What gives a firm tight control for coordinating a globally dispersed value chain?

Entering Foreign Markets Learning Objectives

1. Explain the three basic decision that firms contemplating foreign expansion must make: which markets to enter, when to enter those markets, and on what scale
2. Compare and contrast the different modes that firms use to enter foreign markets
3. Identify the factors that influence a firm’s choice of entry mode
4. Recognize the pros and cons of a acquisition versus greenfield ventures as an entry strategy

Introduction . Chapter on two topics

1. The decision of which foreign markets to enter, when to enter them, and on what scale
2. The choice of entry mode

Basic Entry Decision . A firm contemplating foreign expansion must make 3 basic decisions

1. Which markets to enter
2. When to enter those markets
3. On what scale

Which Foreign Markets . Choice must be based on an assessment of a nation’s long-run revenue potential - The attractiveness of a country as a potential market for an international business depends on balancing the benefits, costs, and risks associated with doing business in that countries a. Long-run economic benefits has many factors to consider 1. Size of market (demographics) 2. Present wealth (purchasing power) 3. future wealth of consumers → dependent on economic growth rate b. Likely future economic growth rates appear to be a function of a free market system and a country’s capacity for growth (which may be greater in less developed nations) c. Costs and risks associated for doing business in a foreign country are typically lower in economically advanced and politically stable democratic nation, and they are greater in less developed and politically unstable nations - International business can create value in a foreign market a. Depends on the suitability of product offering in that market and the nature of indigenous competition 1. If international business can offer a product that has not been widely available in that market and that satisfies unmet need, the value of that product to consumer is likely to be much greater than if the international business simply offers the same type of product that indigenous competitors and other foreign entrants are already offering

1. Greater value translates into an ability to charge higher prices and/or to build sales volume more rapidly

Timing of Entry Timing of Entry : Entry is early when a firm enters a foreign market before other foreign firms and late when a firm enters after other foreign firms and late when a firm enters after other international businesses have established themselves First-Movers Advantages : Advantages accruing to the first to enter a market First-Movers Disadvantages : Disadvantages associated with entering a foreign market before other international businesses Pioneering Costs : Costs an early entrant bears that later entrants avoid, such as the time and effort in learning the rules, failure due to ignorance, and the liability of being a foreigner . Once attractive markets have been identified, it is important to consider the timing of entry - 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 a. Advantages associated with entering a market early → first-movers advantages 1. Ability to preempt rivals and capture demand by establishing a strong brand name 2. Ability to build sales volume in that country and ride down the experience curve ahead of rivals, giving the early entrant a cost advantage over later entrants (cost advantage may enable early entrants to cut prices b below that of later entrants) 3. Ability of early entrants to create switching costs that tie customers into their products or services (switching costs can make it difficult for later entrants to win business) b. Disadvantages associated with entering a market early → first-movers disadvantages 1. Pioneering costs - costs that an early entrant has to bear that a later entrant can avoid 2. Regulations change in a way that diminishes the value of an early entrant’s investments

Scale of Entry and Strategic Commitments . Scale of entry - Entering a market on a large scale involves the commitment of significant resources and implies rapid entry - Not all firms have the resources necessary to enter on a large scale, and even some large firms prefer to enter foreign markets on a small scale and then build slowly as they become more familiar with the market . The consequences of entering on a significant scale - entering rapidly - are associated with the value of the resulting strategic commitments - A strategic commitment has a long-term impact and is difficult to reverse - Deciding to enter a foreign market on a significant scale is major strategic commitment

Exporting Exporting : Sale of products produced in one country to residents of another country . Many manufacturing firms begin their global expansion as exporters and only later switch to another mode for serving a foreign market

. Advantages - Exporting has 2 distinct advantages 1. It avoids the often substantial costs of establishing manufacturing operations in the ghost country 2. Exporting may help a firm achieve experience curve and location economies a. By manufacturing the product in a centralized location and exporting it to other national markets, the firm may realize substantial scale economies from its global sales volume

