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GLOBAL/INTERNATIONAL BUSINESS

TOPIC: Direct Investment & Collaborative Strategies

OBJECTIVES

• To clarify why companies may need to use modes other than exportingto operate effectively in international business

• To comprehend why and how companies make foreign directinvestments

• To understand the major motives that guide managers when choosinga collaborative arrangement for international business

• To define the major types of collaborative arrangements

• To describe what companies should consider when entering intoarrangements with other companies

• To grasp what makes collaborative arrangements succeed or fail• To see how companies can manage diverse collaborative arrangements

Chapter Overview

Although most companies operating internationally would prefer exporting

to other market entry modes, there are circumstances in which exporting

may not be feasible. In these cases, companies may engage in directinvestment in other countries, or enter markets through various

collaborative strategies such as joint ventures and alliances. Collaborative

strategies allow firms to spread both assets and risk across countries by

entering into contractual agreements with a variety of potential partners.

Chapter Fourteen first discusses reasons for not exporting and then

explores the motives that drive firms to engage in noncollaborative and

collaborative arrangements, as well as the various types of possible

arrangements, including foreign direct investment, licensing, franchising,

joint ventures, and equity alliances. It goes on to explore the various

problems that may arise in FDI and collaborative ventures and concludes

with a discussion of the various methods for managing these evolving

arrangements.



Chapter Outline

OPENING CASE: Cisco Systems

[See Map 14.1]

Globalization has pushed Cisco Systems into a broader range of markets

in order to follow the expansion patterns of its customers, solicit new

business, and study new ideas and products. Cisco’s worldwide alliances

spur the company to continue learning and to refine its competencies.

They enable it to meet customer needs that fall outside its areas of core

competencies, while simultaneously permitting Cisco and its partners to

enhance their competitiveness by focusing on their respective

competencies. Alliances have also permitted Cisco to limit its capital

outlays in potentially lucrative but risky ventures. Cisco believes alliances

improve its processes, reduce its costs and expose it to the best

competitive practices. The firm’s official Strategic Alliances Team manages

crucial partnerships with industry-leading technology and integrator firms,

and it is the driving force behind the collaborative development effort to

accelerate new market opportunities. Cisco has generally standardized the

mechanics of partnership agreements. However, it continues to work to

improve the odds of collaborative success by better managing the mattersof trust, commitment and culture that shape what Cisco calls “interwoven

dependencies and relationships” with its partners.

Teaching Tip: Review the PowerPoint slides for Chapter Fourteen and

select those you find most useful for enhancing your lecture and class

discussion. For additional visual summaries of key chapter points,

review the figures in the text.

I. INTRODUCTIONWhen forming objectives and implementing strategies in a variety of country environments, firms must either handle international businessoperations on their own or collaborate with other companies (Figure14.2). Although exporting is usually the preferred alternative since itallows firms to produce in their home countries, participating in somemarkets may require using a variety of other equity and nonequity



arrangements (Figure 14.3). These can range from wholly ownedoperations to partially owned subsidiaries, joint ventures, equityalliances, licensing, franchising, management contracts, and turnkeyoperations.

II.WHY EXPORTING MAY NOT BE FEASIBLE

Companies may find more advantages by producing in foreigncountries rather than by exporting to them due to a variety of reasons.

A. Cheaper to Produce Abroad

Competition requires companies to control their costs and to chooseproduction locations with this factor in mind.

B. Transportation Costs

Some products and services become impractical to export after thecost of transportation is added to production costs. In general, thefarther the target market is from the home country, the higher thetransportation costs. Also, the higher transportation costs arerelative to production costs, the more difficult it is to be competitivethrough exporting. Some services are impossible to export andrequire establishing operations in the target country.

C. Lack of Domestic Capacity

As long as a company has excess capacity, it can service foreignmarkets and price on the basis of variable rather than full costs.When demand exceeds capacity, however, new facilities are neededand are often located nearer to the end consumers in othercountries.

D. Need to Alter Products and Services

Special requirements for products in some markets may requireadditional investments that are often better made in the country thecompany intends to sell to. The more that products must be alteredfor foreign markets, the more likely production will shift to thoseforeign markets.



