MODES OF ENTERING INTERNATIONAL BUSINESS

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Introduction

• Any firm contemplating foreign expansion must struggle with the following decisions

– Which foreign market(s) to enter??

– When to enter them??

– On what scale??

– Which mode of entry will be utilized??

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Which Foreign Markets

• The firm has alternative foreign markets to enter. In order to achieve their goals successfully, the firms have to,

Analyse alternative foreign market

Evaluate the respective costs, benefits and risks

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Contd…

Analyse Alternative Foreign markets

o Current and Potential Size of Market

o Level of Competition

o Political & Legal Environments

o Socio-cultural Background

o Size of the Population

o GDP

o Economic Growth rate

o Urban areas/Rural areas

o Purchasing Power

o Infrastructure

o Availability of Technical and Non technical work force

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Contd…

Assessing Costs, Benefits & Risks

o Costs :

Direct Costs

Opportunity Costs

o Benefits

High Sales, Profits

Additional Resources

Lower Costs

Economies of Scale

Power & Prestige

Competitive Advantage

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Contd…

o Risks

Exchange rate fluctuations

Operating complexity

Direct Financial losses due to misassessment of market potential

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Timing the Entry

• Another important decision to make, is when to enter a foreign market??

Whether to be a first entrant in the market or,

to be a late entrant??

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Contd…

• Advantages frequently associated with entering a market early are commonly known as first-mover advantages– The ability to preempt rivals and capture demand by establishing

a strong brand name

– Significant & Sustained market share

– Ability to build sales volume

• Disadvantages associated with entering a foreign market before other international businesses are referred to as first-mover disadvantages – Pioneering costs are costs that an early entrant has to bear

– Time & effort in learning the rules

– Mistakes due to ignorance

– Higher investment in R&D

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Contd…

• Late Entrant Strategies

Reduce price to penetrate an existing market

Improve a product or service with focus on niche market

Develop new channels of distribution

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Scale of Entry

• Large scale entry – Requires commitment of significant resources & implies rapid

entry.

• Strategic commitment – Decision that has long term impact & is difficult to reverse

(entering market on large scale)– Change the competitive playing field & unleash number of

changes – e.g. how competitors might react– Can limit strategic flexibility

• Small scale entry – Allows firm to learn about a foreign market while limiting the firm’s

exposure -> limits risks– May be more difficulty to build market share & capture early

mover advantages– Can use MNEs to learn & bench mark against– Can focus on niches the MNE ignores or can’t serve

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MODES OF ENTRY IN FOREIGN MARKET

• A company has three different modes of foreign market entry:

EXPORT ENTRY MODE

CONTRACTUAL ENTRY MODE

INVESTMENT ENTRY MODE

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1. Export Entry Mode includes,

- Direct Exports

- Indirect Exports

2. Contractual Entry Mode includes,

- International Licensing

- International Franchising

- Contract Manufacturing

- Management Contracts

- Turnkey Projects

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3. Investment Entry Mode

- Foreign Direct Investment

- Mergers and Acquisition

- Joint Venture

- Takeover

- Collaboration

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Characteristics of Modes of Entry

• The characteristics of export, contractual and investment entry modes are analysed on the basis of five aspects

i. Control

ii. Dissemination Risks

iii. Resource Commitment

iv. Flexibility

v. Ownership

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i. Control refers to that the extent of a firm in governs the production process, co-ordinate activities, logistical and marketing and so on.

ii. Dissemination risk refers to the extent to which a firm’s know-how will be expropriated by a contractual partner.

iii. Resource commitment refers to the financial, physical and human resources that firms commit to a host market

iv. Flexibility assesses that whether a firm can change the entry modes quickly and with low cost in the face of evolving circumstances.

v. Ownership refers to the extent of a firms equity participation in an entry mode.

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Entry Method

Control Risk

Dissemination Resource commitment

Flexibility Ownership

Investments

High Low High Low High

Contracts Medium Med-High Med-High Medium Med-High

Exports Low Low Low High Low

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EXPORT ENTRY MODE EXPORT ENTRY MODE

• Export deals with physical movement of goods & services from one destination to another through a customs port following the rules of both the country of origin and the country of destination.

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• Exporting is the appropriate strategy when one or more of the following conditions prevail :

The volume of foreign business is not large enough to justify production in the foreign market.

Cost of production is high There are political or other risks of investment in that

country. The market may not big enough in the long term

Exporting is attractive when the concerned company has excess capacity.

Also exports ensure that the company has other markets to cater when faced with stiff competition in home market or when home market reaches saturation levels.