. Disadvantages - Exporting has a number of drawbacks 1. Exporting from the firm’s home base may not be appropriate if lower-cost locations for manufacturing the product can be found abroad (i., if the firm can realize location economies by moving production elsewhere) - thus firms may push for transnational strategies 2. High transportation costs can make exporting uneconomical, particularly for bulk products - one way getting around this is to manufacture bulk products regionally → enables firm to realize some economies from large-scale production and at same time limit transportation costs 3. Tariff barriers can make exporting uneconomical 4. Arises when a firm delegates its marketing, sales, and service in each country where it does business to another company - this is a common approach for manufacturing firms that are just beginning to expand internationally a. Local agents often carry the products of competing firms and so have divided loyalties - as such - local agents may not do as good a job as the firm would if it managed its marketing itself b. Way around this is to set up wholly owned subsidiaries in foreign nations to handle local marketing, sales, and service so that the firm can exercise tight control over marketing and sales in the country while reaping cost advantages of manufacturing the product in a single location or a few choice locations

Turnkey Projects Turnkey Project : A project in which a firm agrees to set up an operating plant for a foreign client and hand over the <key= when the plant is fully operational - Most common in chemical, pharmaceutical, petroleum-refining, and metal-refining industries, all of which use complex, expensive production technologies

. Advantages

• The know-how required to assemble and run a technologically complex process is available asset a. Turnkey projects are a way of earning great economic returns from that asset
• Turnkey strategy is useful where FDI is limited by host-government regulations a. You have the resource and then gain the technology via turnkey b. Such deals are often attractive to the selling firm because without them, they would have no way to earn a return on their valuable know-how in that country
• A turnkey strategy can also be less risky than conventional FDI a. In a country with unstable political and economic environments, a longer-term investment might expose the firm to unacceptable political and/or economic risks

. Disadvantages - 3 main drawbacks 1. The firm that enters into a turnkey deal will have no long-term interest in the foreign country → can be a disadvantage if that country subsequently proves to be a major market for the output of the process that has been exported. One way around this is to take a minority equity interest in the operation 2. The firm that enters into a turnkey project with a foreign enterprise may inadvertently create a competitor 3. 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 4. to potential and/or actual competitors

Licensing Licensing Agreement : Arrangement in which a licensor grants the rights to intangible property to a licensee for a specified period and receives a royalty fee in return

. Advantages - In the typical international licensing deal, the licensee puts up most of the capital necessary to get the overseas operation going - Thus, a primary advantage of licensing is that the firm does not have to bear the development costs and risks associated with opening a foreign market - Licensing is very attractive for firms lacking the capital to develop operations overseas - Licensing can be attractive when a firm is unwilling to commit substantial financial resources to an unfamiliar or politically volatile foreign market - Licensing used when a firm wishes to participate in a foreign market but is prohibited from doing so by barriers to investment - Licensing is used when a firm possesses some intangible property that might have business applications, but it doesn not want to develop those applications itself

. Disadvantages - 3 drawbracks 1. Does not give a firm the tight control over manufacturing, marketing, and strategy that is required for realizing experience curve and location economies →

Joint Venture : A cooperative undertaking between two or more firms

. Advantages - Number of advantages 1. Firm benefits from a local partner’s knowledge of the host country’s competitive conditions, culture, language, political systems, and business 2. When the development costs and/or risks of opening a foreign market are high, a firm might gain by sharing these costs and or risks with a local partner 3. In many countries, political considerations make joint ventures the only feasible entry mode - and research suggests that joint ventures with local partners face a low risk of being subject ot nationalization or other forms of adverse government interference

. Disadvantages - Major disadvantages with joint ventures 1. Licensing. A firm that enters into a joint venture risks giving control of its technology to its partner. This can be limited by one or the other taking a larger majority dominant stake 2. Joint venture does not give a firm the tight control over 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 need for engaging in coordinated global attacks against its rivals 3. Shared ownership arrangement can lead to conflicts and battles for control between the investing firms if their goals and objectives change or if they take different views as to what the strategy should be

Wholly Owned Subsidiaries Wholly Owned Subsidiary : A subsidiary in which the firm owns 100% of the stock

. Advantages - Several clear advantages of wholly owned subsidiaries 1. When a firm’s competitive advantage is based on technological competence, a wholly owned subsidiary will often be the preferred entry mode because it reduces the risk of losing control over that competence 2. Wholly owned subsidiary gives a firm tight control over operations in different countries - necessary for engaging in global strategic coordination 3. Wholly owned subsidiary may be required if a firm is trying to realize location and experience curve economies (as firms pursuing global and transnational strategies try to do)

