chapter 12 Entering Foreign Markets Mc GrawHillIrwin Global

Chapter 12: Entering Foreign Markets 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) 12 - 3

Chapter 12: Entering Foreign Markets 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 12 - 4

Chapter 12: Entering Foreign Markets 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. 12 - 5

Chapter 12: Entering Foreign Markets 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 12 - 6

Chapter 12: Entering Foreign Markets 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 12 - 7

Chapter 12: Entering Foreign Markets 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 12 - 8

Chapter 12: Entering Foreign Markets 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 12 - 9

Chapter 12: Entering Foreign Markets 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) 12 - 10

Chapter 12: Entering Foreign Markets 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 12 - 11

Chapter 12: Entering Foreign Markets 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 12 - 12

Chapter 12: Entering Foreign Markets 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 12 - 13

Chapter 12: Entering Foreign Markets Classroom Performance System The time and effort in learning the rules of a new market, failure due to ignorance, and the liability of being a foreigner are all examples of a) First mover advantages b) Strategic commitments c) Pioneering costs d) Market entry costs 12 - 14

Chapter 12: Entering Foreign Markets 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 12 - 15

Chapter 12: Entering Foreign Markets 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 12 - 16

Chapter 12: Entering Foreign Markets 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 12 - 17

Chapter 12: Entering Foreign Markets 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 12 - 18

Chapter 12: Entering Foreign Markets 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 12 - 19

Chapter 12: Entering Foreign Markets 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 12 - 20

Chapter 12: Entering Foreign Markets 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 12 - 21

Chapter 12: Entering Foreign Markets 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 12 - 22

Chapter 12: Entering Foreign Markets 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 knowhow to the firm in addition to a royalty payment 12 - 23

Chapter 12: Entering Foreign Markets 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 12 - 24

Chapter 12: Entering Foreign Markets Advantages • The firm avoids many costs and risks of opening up a foreign market 12 - 25

Chapter 12: Entering Foreign Markets 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 12 - 26

Chapter 12: Entering Foreign Markets Joint Ventures • A joint venture is the establishment of a firm that is jointly owned by two or more otherwise independent firms 12 - 27

Chapter 12: Entering Foreign Markets 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 12 - 28

Chapter 12: Entering Foreign Markets 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 12 - 29

Chapter 12: Entering Foreign Markets 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 12 - 30

Chapter 12: Entering Foreign Markets 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 12 - 31

Chapter 12: Entering Foreign Markets Disadvantage • Firms bear the full costs and risks of setting up overseas operations 12 - 32

Chapter 12: Entering Foreign Markets Classroom Performance System Most firms begin their foreign expansion with a) Exporting b) Joint ventures c) Licensing or franchising d) Wholly owned subsidiaries 12 - 33

Chapter 12: Entering Foreign Markets 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 12 - 34

Chapter 12: Entering Foreign Markets The advantages and disadvantages of the various entry modes are shown in Table 12. 1. 12 - 35

Chapter 12: Entering Foreign Markets 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 12 - 36

Chapter 12: Entering Foreign Markets 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 12 - 37

Chapter 12: Entering Foreign Markets 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 12 - 38

Chapter 12: Entering Foreign Markets Classroom Performance System A firm that wants the ability to engage in global strategic coordination should choose a) Franchising b) Joint ventures c) Licensing d) Wholly owned subsidiaries 12 - 39

Chapter 12: Entering Foreign Markets 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)? 12 - 40

Chapter 12: Entering Foreign Markets Pros and Cons of Acquisition Benefits of 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 greenfield ventures 12 - 41

Chapter 12: Entering Foreign Markets 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 12 - 42

Chapter 12: Entering Foreign Markets 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 12 - 43

Chapter 12: Entering Foreign Markets 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 12 - 44

Chapter 12: Entering Foreign Markets Classroom Performance System Which of the following is not an advantage of acquisitions as compared to greenfield investments? a) They are quicker to execute b) Attempts to realize synergies by integrating the operations of the acquired entities can be challenging and take time c) They enable firms to preempt their competitors d) They may be less risky 12 - 45

Chapter 12: Entering Foreign Markets CRITICAL THINKING AND DISCUSSION QUESTIONS 1. Review the Management Focus on 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? 12 - 46

Chapter 12: Entering Foreign Markets CRITICAL THINKING AND DISCUSSION QUESTIONS 2. Licensing propriety technology to foreign competitors is the best way to give up a firm's competitive advantage. Discuss. 12 - 47

Chapter 12: Entering Foreign Markets CRITICAL THINKING AND DISCUSSION QUESTIONS 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? 12 - 48

Chapter 12: Entering Foreign Markets CRITICAL THINKING AND DISCUSSION QUESTIONS 4. A small Canadian firm that has developed some valuable new medical products using its unique biotechnology know-how is trying to decide how best to serve the European Community market. Its choices are given below. The cost of investment in manufacturing facilities will be a major one for the Canadian firm, but it is not outside its reach. If these are the firm’s only options, which one would you advise it to choose? Why? • Manufacture the product at home and let foreign sales agents handle marketing. • 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. The product would be manufactured in Europe by a 50/50 joint venture, and marketed by the European firm. 12 - 49