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Depending upon the involvement of the exporter, exports can be classified as direct or indirect

Direct exporters export their goods and services in their own name and all proceeds are directly remitted by the buyer in the proper manner through the proper channel.

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Indirect exporters supply goods to direct exporters. Indirect exporting usually means that the company sells to a buyer (importer or distributor) in the home country who in turn exports the product.

• Lack of expertise, international contacts and manpower cause them to depend upon direct exporters.

• Farmers rarely export grains on their own. Artisans cannot develop international contacts to clinch deals. Therefore, they become indirect exporters. Their products are going to other countries but not in their names

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• Exporters can be classified in various ways :

Depending upon the size of the business, they are classified as small or large exporters.

Depending upon the product lines exported, they are classified as single or multi-product exporters

Depending upon the destination of their exports, they are classified as single destination exporters or multi destination exporters.

Depending upon the frequency of their exports they are classified as occasional exporters and dynamic exporters

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• Advantages Need for limited finance Less risk Avoids the often substantial

cost of establishing manufacturing

Ideal for companies starting exporting for the first time

Also ideal for small sized companies

• Disadvantages Not appropriate if lower cost

manufacturing locations High transport costs can

make exporting uneconomical especially bulk products

Tariff barriers can make exporting uneconomical

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CONTRACTUAL ENTRY MODE

• Contractual Agreements

Contractual agreements are long-term, non-equity associations between a company and another in a foreign market

Contractual agreements generally involve the transfer of technology, processes, trademarks, or human skills

• Contractual forms of market entry include:

- International Licensing

- International Franchising

- Contract Manufacturing

- Management Contracts

- Turnkey Projects

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1) International Licensing

• In this mode of entry, the domestic manufacturer leases the right to use its intellectual property, i.e., technology, work method, patents, copy rights, brand names, trademarks etc. to a manufacturer in a foreign country for a fee.

• Here the manufacturer in the domestic country is called ‘licensor’ and the manufacturer in the foreign country is called ‘licensee’

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• For example, British American Tobacco Company (BATS) has given licenses in many countries for manufacture of their brand of cigarettes “555”. In India, ITC is the licensed producer of”555”.

• Another example, Pepsi Cola granted license to Heineken of the Netherlands giving them the exclusive right to produce and sell Pepsi Cola in the Netherlands.

• Nike International ltd entered India by licensing to Sierra Industrial Enterprises. The licensee would take care of quality control, marketing and distribution operation and would pay Nike 5% royalty on ex-factory price on both footwear and apparel.

• Arvind Mills owns Indian marketing rights for leading US brands like Arrow, Lee and Wrangler.

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• Advantages Licensing mode carries

relatively low investment on the part of licensor

Licensing mode carries low financial risk to the licensor

Licensing can investigate the foreign market without much efforts on his part

Licensee gets the benefits with less investment on R&D.

Licensee escapes himself from the risk of product failure

• Disadvantages Licensing agreements

reduce the market opportunities for both the licensor and licensee.

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2) International Franchising

• A contractual entry mode in which one company (the franchiser) supplies another (the franchisee) with intangible property and other assistance over an extended period is called franchising

• Franchising is a form of licensing wherein the franchiser exercises more control over the franchisee.

• The franchisee invests the money and pays certain fees to the franchiser.

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• The franchiser supplies the main part of the product and provides the following services to the franchisee :

- Trade marks, operating systems, product and brand reputations.

- Company support systems like advertising, training of employees, quality assurance are also involved in franchising.

Examples :

• Fast food companies like McDonalds, Domino’s, Pizza Hut, KFC have franchised restaurants worldwide.

• NIIT & Aptech have appointed franchisees in Africa, South East Asia, Gulf countries and China.

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• ADVANTAGES Franchisor can enter global

markets with low investment and low risks

Franchisor can get the information regarding the market, culture, customs and environment of the host country.

Franchisor learns more lessons from the experiences of the franchisees, which he could not experience from the home country’s market

• DISADVANTAGES Franchiser may find it

cumbersome to manage a large no. of franchisees in a variety of national markets.

Franchisees can experience a loss of organizational flexibility in franchising agreement.

Both the parties have the responsibilities to maintain product quality and product promotion

There is a scope for misunderstanding between the parties

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Franchisee can early start a business with low risk as he selects an established and proven product and operating system

Franchisee escapes from the risk of product failure

There is a problem of leakage of trade secrets.

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• FRANCHISING Franchising is based on

securities law if one takes up franchising

as a means of expanding a business, then compliance with the franchise laws, like the securities laws, requires registration of the franchise in the applicable jurisdictions.

More expensive and time consuming procedures.

• LICENSING Licensing is a form of

contract law licensing is merely a

contract between two independent contractors and franchise registration is not required.

