm seeks thebest people for key jobsthroughout the
company,regardless of nationality.514 Part Five Competing in the
Global Marketplacepolicy has a number of advantages. First, it
enablesthe firm to make the best use of its humanresources. Second,
and perhaps more important,a geocentric policy enables the firm to
build acadre of international executives who feel athome working in
a number of cultures. Creationof such a cadre may be a critical
first step towardbuilding a strong unifying corporate cultureand an
informal management network,both of which are required for global
standardizationand transnational strategies. 12 Firmspursuing a
geocentric staffing policy may bebetter able to create value from
the pursuit ofexperience curve and location economies andfrom the
multidirectional transfer of core competenciesthan firms pursuing
other staffingpolicies. In addition, the multinational
compositionof the management team that results fromgeocentric
staffing tends to reduce cultural myopiaand to enhance local
responsiveness. Thus, other things being equal, a
geocentricstaffing policy seems the most attractive. See the
Another Perspective formore details.A number of problems limit the
firms ability to pursue a geocentric policy. Manycountries want
foreign subsidiaries to employ their citizens. To achieve this
goal,they use immigration laws to require the employment of
host-country nationals ifthey are available in adequate numbers and
have the necessary skills. Most countries,including the United
States, require firms to provide extensive documentationif they
wish to hire a foreign national instead of a local national.
Thisdocumentation can be time consuming, expensive, and at times
futile. A geocentricstaffing policy also can be expensive to
implement. Training and relocation costsincrease when transferring
managers from country to country. The company mayalso need a
compensation structure with a standardized international base pay
levelhigher than national levels in many countries. In addition,
the higher pay enjoyedby managers placed on an international fast
track may be a source of resentmentwithin a firm.Summary The
advantages and disadvantages of the three approaches to
staffingpolicy are summarized in Table 16.1 . Broadly speaking, an
ethnocentric approach iscompatible with an international strategy,
a polycentric approach is compatible with alocalization strategy,
and a geocentric approach is compatible with both
globalstandardization and transnational strategies. (See Chapter 11
for details of thestrategies.)While the staffing policies described
here are well known and widely used amongboth practitioners and
scholars of international businesses, some critics have claimedthat
the typology is too simplistic and that it obscures the internal
differentiation ofmanagement practices within international
businesses. The critics claim that withinsome international
businesses, staffing policies vary significantly from national
subsidiaryto national subsidiary; while some are managed on an
ethnocentric basis, othersare managed in a polycentric or
geocentric manner. 13 Other critics note that the staffingpolicy
adopted by a firm is primarily driven by its geographic scope, as
opposed toits strategic orientation. Firms that have a broad
geographic scope are the most likelyto have a geocentric mind-set.
14Another PerspectiveWomen in International AssignmentsWould you
send a woman expatriate to Saudi Arabia,Kuwait, Japan, or Korea?
How are Western women expatriatesdoing in foreign cultures that
have traditionally limitedwomens public roles? Women sent to these
countrieshave met with substantial success. Their key challenge
isto get the assignments! Once in place, women expatriatesare
successful. This is in part because once in the culture,women
expatriates are seen first as expatriates who falloutside the local
role for women. In addition, expatwomen also have salience in their
new environmenttheyare noticedand this can be a distinct business
advantage.Locals often take pride in developing business
relationshipswith women expatriates because by doing sothey can
suggest that the foreign stereotype of their cultureis superficial
and incomplete.Chapter Sixteen Global Human Resource Management
515EXPATRIATE MANAGERS Two of the three staffing policies we
havediscussedthe ethnocentric and the geocentricrely on extensive
use of expatriatemanagers. As defined earlier, expatriates are
citizens of one country who are workingin another country ( John
Ross, profiled in the opening case, was an expatriate).