E. Trade Restrictions

Although import barriers have been on the decline, some significanttariffs continue to exist. In these situations, avoiding barriersthrough production in the target country must be weighed against

other considerations such as the market size of the country and thescale of technology used in production. When barriers fall within agroup of countries, companies may be attracted to make directinvestments to serve the entire region since the expanded marketmay justify scale economies.

F. Country of Origin Effects

Consumers may prefer goods produced in their own country overimports because of nationalistic feelings. For some products,

consumers may prefer imported goods from specific countries dueto a perception that those products are superior. Otherconsiderations like the availability of service and replacement partsfor imported products, or adoption of just-in-time manufacturingsystems may influence production locations.

III. NONCOLLABORATIVE FOREIGN EQUITYARRANGEMENTS

Two forms of foreign direct investment (FDI) that do not involvecollaboration are wholly owned operations and partially ownedoperations with the remainder widely held.

A. Foreign Direct Investment and Control

To qualify as a foreign direct investment, the investor must have

control. This can be established with a small percentage of the

holdings if ownership is widely dispersed. The more ownership a

company has, the greater its control over the managementdecisions of the operation. There are three primary reasons for

companies to want a controlling interest—internalization theory,

appropriability theory, and freedom to pursue global objectives.



1. Internalization. Control through self-handling of operations is

known as internalization. Transactions cost theory holds that

companies should organize operations internally when the costs

of doing so are lower than contracting with another party to

handle it for them. Internalization may result in lower costs

because:

• Different operating units with the same company likely share

a common culture which expedites communications

• The company can use its own managers who understand and

are committed to carrying out its objectives

• Negotiations that might delay the investment or complicate itsmanagement can be avoided

• The company can avoid possible problems with enforcing an

agreement

2. Appropriability. Appropriability theory is the idea that

companies want to deny rivals and potential rivals’ access to

resources such as capital, patents, trademarks, and

management know-how that might be captured through

collaborative agreements.

3. Pursuit of Global Strategies. When a company has a wholly

owned foreign operation, it may more easily have that operation

participate in a global or transnational strategy. Furthermore,

the fact that most countries have laws to protect minority

shareholders’ interest means that sharing of ownership may

restrict a company from implementing a global or transnationalstrategy.

B. Methods for Making FDI

FDI usually involves international capital movement, but could also

involve the transfer of other assets such as managers, cost control



systems. Companies can either acquire an interest in an existing

company or construct new facilities, known as a greenfield

investment .

1. Reasons for Buying. Companies may acquire existingoperations in order to avoid adding further capacity to the

market, to avoid start-up problems, obtain easier financing, and

get an immediate cash flow rather than tying up funds during

construction. A company may also save time, reduce costs, and

reduce risks by buying an existing company.

2. Reasons for Greenfield. Companies may choose to build if no

suitable company is available for acquisition, if the acquisition is

likely to lead to carry-over problems, and if the acquisition is

harder to finance. In addition, local governments may prevent

acquisitions because they want more competitors in the market

and fear foreign domination.

II.MOTIVES FOR COLLABORATIVE ARRANGEMENTS

Each participant in a collaborative arrangement has its own basic

objectives for operating internationally as well as its own motives for

collaborating with a partner.

A. Motives for Collaborative Arrangements: GeneralCompanies collaborate with other firms in either their domestic or

foreign operations in order to spread and reduce costs, to specialize

in particular competencies, to avoid or counter competition, to

secure vertical and/or horizontal linkages and to learn from other

companies.

1. Spread and Reduce Costs. When the volume of businessis small, or one partner has excess capacity, it may be lessexpensive to collaborate with another firm. Nonetheless, thecosts of negotiation and technology transfer must not beoverlooked.



