Chapter Entering Foreign Markets 9. INTRODUCTION A firm expanding internationally must decide: which...

chapter

Entering Foreign Markets

9


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)

There are several options including:

• exporting

• licensing or franchising to host country firms

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


The advantages and disadvantages associated with each entry mode is determined by:

• transport costs and trade barriers• political and economic risks• firm strategy

While it may make sense for some firms to serve a market by exporting, other firms might set up a wholly owned subsidiary, or utilize some other entry mode.


BASIC ENTRY DECISIONS

There are three basic decisions that a firm contemplating foreign expansion must make: • which markets to enter

• when to enter those markets

• on what scale


Which Foreign Markets?

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

• Typically, the most favorable markets are those that are politically stable developed and developing nations that have free market systems, and where there is not a dramatic upsurge in either inflation rates, or private sector debt •Those that are less desirable are politically unstable developing nations that operate with a mixed or command economy, or developing nations where speculative financial bubbles have led to excess borrowing

• Firms are more likely to be successful if they offer a product that has not been widely available in a market and that satisfies an unmet need


Timing of Entry

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


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


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)


Pioneering costs arise when a business system in a foreign country is so different from that in a firm’s 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


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


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


ENTRY MODES

These are six different ways to enter a foreign market.

Exporting

• Most manufacturing firms begin their global expansion as exporters and only later switch to another mode for servicing a foreign market


Advantages

• Exporting avoids the substantial cost of establishing manufacturing operations in the host country

• Exporting may also help a firm achieve experience curve location economies


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 exporter’s best interest


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


Advantages

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


Disadvantages

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


Licensing

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

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


Advantages

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

• The firm avoids barriers to investment

• It allows a firm with intangible property that might have business applications, but which doesn’t want to develop those applications itself, to capitalize on market opportunities


Disadvantages

• The firm doesn’t have the tight control over manufacturing, marketing, and strategy that is required for realizing experience curve and location economies• Licensing limits a firm’s ability to coordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another• There is the potential for loss of proprietary (or intangible) technology or property• One way of reducing this risk is through the use of cross-licensing agreements where a firm might license intangible property to a foreign partner, but requests that the foreign partner license some of its valuable know-how to the firm in addition to a royalty payment


Franchising

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


Advantages

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


Disadvantages

• Franchising may inhibit the firm's ability to take profits out of one country to support competitive attacks in another

• The geographic distance of the firm from its foreign franchisees can make poor quality difficult for the franchisor to detect


Joint Ventures

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


Advantages

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


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


Wholly Owned Subsidiaries

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

Establishing a wholly owned subsidiary in a foreign market can be done two ways:

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


Advantages

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


Disadvantage

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


SELECTING AN ENTRY MODE

The optimal choice of entry mode involves trade-offs.

Core Competencies and Entry Mode

• The optimal entry mode depends to some degree on the nature of a firm’s core competencies


Advantages and disadvantages of the various entry modes


Technological Know-How

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


Management Know-How

• The competitive advantage of many service firms is based upon management know-how

• The risk of losing control over the management skills to franchisees or joint venture partners is not high, and the benefits from getting greater use of brand names is significant


Pressures for Cost Reductions and Entry Mode

• The greater the pressures for cost reductions, the more likely a firm will want to pursue some combination of exporting and wholly owned subsidiaries

• This will allow it to achieve location and scale economies as well as retain some degree of control over its worldwide product manufacturing and distribution


GREENFIELD VENTURE OR ACQUISITION?

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


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


Why Do Acquisitions Fail?

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


Reducing the Risks of Failure

Problems can minimized:• through careful screening of the firm to be acquired

• by moving rapidly once the firm is acquired to implement an integration plan


Pros and Cons of Greenfield Ventures

• The main advantage of a greenfield venture is that it gives the firm a greater ability to build the kind of subsidiary company that it wants

• However, greenfield ventures are slower to establish

• Greenfield ventures are also risky


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