Sometimesthe term inpatriates is used to identify a subset of
expatriates who are citizens ofa foreign country working in the
home country of their multinational employer. 15Thus, a citizen of
Japan who moves to the United States to work at Microsoft wouldbe
classified as an inpatriate. With an ethnocentric policy, the
expatriates are all homecountrynationals who are transferred
abroad. With a geocentric approach, the expatriatesneed not be
home-country nationals; the firm does not base transfer decisionson
nationality. A prominent issue in the international staffing
literature is expatriatefailure the premature return of an
expatriate manager to his or her home country. 16Here we briefly
review the evidence on expatriate failure before discussing a
numberof ways to minimize the failure rate.Expatriate Failure Rates
Expatriate failure represents a failure of the firmsselection
policies to identify individuals who will not thrive abroad. 17
Theconsequences include premature return from a foreign posting and
high resignationrates, with expatriates leaving their company at
about twice the rate of domesticmanagements. 18 Research suggests
that between 16 and 40 percent of all Americanemployees sent abroad
to developed nations return from their assignments early,and almost
70 percent of employees sent to developing nations return home
early. 19Although detailed data are not available for most
nationalities, one suspects thathigh expatriate failure is a
universal problem. Some 28 percent of British expatriates,for
example, are estimated to fail in their overseas postings. 20 The
costs of expatriatefailure are high. One estimate is that the
average cost per failure to the parent firmcan be as high as three
times the expatriates annual domestic salary plus the cost
ofrelocation (which is affected by currency exchange rates and
location of assignment).LEARNING OBJECTIVE 3Explain why managersmay
fail to thrive inforeign postings.Expatriate FailureThe premature
return ofan expatriate manager tohis or her home
country.StaffingApproachStrategicAppropriateness Advantages
DisadvantagesEthnocentric International Overcomes lack ofqualified
managersin host nationUnified cultureHelps transfer
corecompetenciesProduces resentment inhost countryCan lead to
culturalmyopiaPolycentric Localization Alleviates
culturalmyopiaInexpensive toimplementLimits career mobilityIsolates
headquartersfrom foreign subsidiariesGeocentric
Globalstandardization andtransnationalUses human
resourcesefficientlyHelps build strongculture and
informalmanagement networksNationalimmigrationpolicies may
limitimplementationExpensive.
Qn5: 6 mechanism are referring entry modes of getting into a
foreign market, they are 1. exporting 2. licensing, 3. franchising
4. Fully owned subsidiaries 5. Turnkey projects 6. Joint ventures.
Google these terms, get the definitions and write down advantages
and disadvantages of all these 6.Entry ModesOnce a firm decides to
enter a foreign market, the question arises as to the best modeof
entry. Firms can use six different modes to enter foreign markets:
exporting, turnkeyprojects, licensing, franchising, establishing
joint ventures with a host-country firm, orsetting up a new wholly
owned subsidiary in the host country. Each entry mode hasadvantages
and disadvantages. Managers need to consider these carefully
whendeciding which to use. 11EXPORTING Many manufacturing firms
begin their global expansion as exportersand only later switch to
another mode for serving a foreign market. We take a closelook at
the mechanics of exporting in the next chapter. Here we focus on
the advantagesand disadvantages of exporting as an entry
mode.Advantages Exporting has two distinct advantages. First, it
avoids the oftensubstantial costs of establishing manufacturing
operations in the host country. Second,exporting may help a firm
achieve experience curve and location economies(see Chapter 11). By
manufacturing the product in a centralized location and exportingit
to other national markets, the firm may realize substantial scale
economies from itsglobal sales volume. This is how Sony came to
dominate the global TV market, howMatsushita came to dominate the
VCR market, how many Japanese automakers madeinroads into the U.S.
market, and how South Korean firms such as Samsung gainedmarket
share in computer memory chips.Disadvantages Exporting has a number
of drawbacks. First, exporting from thefirms home base may not be
appropriate if lower-cost locations for manufacturing theproduct
can be found abroad (i.e., if the firm can realize location
economies by movingproduction elsewhere). Thus, particularly for
firms pursuing global or transnationalstrategies, it may be
preferable to manufacture where the mix of factor conditions ismost
favorable from a value-creation perspective and to export to the
rest of the worldfrom that location. This is not so much an
argument against exporting as an argumentagainst exporting from the
firms home country. Many U.S. electronics firms havemoved some of
their manufacturing to the Far East because of the availability of
lowcost,highly skilled labor there. They then export from that
location to the rest of theworld, including the United States.A
second drawback to exporting is that high transportation costs can
make exportinguneconomical, particularly for bulk products. One way
of getting around this is tomanufacture bulk products regionally.