2. Specialize in Competencies. The resource-based viewof the firm holds that each firm has a unique combination of competencies. Thus, a firm can maximize its performance byconcentrating on those activities that best fit its competencies

and relying on partners to supply other products, services, orsupport activities.3. Avoid or Counter Competition. When markets are notlarge enough for numerous competitors, or when firms need toconfront a market leader, they may band together in ways toavoid competing with one another or combine resources toincrease their market presence.4. Secure Vertical and Horizontal Links. If a firm lacksthe competence and/or resources to own and manage all of the

activities of the value-added chain, a collaborative arrangementmay yield greater vertical access and control. At the horizontallevel, economies of scope in distribution, a better smoothing of sales and earnings through diversification and an ability topursue projects too large for any single firm can all be realizedthrough collaboration.5. Gain Knowledge. Many firms pursue collaborativearrangements in order to learn about their partners’ technology,operating methods, or home markets and thus broaden their

own competencies and competitiveness over time.B. International Motives for Collaborative ArrangementsCompanies collaborate with other firms in their foreign operations inorder to gain location-specific assets, overcome legal constraints,diversify geographically and minimize their exposure in high-riskenvironments.1. Gain Location-Specific Assets. Cultural, political, competitive,

and economic differences among countries create challenges for

companies that operate abroad. To overcome such barriers and

gain access to location-specific assets (e.g., distribution access

or a competent workforce), firms may pursue collaborative

arrangements.

2. Overcome Governmental Constraints. Countries may prohibit

or limit the participation of foreign firms in certain industries, or



discriminate against foreign firms via tax rates and profit

repatriation. Firms may be able to overcome such barriers via

collaboration with a local partner.

3. Diversify Geographically. By operating in a variety ofcountries, a firm can smooth its sales and earnings; collaborative

arrangements may also offer a faster initial means of entering

multiple markets or establishing multiple sources of supply.

4. Minimize Exposure in Risky Environments. The higher the

risk managers perceive with respect to a foreign operation, the

greater their desire to form a collaborative arrangement.

III. TYPES OF COLLABORATIVE ARRANGEMENTS

While collaborative arrangements allow for a greater spreading of

assets across countries, the various types of arrangements necessitate

trade-offs among objectives. Finding a desirable partner can be

problematic. A firm has a wider choice of operating forms and partners

when there is less likelihood of competition and when it has a desired,

unique, difficult-to-duplicate resource.

A. Some Considerations in Collaborative ArrangementsTwo critical variables that influence the choice of collaborative

arrangement are a firm’s desire for control over its foreign

operations and its prior expansion into foreign ventures.

1. Control. The loss of control over flexibility, revenues andcompetition is a critical variable in the selection of forms offoreign operation. The more a firm depends on collaborativearrangements, the more likely its control will be lessened over

decisions regarding quality, new product directions andproduction expansion.

POINT-COUNTERPOINT:

Should Countries Limit Foreign Control of Key Industries?



POINT: Countries should limit foreign control of key industries in order to

protect their economic and security interests, especially in key industries

such as transportation, mass media, and energy. History has shown that

home governments have used powerful foreign companies to influence

policies in the countries where they operate, and that foreign companies

have used their home governments as instruments to improve their

interests in a country. Whenever a company is controlled from abroad,

decisions about that company can be made abroad, possibly to the

detriment of the host country.

COUNTERPOINT: Decisions made by foreign companies are not likelyto be much different than decisions made by local companies. MNEs

staff their foreign subsidiaries mainly with nationals of the countrieswhere they operate, and make decisions based on a good deal of local advice. Their decisions have to adhere to local laws andconsider the views of suppliers and customers. Protection of certainindustries from foreign control could reduce competitiveness in thoseindustries and harm, rather than help, the local people. Those whoargue for limits are relying on the outdated dependencia theory,which holds that emerging economies have practically no power intheir dealings with MNEs. More recent bargaining school theory

states that the terms for a foreign investor’s operations depend onhow much the investor and host country need the other’s assets.Countries and foreign companies need each other, and both will loseif limitations are placed on foreign control.

2. Prior Expansion of the Company. If a firm already ownsand controls operations in a foreign country, the advantages of collaboration may not be as attractive as otherwise.