. Disadvantages - Establishing a wholly owned subsidiary is generally the most costly method of serving a foreign market from a capital investment standpoint

a. Firms doing this must bear the full capital costs and risks of setting up overseas operations b. The risks associated with learning to do business in a new culture are less if the firm acquires an established host-country enterprise 1. However, acquisitions can raise additional problems such as trying to marry divergent corporate cultures and may end up offsetting any benefits derived by acquiring an established operation

Selecting an Entry Mode . All entry modes agave advantages and disadvantages - thus trade-offs are inevitable when selecting an entry mode

Core Competencies and Entry Mode . Technological Know-How - If a firm’s competitive advantage (its core competence) is based on control over proprietary technological know-how, licensing, and joint-venture agreements should be avoided to minimize the risk of losing control over that technology

. A firm can establish a wholly owned subsidiary in a country by building a subsidiary from the ground up, the so-called greenfield strategy, or by acquiring an enterprise in the target market - The volume of cross-border acquisitions has been growing at a rapid rate for 2 decades - 40 - 80% of all FDI has been in the form of M&A

Pros and Cons of Acquisitions . 3 major pros 1. Quick to execute 2. Firms make acquisitions to preempt their competitors. Preemption is needed in markets that are rapidly globalizing and acquisition makes it possible 3. Managers may believe acquisitions to be less risky than greenfield ventures - When a firm makes an acquisition, it buys a set of assets that are producing a known revenue and profit - also acquiring knowledge, brand, logistics, culture, etc. - In contrast, the revenue and profit stream that a greenfield venture might generate is uncertain because it does not yet exist . Cons - Many acquisitions produce disappointing results a. Many acquisitions end up destroying rather than creating value

. Why Do Acquisitions Fail? - Acquisitions fail for several reasons 1. Acquiring firms often overpay for the assets of the acquired firm 2. Clash between cultures of the acquiring and acquired firms 3. Attempts to realize gains by integrating the operations of the acquired and acquiring entities often run into roadblocks and take much longer than forecast 4. Many acquisitions fail due to inadequate pre acquisition screening

. Reducing the Risks of Failure - These problem can all be overcome if the firm is careful about its acquisition strategy - Screening of the foreign enterprise to be acquired, including a detailed auditing of operations, financial position, and management culture, can help to make sure the firm: 1. Does not pay too much for the acquired unit 2. Does not uncover any nasty surprises after the acquisition 3. Acquires a firm whose organization culture is not antagonistic to that of the acquiring enterprise - It is important for the acquirer to allay any concerns that management in the acquired enterprise might have - objective should be to reduce unwanted management attrition after the acquisition - Managers must move rapidly after an acquisition to put an integration plan in place and to act on that plan

Pros and Cons of Greenfield Ventures

. The big advantage of establishing a greenfield venture in a foreign country is that it gives the firm a much greater ability to build the kind of subsidiary company that it wants - Similarly, it is much easier to establish a set of operating routines in a new subsidiary than it is to convert the operating routine of an acquired unit a. This is a very important advantage for many international businesses where transferring products, competencies, skills, and know-how from the established operations of the firm to the new subsidiary are principal way of creating value . Cons - Slower to establish - Risky - a degree of uncertainty is associated with future revenue and profit prospects a. However, if firm has experience with greenfield ventures, could be less risky than acquisition because they know what they’re doing and won’t have any unexpected surprise risks that may come with acquisitions - Possibility of being preempted by more aggressive global competitors who enter via acquisitions and build a big market presence that limits the market potential for the greenfield venture

Which Choice? . Situational - If the firm is seeking to enter a market where there are already well-established incumbent enterprises and where global competitors are also interested in establishing a presence, it may pay the firm to enter via an acquisition a. In such situation, a greenfield venture may be too slow to establish a sizable presence - If the firm is considering entering a country where there are no incumbent competitors to be acquired, then a greenfield venture may be the only mode. Even when incumbents exist, if the competitive advantage of the firm is based on the transfer of organizationally embedded competencies, skills, routines, and culture, it may still be preferable to enter via a greenfield venture a. Things such as skills and organizational culture, which are based on significant knowledge that is difficult to articulate and codify, are much easier to embed in a new venture than they are in an acquired entity, where the firm may have to overcome the established routines and culture of the acquired firm

What is a reason for why small

Which of the following modes of entry into foreign markets does a firm agree to set up an operating plant for a foreign client?

Which entry mode into a foreign market best serves a high tech firm because it reduces the risk of losing that competence?

Which of the following is an advantage of choosing exporting when expanding internationally?