This strategy enables the firm to realize someeconomies from
large-scale production and at the same time to limit its
transportationcosts. For example, many multinational chemical firms
manufacture their productsregionally, serving several countries
from one facility.LEARNING OBJECTIVE 2Outline the advantagesand
disadvantages of thedifferent modes that firmsuse to enter
foreignmarkets.406 Part Five Competing in the Global
MarketplaceAnother drawback is that tariff barriers can make
exporting uneconomical. It washigh tariff barriers that persuaded
JCB to initially invest in the Indian market for
constructionequipment (see the opening case). Similarly, the threat
of tariff barriers bythe host-country government can make it very
risky. A fourth drawback to exportingarises when a firm delegates
its marketing, sales, and service in each country where itdoes
business to another company. This is a common approach for
manufacturingfirms that are just beginning to expand
internationally. The other company may be alocal agent, or it may
be another multinational with extensive international
distributionoperations. Local agents often carry the products of
competing firms and so havedivided loyalties. In such cases, the
local agent may not do as good a job as the firmwould if it managed
its marketing itself. Similar problems can occur when
anothermultinational takes on distribution.The way around such
problems is to set up wholly owned subsidiaries in foreignnations
to handle local marketing, sales, and service. By doing this, the
firm can exercisetight control over marketing and sales in the
country while reaping the cost advantages ofmanufacturing the
product in a single location, or a few choice locations.TURNKEY
PROJECTS Firms that specialize in the design, construction,
andstart-up of turnkey plants are common in some industries. In a
turnkey project , thecontractor agrees to handle every detail of
the project for a foreign client, includingthe training of
operating personnel. At completion of the contract, the foreign
clientis handed the key to a plant that is ready for full
operationhence, the term turnkey.This is a means of exporting
process technology to other countries. Turnkey projectsare most
common in the chemical, pharmaceutical, petroleum refining, and
metalrefining industries, all of which use complex, expensive
production technologies.Advantages The know-how required to
assemble and run a technologicallycomplex process, such as refining
petroleum or steel, is a valuable asset. Turnkeyprojects are a way
of earning great economic returns from that asset. The strategy
isparticularly useful where FDI is limited by host-government
regulations. Forexample, the governments of many oil-rich countries
have set out to build their ownpetroleum refining industries, so
they restrict FDI in their oil and refining sectors.But because
many of these countries lack petroleum-refining technology, they
gainit by entering into turnkey projects with foreign firms that
have the technology.Such deals are often attractive to the selling
firm because without them, they wouldhave no way to earn a return
on their valuable know-how in that country. A turnkeystrategy can
also be less risky than conventional FDI. In a country with
unstablepolitical and economic environments, a longer-term
investment might expose thefirm to unacceptable political or
economic risks (e.g., the risk of nationalization orof economic
collapse).Disadvantages Three main drawbacks are associated with a
turnkey strategy.First, the firm that enters into a turnkey deal
will have no long-term interest in theforeign country. This can be
a disadvantage if that country subsequently proves to bea major
market for the output of the process that has been exported. One
way aroundthis is to take a minority equity interest in the
operation. Second, the firm that entersinto a turnkey project with
a foreign enterprise may inadvertently create a competitor.For
example, many of the Western firms that sold oil-refining
technology to firms inSaudi Arabia, Kuwait, and other Gulf states
now find themselves competing with thesefirms in the world oil
market. Third, if the firms process technology is a source
ofcompetitive advantage, then selling this technology through a
turnkey project is alsoselling competitive advantage to potential
or actual competitors.Turnkey ProjectA project in which a
firmagrees to set up anoperating plant for aforeign client and
handover the key when theplant is fully operational.Chapter Twelve
Entering Foreign Markets 407LICENSING A licensing agreement is an
arrangement whereby a licensor grantsthe rights to intangible
property to another entity (the licensee) for a specified
period,and in return, the licensor receives a royalty fee from the
licensee. 12 Intangible propertyincludes patents, inventions,
formulas, processes, designs, copyrights, and trademarks.For
example, to enter the Japanese market, Xerox, inventor of the
photocopier,established a joint venture with Fuji Photo that is
known as FujiXerox. Xerox thenlicensed its xerographic know-how to
FujiXerox. In return, FujiXerox paid Xerox aroyalty fee equal to 5
percent of the net sales revenue that FujiXerox earned from
thesales of photocopiers based on Xeroxs patented know-how. In the
FujiXerox case,the license was originally granted for 10 years, and
it has been renegotiated andextended several times since. The
licensing agreement between Xerox and FujiXeroxalso limited
FujiXeroxs direct sales to the Asian Pacific region (although
FujiXeroxdoes supply Xerox with photocopiers that are sold in North
America under theXerox label). 13Advantages In the typical
international licensing deal, the licensee puts up mostof the
capital necessary to get the overseas operation going. Thus, a
primary advantageof licensing is that the firm does not have to
bear the development costs and risksassociated with opening a
foreign market. Licensing is attractive for firms lacking
thecapital to develop operations overseas. In addition, licensing
can be attractive when afirm is unwilling to commit substantial
financial resources to an unfamiliar or politicallyvolatile foreign
market. A firm may use licensing when it wishes to participate ina
foreign market but is prohibited from doing so by barriers to
investment. This wasone of the original reasons for the formation
of the FujiXerox joint venture in 1962.Xerox wanted to participate
in the Japanese market but was prohibited from setting upa wholly
owned subsidiary by the Japanese government. So Xerox set up the
jointventure with Fuji and then licensed its know-how to the joint
venture.Finally, licensing is frequently used when a firm possesses
some intangible propertythat might have business applications, but
it does not want to develop those applicationsitself. For example,
Bell Laboratories at AT&T originally invented the
transistorcircuit in the 1950s, but AT&T decided it did not
want to produce transistors, so itlicensed the technology to a
number of other companies, such as Texas Instruments.Similarly,
Coca-Cola has licensed its famous trademark to clothing
manufacturers,which have incorporated the design into
clothing.Disadvantages Licensing has three serious drawbacks.