B. Licensing

Under a licensing agreement , a firm (the licensor) grants rights tointangible property to another company (the licensee) to use in a

specified geographic area for a specified period of time; in

exchange, the licensee ordinarily pays a royalty to the licensor.

Such rights may be exclusive or nonexclusive. Usually the licensor is

obliged to furnish technical information and assistance, while the



licensee is obliged to exploit the rights effectively and pay

compensation to the licensor. Intangible property may be classified

as:

• patents, inventions, formulas, processes, designs, patterns

• copyrights for literary, musical, or artistic compositions

• trademarks, trade names, brand names

• franchises, licenses, contracts

• methods, programs, procedures, systems.

1. Major Motives for Licensing. Licensing often has aneconomic motive, such as the desire for faster start-up, lowercosts, or access to additional property rights (e.g., technology).For the licensor, the risks and costs of a given venture arelessened; for the licensee, costs are less than if it had to developa product or process on its own. Cross-licensing represents thesituation in which companies in various countries exchangetechnology rather than compete with each other with everyproduct in every market.2. Payment. The amount and type of payment for licensingarrangements may vary. Each contract tends to be negotiated onits own merits; the bargaining range is based on dualexpectations. Both agreement-specific and environment-specificfactors may affect the value of a license.3. Sales to Controlled Entities. Many licenses are given tofirms owned in part or in whole by the licensor. From a legalstandpoint, subsidiaries are separate companies; thus, a licensemay be required in order to transfer intangible property.

C. FranchisingFranchising represents a specialized form of licensing in which the

franchisor not only sells an independent franchisee the use of the

intangible property essential to the franchisee’s business, but also

operationally assists the business on a continuing basis. In a sense,

the two partners act like a vertically integrated firm because they



are interdependent and each produces a part of the product that

ultimately reaches the customer.

1. Organization of Franchising. A franchisor may penetrate

a foreign country by dealing directly with its foreign franchisees,or by setting up a master franchise and giving that organizationthe right to open outlets on its own or to develop sub-franchisesin the country or region.2. Operational Modifications. Franchise success is derivedfrom three factors: product standardization, effective cost controland high recognition. Nonetheless, franchisors face a classicdilemma: the more they standardize on a global basis, the lowerthe potential for product acceptance in a given country; the more

they permit adaptation to local conditions, the less the franchisor can offer the franchisee, the higher the costs and the less thecontrol by the franchisor.

D. Management ContractsA management contract represents an arrangement in which one

firm provides management personnel to perform general or

specialized functions to another firm for a fee. A firm usually

pursues such contracts when it believes a partner can manage

certain operations more efficiently and effectively than it can itself.

E. Turnkey OperationsTurnkey operations represent a type of collaborative arrangement in

which one firm contracts with another to build complete, ready-to-

operate facilities. Usually, suppliers of turnkey facilities are

industrial-equipment and construction companies; projects may cost

billions of dollars; customers most often are government agencies

or large MNEs.

F.Joint Ventures

A joint venture represents a direct investment in which two or more

partners share ownership. As a firm’s share of the equity declines,

its ability to control a given operation also declines. A consortium

represents the joining together of several entities (e.g., companies



and governments) to combine resources and/or to strengthen the

possibility of pursuing a major undertaking. Other forms of joint

ventures include:

• Two companies from the same country joining together in aforeign market, such as NEC and Mitsubishi (Japan) in the United

Kingdom

• A foreign company joining with a local company, such as Great

Lakes Chemical (U.S.) and A. H. Al Zamil in Saudi Arabia

• Companies from two or more countries establishing a joint

venture in a third country, such as that of Diamond Shamrock

(U.S.) and Sol Petroleo (Argentina) in Bolivia

• A private company and a local government forming a joint

venture (sometimes called a mixed venture), such as that of

Philips (Dutch) with the Indonesian government

• A private company joining a government-owned company in a

third country, such as BP Amoco (private British-U.S.) and Eni

(government-owned Italian) in Egypt

A. Equity AlliancesAn equity alliance represents a collaborative arrangement in which

at least one of the collaborating firms takes an ownership position

(usually a minority) in the other(s). The purpose of an equity

alliance is to solidify a collaborating contract, thus making it more

difficult to break.

