IBM Lecture No.3

8/4/2019 IBM Lecture No.3

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Entering ForeignMarkets

McGraw-Hill/Irwin

Global Business Today, 5e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.


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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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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 toserve that market


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The advantages and disadvantages associated with each entrymode 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 byexporting, other firms might set up a wholly owned subsidiary, orutilize some other entry mode.


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BASIC ENTRY DECISIONS

There are three basic decisions that a firm contemplating foreignexpansion must make:

which markets to enter

when to enter those markets

on what scale


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Which Foreign Markets?

The choice between different foreign markets is based on an assessment of their longrun profit potential.

Typically, the most favorable markets are those that are politically stable developedand developing nations that have free market systems, and where there is not a dramaticupsurge in either inflation rates, or private sector debt

Those that are less desirable are politically unstable developing nations that operatewith 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 widelyavailable in a market and that satisfies an unmet need


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Timing of Entry

With regard to the timing of entry, we say that entry is earlywhen 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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The advantages associated with entering a market early are called

first mover advantages, and include:

the ability to pre-empt rivals and capture demand byestablishing 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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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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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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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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Scale of Entry and Strategic Commitments

The consequences of entering a market on a significant scale areassociated with the value of the resulting strategic commitments

(decisions that have a long term impact and are difficult toreverse)

Deciding to enter a foreign market on a significant scale is amajor strategic commitment that changes the competitive playing

field Small-scale entry has the advantage of allowing a firm to learnabout a foreign market while simultaneously limiting the firmsexposure to that market


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ENTRY MODES

These are six different ways to enter a foreign market.

Exporting

Most manufacturing firms begin their global expansion asexporters and only later switch to another mode for servicing a

foreign market


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Advantages

Exporting avoids the substantial cost of establishing

manufacturing operations in the host country

Exporting may also help a firm achieve experience curvelocation economies


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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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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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Advantages

Turnkey projects are a way of earning great economic returnsfrom the know-how required to assemble and run a

technologically complex process

Turnkey projects make sense in a country where the political andeconomic environment is such that a longer-term investment

might expose the firm to unacceptable political and/or economic

risk


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Disadvantages

By definition, the firm that enters into a turnkey deal will haveno 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 competitiveadvantage, then selling this technology through a turnkey project

is also selling competitive advantage to potential and/or actual

competitors


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Licensing

A licensing agreement is an arrangement whereby a licensorgrants 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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Advantages

The firm does not have to bear the development costs and risksassociated with opening a foreign market

The firm avoids barriers to investment

It allows a firm with intangible property that might havebusiness applications, but which doesnt want to develop thoseapplications itself, to capitalize on market opportunities


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Disadvantages

The firm doesnt have the tight control over manufacturing, marketing, and

strategy that is required for realizing experience curve and location economiesLicensing limits a firms ability to coordinate strategic moves acrosscountries by using profits earned in one country to support competitive attacksin another

There is the potential for loss of proprietary (or intangible) technology orproperty

One way of reducing this risk is through the use ofcross-licensingagreements where a firm might license intangible property to a foreignpartner, but requests that the foreign partner license some of its valuable know-how to the firm in addition to a royalty payment


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Franchising

Franchising is basically a specialized form of licensing inwhich 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 foreignmarket


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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 franchiseescan make poor quality difficult for the franchisor to detect


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Joint Ventures

Ajoint venture is the establishment of a firm that is jointly

owned by two or more otherwise independent firms


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Advantages

A firm can benefit from a local partner's knowledge of the hostcountry'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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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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Wholly Owned Subsidiaries

In a wholly owned subsidiary, the firm owns 100 percent of thestock.

Establishing a wholly owned subsidiary in a foreign market canbe 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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Advantages

A wholly owned subsidiary reduces the risk of losing controlover 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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Disadvantage

Firms bear the full costs and risks of setting up overseas

operations


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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 natureof a firms core competencies


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


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Technological Know-How

A firm with a competitive advantage based on proprietarytechnological 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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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 tofranchisees or joint venture partners is not high, and the benefits

from getting greater use of brand names is significant


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Pressures for Cost Reductions and Entry Mode

The greater the pressures for cost reductions, the more likely afirm 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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GREENFIELD VENTURE OR ACQUISITION?

Should a firm establish a wholly owned subsidiary in a countryby 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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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 green-

field ventures


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Why Do Acquisitions Fail?

Acquisitions fail for several reasons:

the acquiring firms often overpay for the assets of the acquiredfirm

there may be a clash between the cultures of the acquiring andacquired firm

attempts to realize synergies by integrating the operations of theacquired and acquiring entities often run into roadblocks and takemuch longer than forecast

there is inadequate pre-acquisition screening


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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 anintegration plan


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Pros and Cons of Greenfield Ventures

The main advantage of a greenfield venture is that it gives thefirm 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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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 globalname.


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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 toforeign competitors does significantly increase the risk of losing the technology.Therefore licensing should generally be avoided in these situations. Yet licensingstill may be a good choice in some instances. When a licensing arrangement can bestructured in such a way as to reduce the risks of a firm's technological know-howbeing expropriated by licensees, then licensing may be appropriate. A further

example is when a firm perceives its technological advantage as being onlytransitory, and it considers rapid imitation of its core technology by competitors to belikely. In such a case, the firm might want to license its technology as rapidly aspossible to foreign firms in order to gain global acceptance for its technology beforeimitation occurs. Such a strategy has some advantages. By licensing its technologyto competitors, the firm may deter them from developing their own, possiblysuperior, technology. And by licensing its technology the firm may be able toestablish its technology as the dominant design in the industry. In turn, this mayensure a steady stream of royalty payments. Such situations apart, however, theattractions of licensing are probably outweighed by the risks of losing control overtechnology, and licensing should be avoided


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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 corecompetence) is based on control over proprietary technologicalknow-how, licensing and joint venture arrangements should beavoided if possible so that the risk of losing control over thattechnology is minimized. For firms with a competitiveadvantage based on management know-how, the risk of losingcontrol over the management skills to franchisees or jointventure partners is not that great. Consequently, many servicefirms 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, butmost service firms have found that joint ventures with localpartners work best for controlling subsidiaries.


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4. A small Canadian firm that has developed some valuable new medicalproducts using its unique biotechnology know-how is trying to decide howbest to serve the European Community market. Its choices are given below.

The cost of investment in manufacturing facilities will be a major one for theCanadian firm, but it is not outside its reach. If these are the firms onlyoptions, which one would you advise it to choose? Why?

Manufacture the product at home and let foreign sales agents handlemarketing.

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. Theproduct would be manufactured in Europe by a 50/50 joint venture, andmarketed 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 transportationcosts 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 technologicalloss, and would allow the firm to maintain much tighter control over thequality 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 betteraccess to the market and potentially access to its products and technology,and that this same firm would insist on the 50/50 manufacturing jointventure 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 effectivein attacking the market. If a foreign sales agent can be found that is alreadyquite 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 awholly 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 aboutthe market and will likely earn greater profits if sets up its own sales force.

Documents

IBM Lecture No.3