First, it does not give afirm the tight control over manufacturing,
marketing, and strategy that is required forrealizing experience
curve and location economies. Licensing typically involves
eachlicensee setting up its own production operations. This
severely limits the firms abilityto realize experience curve and
location economies by producing its product in a
centralizedlocation. When these economies are important, licensing
may not be the bestway to expand overseas.Second, competing in a
global market may require a firm to coordinate strategicmoves
across countries by using profits earned in one country to support
competitiveattacks in another. By its very nature, licensing limits
a firms ability to do this. Alicensee is unlikely to allow a
multinational firm to use its profits (beyond those due inthe form
of royalty payments) to support a different licensee operating in
anothercountry.A third problem with licensing is one that we
encountered in Chapter 7 when wereviewed the economic theory of
FDI. This is the risk associated with licensing
technologicalknow-how to foreign companies. Technological know-how
constitutes thebasis of many multinational firms competitive
advantage. Most firms wish to maintainLicensingAgreementArrangement
in which alicensor grants the rightsto intangible propertyto the
licensee for aspecified period andreceives a royalty fee
inreturn.408 Part Five Competing in the Global Marketplacecontrol
over how their know-how is used, and a firmcan quickly lose control
over its technology by licensingit. Many firms have made the
mistake ofthinking they could maintain control over theirknow-how
within the framework of a licensing agreement.RCA Corporation, for
example, once licensedits color TV technology to Japanese firms
includingMatsushita and Sony. The Japanese firms quickly
assimilatedthe technology, improved on it, and used itto enter the
U.S. market, taking substantial marketshare away from RCA.There are
ways of reducing this risk. One way isby entering into a
cross-licensing agreement w itha foreign firm. Under a
cross-licensing agreement, afirm might license some valuable
intangible propertyto a foreign partner, but in addition to a
royalty payment,the firm might also request that the foreignpartner
license some of its valuable know-how to thefirm. Such agreements
may reduce the risks associated with licensing
technologicalknow-how, because the licensee realizes that if it
violates the licensing contract (byusing the knowledge obtained to
compete directly with the licensor), the licensor cando the same to
it. Cross-licensing agreements enable firms to hold each other
hostage,which reduces the probability that they will behave
opportunistically toward eachother. 14 Such cross-licensing
agreements are increasingly common in high-technologyindustries.
For example, the U.S. biotechnology firm Amgen licensed one of its
keydrugs, Nuprogene, to Kirin, the Japanese pharmaceutical company.