IV. PROBLEMS OF COLLABORATIVE ARRANGEMENTS

Dissatisfaction with the results of collaboration can cause anarrangement to break down. Problems arise for a number of reasons.A. Collaboration’s Importance to Partners

One partner may give more attention to the collaboration than the

other—often because of a difference in size. An active partner will



blame the less active partner for its lack of attention, while the less

active partner will blame the other for poor decisions.

B. Differing Objectives

Although firms may enter into collaborative arrangements withcomplementary capabilities and objectives, their views regarding

such things as reinvestment vs. profit repatriation and desirable

performance standards may evolve quite differently over time.

C. Control ProblemsWhen no single party has control of a collaborative arrangement,

the venture may lack direction; if one party dominates, it must still

consider the interests of the other. By sharing assets with another

firm, a company may lose some control over the extent and/or

quality of the assets’ use. Further, even when control is ceded to

one of the partners, both may be held responsible for problems.

D. Partners’ Contributions and AppropriationsOne partner’s ability to contribute technology, capital and other

assets may diminish (at least on a relative basis) over time.

Further, in almost all collaborations the danger exists that one

partner will use the others’ contributed assets, or take more than itsfair share from the operation, thus enabling it to become a direct

competitor. Such weaknesses may cause a drag on a venture and

even lead to the dissolution of the agreement.

E. Differences in CultureDifferences in both national and corporate cultures may cause

problems with collaborative arrangements, especially joint ventures.

Firms differ by nationality in terms of how they evaluate the success

of an operation (e.g., profitability, strategic market position and/or

social objectives). Nonetheless, joint ventures from culturally

distant countries tend to survive at least as well as those between

partners from similar cultures.

A. MANAGING FOREIGN ARRANGEMENTS



As a collaborative arrangement evolves, partners need to reassess

certain decisions in light of their resource bases and external

environmental changes.

A. Dynamics of Collaborative ArrangementsThe evolutionary costs of a firm’s foreign operations may be very

high as it switches from one operational mode to another, especially

if it must pay termination fees. Thus, a firm must develop the

means to evaluate performance by separating the controllable and

uncontrollable factors at its various profit centers.

B. Finding Compatible PartnersA firm may actively seek a partner for its foreign operations, or it

can react to a proposal from another company to collaborate with it.

Potential partners should be evaluated both for the resources they

can offer and their willingness to work together. The proven ability

to handle similar types of collaboration is a key professional

qualification.

C. Negotiating ProcessCertain technology transfer considerations are unique to

collaborative arrangements; often pre-agreements are set up toprotect concerned parties. The secrecy of financial terms, especially

when government authorities consult their counterparts in other

countries, is an especially sensitive area. Market conditions may

dictate the need for different terms in different countries.

D. Contractual ProvisionsTo minimize potential points of disagreement, contract provisions

should address the following factors:

• Terminating the agreement if the parties do not adhere to the

directives

• Methods of testing for quality

• Geographical limitations on the asset’s use



• Which company will manage which parts of the operation

outlined to the agreement

• What each company’s future commitments will be

• How each company will buy from, sell to, or use intangible assets

that come from the collaborative arrangement

E. Performance Assessment

All parties should establish mutual goals so all involved understand

what is expected, and a contract should spell out expectations. In

addition to the continuing assessment of the venture’s performance,

a firm should also periodically assess the possible need for a change

in the type of collaboration.

LOOKING TO THE FUTURE:

Why Innovation Breeds Collaboration

Because the cost of invention is often so high, it follows that firms of

considerable size will carry out most innovation. Although firms can

become ever larger through mergers and acquisitions, collaborative

arrangements are likely to be increasingly important in the future as

governments opt to restrict such activities because of antitrust concerns.

At the same time, collaborative arrangements will bring forth both

opportunities and problems as firms move simultaneously into new

countries and to new types of contractual arrangements with new

partners. The more partners in a given alliance, the more strained the

decision-making and control processes will likely be.

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