The license givesKirin the right to sell Nuprogene in Japan. In
return, Amgen receives a royalty paymentand, through a licensing
agreement, gained the right to sell some of Kirinsproducts in the
United States.Another way of reducing the risk associated with
licensing is to follow theFujiXerox model and link an agreement to
license know-how with the formation of ajoint venture in which the
licensor and licensee take important equity stakes. Such anapproach
aligns the interests of licensor and licensee, because both have a
stake inensuring that the venture is successful. Thus, the risk
that Fuji Photo might appropriateXeroxs technological know-how, and
then compete directly against Xerox in theglobal photocopier
market, was reduced by the establishment of a joint venture inwhich
both Xerox and Fuji Photo had an important stake.FRANCHISING
Franchising is similar to licensing, although franchising tends
toinvolve longer-term commitments than licensing. Franchising is
basically a specializedform of licensing in which the franchiser
not only sells intangible property (normallya trademark) to the
franchisee, but it also insists that the franchisee agree toabide
by strict rules as to how it does business. The franchiser will
also often assist thefranchisee to run the business on an ongoing
basis. As with licensing, the franchisertypically receives a
royalty payment, which amounts to some percentage of the
franchiseesrevenues. Whereas licensing is pursued primarily by
manufacturing firms,franchising is employed primarily by service
firms. 15 McDonalds is a good example ofa firm that has grown by
using a franchising strategy. McDonalds strict rules as to
howfranchisees should operate a restaurant extend to control over
the menu, cookingmethods, staffing policies, and design and
location. McDonalds also organizes thesupply chain for its
franchisees and provides management training and
financialassistance. 16RCA found one disadvantage to licensing:
when it licensed its color TVtechnology to Japanese firms, these
firms quickly assimilated the technology,improved it, and entered
the U.S. market, taking market shareaway from RCA. Christopher
KerriganCross-LicensingAgreementAn arrangement inwhich a
companylicenses valuableintangible property toa foreign partner
andreceives a license forthe partners
valuableknowledge.FranchisingA specialized form oflicensing in
which thefranchiser not only sellsintangible property(normally a
trademark)to the franchisee, but italso insists that thefranchisee
agree to abideby strict rules as to how itdoes business.Chapter
Twelve Entering Foreign Markets 409Advantages The advantages of
franchising as an entry mode are similar to thoseof licensing. The
firm is relieved of many of the costs and risks of opening a
foreignmarket on its own. Instead, the franchisee typically assumes
those costs and risks. Thiscreates a good incentive for the
franchisee to build a profitable operation as quickly aspossible.
Thus, using a franchising strategy, a service firm can build a
global presencequickly and at a relatively low cost and risk, as
McDonalds has.Disadvantages The disadvantages of franchising can be
less pronounced than inthe case of licensing. Many service
companies, such as hotels, use franchising; in suchinstances, the
firm has no reason to consider the need for coordination of
manufacturingto achieve experience curve and location economies.
But franchising may inhibitthe firms ability to take profits out of
one country to support competitive attacks inanother. A more
significant disadvantage of franchising is quality control. The
foundationof franchising arrangements is that the firms brand name
conveys a message toconsumers about the quality of the firms
product. Thus, a business traveler checking inat a Four Seasons
hotel in Hong Kong can reasonably expect the same quality of
room,food, and service that she would receive in New York. The Four
Seasons name is supposedto guarantee consistent product quality.
This presents a problem in that foreignfranchisees may not be as
concerned about quality as they are supposed to be, and theresult
of poor quality can extend beyond lost sales in a particular
foreign market to adecline in the firms worldwide reputation. For
example, if the business traveler has abad experience at the Four
Seasons in Hong Kong, she may never go to another FourSeasons hotel
and may urge her colleagues to do likewise. The geographical
distance ofthe firm from its foreign franchisees can make poor
quality difficult to detect. In addition,the sheer numbers of
franchiseesin the case of McDonalds, tens of thousandscan make
quality control difficult. Due to these factors, quality problems
may persist.One way around this disadvantage is to set up a
subsidiary in each country in whichthe firm expands. The subsidiary
might be wholly owned by the company or a jointventure with a
foreign company. The subsidiary assumes the rights and obligations
toestablish franchises throughout the particular country or region.
McDonalds, forexample, establishes a master franchisee in many
countries. Typically, this master franchiseeis a joint venture
between McDonalds and a local firm. The proximity and thesmaller
number of franchises to oversee reduce the quality-control
challenge. In addition,because the subsidiary (or master
franchisee) is at least partly owned by the firm,the firm can place
its own managers in the subsidiary to help ensure that it is doing
agood job of monitoring the franchises. This organizational
arrangement has provenvery satisfactory for McDonalds, KFC, and
others.JOINT VENTURES A joint venture entails establishing a firm
that is jointlyowned by two or more otherwise independent firms.
FujiXerox, for example, was setup as a joint venture between Xerox
and Fuji Photo. Establishing a joint venture witha foreign firm has
long been a popular mode for entering a new market. As we saw inthe
opening case, JCB used a joint venture to enter the Indian markets.
The mosttypical joint venture is a 50/50 venture, in which there
are two parties, each of whichholds a 50 percent ownership stake
and contributes a team of managers to share operatingcontrol (this
was the case with the FujiXerox joint venture until 2001; it is
nowa 25/75 venture, with Xerox holding 25 percent). Some firms,
however, have soughtjoint ventures in which they have a majority
share and thus tighter control. 17Advantages Joint ventures have a
number of advantages. First, a firm benefitsfrom a local partners
knowledge of the host countrys competitive conditions,
culture,language, political systems, and business systems. Thus,
for many U.S. firms, jointJoint VentureEstablishing a firm thatis
jointly owned by twoor more otherwiseindependent firms.410 Part
Five Competing in the Global Marketplaceventures have involved the
U.S. company providing technological know-how andproducts and the
local partner providing the marketing expertise and the local
knowledgenecessary for competing in that country. Second, when the
development costs orrisks of opening a foreign market are high, a
firm might gain by sharing these costsand or risks with a local
partner. Third, in many countries, political considerationsmake
joint ventures the only feasible entry mode (again, that was why
JCB enteredinto a joint venture with Escorts). Research suggests
joint ventures with local partnersface a low risk of being subject
to nationalization or other forms of adverse
governmentinterference. 18 This appears to be because local equity
partners, who may havesome influence on host-government policy,
have a vested interest in speaking outagainst nationalization or
government interference.Disadvantages Despite these advantages,
there are major disadvantages with jointventures. First, as with
licensing, a firm that enters into a joint venture risks
givingcontrol of its technology to its partner. Thus, a proposed
joint venture in 2002 betweenBoeing and Mitsubishi Heavy Industries
to build a new wide-body jet raised fears thatBoeing might
unwittingly give away its commercial airline technology to the
Japanese.However, joint-venture agreements can be constructed to
minimize this risk. Oneoption is to hold majority ownership in the
venture. This allows the dominant partnerto exercise greater
control over its technology. But it can be difficult to find a
foreignpartner who is willing to settle for minority ownership.
Another option is to wall offfrom a partner technology that is
central to the core competence of the firm, whilesharing other
technology.A second disadvantage is that a joint venture does not
give a firm the tight controlover subsidiaries that it might need
to realize experience curve or location economies.Nor does it give
a firm the tight control over a foreign subsidiary that it might
needfor engaging in coordinated global attacks against its rivals.
Consider the entry ofTexas Instruments (TI) into the Japanese
semiconductor market. When TIestablished semiconductor facilities
in Japan, it did so for the dual purpose ofchecking Japanese
manufacturers market share and limiting their cash available
forinvading TIs global market. In other words, TI was engaging in
global strategiccoordination. To implement this strategy, TIs
subsidiary in Japan had to be preparedto take instructions from
corporate headquarters regarding competitive strategy.The strategy
also required the Japanese subsidiary to run at a loss if
necessary. Fewif any potential joint-venture partners would have
been willing to accept suchconditions, since it would have
necessitated a willingness to accept a negative returnon
investment. Indeed, many joint ventures establish a degree of
autonomy thatwould make such direct control over strategic
decisions all but impossible toestablish. 19 Thus, to implement
this strategy, TI set up a wholly owned subsidiaryin Japan.A third
disadvantage with joint ventures is that the shared ownership
arrangementcan lead to conflicts and battles for control between
the investing firms if their goalsand objectives change or if they
take different views as to what the strategy should be.This was
apparently not a problem with the FujiXerox joint venture.
According toYotaro Kobayashi, currently the chairman of FujiXerox,
a primary reason is that bothXerox and Fuji Photo adopted an
arms-length relationship with FujiXerox, givingthe ventures
management considerable freedom to determine its own strategy.
20However, much research indicates that conflicts of interest over
strategy and goalsoften arise in joint ventures. These conflicts
tend to be greater when the venture isbetween firms of different
nationalities, and they often end in the dissolution of theventure.
21 Such conflicts tend to be triggered by shifts in the relative
bargaining powerof venture partners. For example, in the case of
ventures between a foreign firm and aChapter Twelve Entering
Foreign Markets 411local firm, as a foreign partners knowledge
about local market conditions increases, itdepends less on the
expertise of a local partner. This increases the bargaining power
ofthe foreign partner and ultimately leads to conflicts over
control of the ventures strategyand goals. 22 Some firms have
sought to limit such problems by entering into jointventures in
which one partner has a controlling interest.WHOLLY OWNED
SUBSIDIARIES In a wholly owned subsidiary , the firmowns 100
percent of the stock. Establishing a wholly owned subsidiary in a
foreignmarket can be done two ways. The firm either can set up a
new operation in thatcountry, often referred to as a greenfield
venture , or it can acquire an established firm inthat host nation
and use that firm to promote its products. 23 For example, as we
saw inthe Management Focus, INGs strategy for entering the U.S.
market was to acquireestablished U.S. enterprises rather than try
to build an operation from the groundfloor.Advantages There are
several clear advantages of wholly owned subsidiaries.First, when a
firms competitive advantage is based on technological competence,
awholly owned subsidiary will often be the preferred entry mode
because it reduces therisk of losing control over that competence.
(See Chapter 7 for more details.) Manyhigh-tech firms prefer this
entry mode for overseas expansion (e.g., firms in the
semiconductor,electronics, and pharmaceutical industries). It is
notable that JCB wasunwilling to transfer key technology to its
Indian joint venture with Escorts, and onlydid so once it had
purchased its venture partner (see the opening case). Second,
awholly owned subsidiary gives a firm tight control over operations
in different countries.This is necessary for engaging in global
strategic coordination (i.e., using profitsfrom one country to
support competitive attacks in another).Third, a wholly owned
subsidiary may be required if a firm is trying to realizelocation
and experience curve economies (as firms pursuing global and
transnationalstrategies try to do). As we saw in Chapter 11, when
cost pressures are intense, itmay pay a firm to configure its value
chain in such a way that the value added at eachstage is maximized.
Thus, a national subsidiary may specialize in manufacturing
onlypart of the product line or certain components of the end
product, exchanging partsand products with other subsidiaries in
the firms global system. Establishing such aglobal production
system requires a high degree of control over the operations ofeach
affiliate. The various operations must be prepared to accept
centrally determineddecisions as to how they will produce, how much
they will produce, and howtheir output will be priced for transfer
to the next operation. Because licensees orjoint-venture partners
are unlikely to accept such a subservient role, establishingwholly
owned subsidiaries may be necessary. Finally, establishing a wholly
owedsubsidiary gives the firm a 100 percent share in the profits
generated in a foreignmarket.Disadvantages Establishing a wholly
owned subsidiary is generally the mostcostly method of serving a
foreign market from a capital investment standpoint. Firmsdoing
this must bear the full capital costs and risks of setting up
overseas operations.The risks associated with learning to do
business in a new culture are less if the firmacquires an
established host-country enterprise. However, acquisitions raise
additionalproblems, including those associated with trying to marry
divergent corporate cultures.These problems may more than offset
any benefits derived by acquiring anestablished operation. Because
the choice between greenfield ventures and acquisitionsis such an
important one, we shall discuss it in more detail later in the
chapter.Wholly OwnedSubsidiaryA subsidiary in which thefirm owns
100 percent ofthe stock.412 Part Five Competing in the Global
MarketplaceSelecting an Entry ModeAs the preceding discussion
demonstrated, all the entry modes have advantages anddisadvantages,
as summarized in Table 12.1. See the Another Perspective on page
413for another look at entry challenges. Thus, trade-offs are
inevitable when selecting anentry mode. For example, when
considering entry into an unfamiliar country with atrack record for
discriminating against foreign-owned enterprises when
awardinggovernment contracts, a firm might favor a joint venture
with a local enterprise. Itsrationale might be that the local
partner will help it establish operations in an
unfamiliarenvironment and will help the company win government
contracts. However, if thefirms core competence is based on
proprietary technology, entering a joint venturemight risk losing
control of that technology to the joint-venture partner, in which
casethe strategy may seem unattractive. Despite the existence of
such trade-offs, it is possibleto make some generalizations about
the optimal choice of entry mode. 24CORE COMPETENCIES AND ENTRY
MODE As we saw in Chapter 11,often firms expand internationally to
earn greater returns from their core competencies,transferring the
skills and products derived from their core competencies to
foreignmarkets where indigenous competitors lack those skills. The
optimal entry modefor these firms depends to some degree on the
nature of their core competencies. Adistinction can be drawn
between firms whose core competency is in technologicalknow-how and
those whose core competency is in management know-how.LEARNING
OBJECTIVE 3Identify the factors thatinfluence a firms choiceof
entry mode.table 12.1Advantages andDisadvantages ofEntry ModesEntry
Mode Advantages DisadvantagesExporting Ability to realize location
andexperience curve economiesHigh Transport costsTrade
barriersProblems with local marketing agentsTurnkeycontractsAbility
to earn returns fromprocess technology skills incountries where FDI
is restrictedCreating efficient competitorsLack of long-term market
presenceLicensing Low development costs andrisksLack of control
over technologyInability to realize location andexperience curve
economiesInability to engage in global
strategiccoordinationFranchising Low development costs andrisksLack
of control over qualityInability to engage in global
strategiccoordinationJointventuresAccess to local
partnersknowledgeSharing development costsand risksPolitically
acceptableLack of control over technologyInability to engage in
global strategiccoordinationInabilty to realize location
andexperience economiesWhollyownedsubsidiariesProtection of
technologyAbility to engage in globalstrategic coordinationAbiltity
to realize location andexperience economiesHigh costs and
risksChapter Twelve Entering Foreign Markets 413Technological
Know-How As was observedin Chapter 7, if a firms competitive
advantage (itscore competence) is based on control overproprietary
technological know-how, it shouldavoid licensing and joint-venture
arrangements ifpossible to minimize the risk of losing control
overthat technology. Thus, if a high-tech firm sets upoperations in
a foreign country to profit from acore competency in technological
know-how, it willprobably do so through a wholly owned
subsidiary.This rule should not be viewed as hard and fast,however.
Sometimes a licensing or joint-venturearrangement can be structured
to reduce the risk ofthe licensees or joint-venture partners
expropriationof technological know-how. Another exceptionexists
when a firm perceives its technologicaladvantage to be only
transitory, when it expectsrapid imitation of its core technology
bycompetitors. In such cases, the firm might want tolicense its
technology as rapidly as possible toforeign firms to gain global
acceptance for its technology before the imitation occurs. 25Such a
strategy has some advantages. By licensing its technology to
competitors, thefirm may deter them from developing their own,
possibly superior, technology. Further,by licensing its technology,
the firm may establish its technology as the dominant designin the
industry (as Matsushita did with its VHS format for VCRs). This may
ensure asteady stream of royalty payments. However, the attractions
of licensing are frequentlyoutweighed by the risks of losing
control over technology, and if this is a risk, the firmshould
avoid licensing.Management Know-How The competitive advantage of
many service firms isbased on management know-how (e.g.,
McDonalds). For such firms, the risk of losingcontrol over the
management skills to franchisees or joint-venture partners isnot
that great. These firms valuable asset is their brand name, and
brand names aregenerally well protected by international laws
pertaining to trademarks. Given this,many of the issues arising in
the case of technological know-how are of less concernhere. As a
result, many service firms favor a combination of franchising and
subsidiariesto control the franchises within particular countries
or regions. The subsidiariesmay be wholly owned or joint ventures,
but most service firms have found thatjoint ventures with local
partners work best for the controlling subsidiaries. A jointventure
is often politically more acceptable and brings a degree of local
knowledgeto the subsidiary.PRESSURES FOR COST REDUCTIONS AND ENTRY
MODE Thegreater the pressures for cost reductions are, the more
likely a firm will want to pursuesome combination of exporting and
wholly owned subsidiaries. By manufacturing inthose locations where
factor conditions are optimal and then exporting to the rest ofthe
world, a firm may be able to realize substantial location and
experience curveeconomies. The firm might then want to export the
finished product to marketingsubsidiaries based in various
countries. These subsidiaries will typically be whollyowned and
have the responsibility for overseeing distribution in their
particular countries.Setting up wholly owned marketing subsidiaries
is preferable to joint-ventureAnother PerspectiveTake Another Look:
Factors Outside theAdvantages/Disadvantages Entry Mode
GridCitigroup Inc. is literally branching out its banking systembig
time in Russia in 2006. It plans to add as many as 40additional
branches, doubling the number it has in Moscowand St. Petersburg.
This makes perfect business sense,because the consumer borrowing
market there is almostuntapped: 87 percent of Russians have never
taken out abank loan! However, this expansion comes with
majorchallenges, including high rent costs for these branches,
asometimes poor communications system, and a labor marketthat has
made it difficult to find qualified workers. So itis important to
also consider country-specific economicand cultural conditions in
entry modes. (CarrickMollenkamp, Citigroup Plans Rapid Expansion of
RussiaBranches, The Wall Street Journal, June 7, 2006)414 Part Five
Competing in the Global Marketplacearrangements and to using
foreign marketing agents because it gives the firm tightcontrol
that might be required for coordinating a globally dispersed value
chain.It also gives the firm the ability to use the profits
generated in one market to improveits competitive position in
another market. In other words, firms pursuing
globalstandardization or transnational strategies tend to prefer
establishing wholly ownedsubsidiaries. See the Another Perspective
on page 413 for Citibanks approach toentering Russia.