Less expensive and quick set up

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Difference Between Franchising and Difference Between Franchising and LicensingLicensing

• FRANCHISING Franchising is primarly

used in service industries such as auto dealerships, entertainment, lodging, restaurants, and business services.

The franchise agreement covers obligations on both parties and includes a training, mentoring and technical advise component for the franchisee.

Franchising requires ongoing assistance from the franchiser

• LICENSING Licensing is fairly common

in manufacturing industries

There is usually no training component, product development strategy and limited marketing support

Licensing normally involves a one-time transfer of property

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• FRANCHISING If you become a franchisor,

you generally have to give up the operations of your own business and enter the full time business of being a “franchisor”.

There is substantial and complex government regulation in franchising. 

• LICENSING Existing businesses often

buy a license and add the product or service to that existing business; this allows the licensee to keep his “bread winner” business going while he tests the licensing operations

There is little or no government regulation in licensing

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CONTRACT MANUFACTURING

• Many companies outsource their part of or entire products and concentrate mainly on marketing operations.

• Contract manufacturing is the strategy of identifying a manufacturing unit to produce items at a competitive price in any part of the world.

• E.g.: Nike has contracted with a number of factories in South-east Asia to produce its athletic footware and it concentrates on marketing

- Bata also contracted with a no. of cobblers in India to produce its footware and concentrate on marketing

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• Mega Toys – Los Angeles based company contracts with Chinese plants to produce Toys and Mega toys concentrates on marketing

• HUL• There are a number of multinationals which employ

this strategy in India.

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Advantages:

• The company doesn’t have to commit resource for

setting up production facilities.• It frees the company from the risks of investing in

foreign markets.• If idle production capacity is readily available in

foreign country, it enables the marketer to get started immediately.

• In many cases the cost of the product obtained by contract manufacturing is lower than if it were manufactured by the international firm.

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• It’s a less risky way to start by CM. If the business does not pick up sufficiently, dropping it is easy. But when you have your own production facility , the exit is difficult.

e.g For many years Godrej Soaps manufactured Dettol for Reckitt and Coleman, Johnson’s Baby soap for J& J and Ponds Dreamflower and Cold cream for Ponds (HUL)

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• Disadvantages

– Less control on manufacturing so quality could get compromised.

– Big risk of developing potential competitors

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MANAGEMENT CONTRACTS

• Companies with a level of technology and managerial expertise may seek the assistance of foreign companies.

• A management contract is an agreement between two companies whereby one company provides managerial and technical assistance and specialized services to the second company for a certain period in return for monetary compensation in the form of either a flat lump sum fee or a percentage on the sales or a share in the profits.

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• Management contracts have been used to a wide extent in the airline industry, Delta airlines, Air France and KLM offer such services in developing countries.

• In Asia, many hotels operate under management contract arrangements, as they can more easily obtain economies of scale, a global reservation systems, brand recognition etc. It is not unusual for contracts to be signed for 25 years, and having a fee as high as 3.5% of total revenues and 6-10% of gross operating profit. The Marriott International Corporation operates solely on management contracts.

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TURNKEY PROJECTS

• A turnkey project is a contract under which a firm agrees to fully design, construct and equip a manufacturing/business/service facility and turn the project over to the purchaser when it is ready for operation for a remuneration.

• The forms of remuneration includes:

- A fixed price (firm plans to implement the project below this price)

- payment on cost plus basis (i.e. total cost incurred plus profit)

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• The recent approach of turnkey projects is Build, Operate and Transfer (BOT) and BOOT (build, own, operate and transfer) depending upon the level of involvement and contract obligations

• To-day infrastructure projects like power plants, airports, refineries, railway lines, highways, and dams are undertaken on a turnkey basis.

• Hyundai, Mitsubishi, L&T, Daewoo are turnkey contractors for international projects.

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INVESTMENT ENTRY MODE

• Investment entry modes entail direct investment in plant and equipment in a country coupled with ongoing involvement in the local operation.

• The investment entry mode includes

- Foreign Direct Investment

- Mergers and Acquisition

- Joint Venture

- Collaboration

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MERGERS

• A merger occurs when two or more companies combines and the resulting firm maintains the identity of one of the firms. One or more companies may merger with an existing company or they may merge to form a new company.

• Usually the assets and liabilities of the smaller firms are merged into those of larger firms. Merger may take two forms-

1. Merger through absorption

2. Merger through consolidation.

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• Merger through Absorption:- An absorption is a combination of two or more companies into an 'existing company'. All companies except one lose their identity in such a merger.

• For example, absorption of Tata Fertilisers Ltd (TFL) by Tata Chemicals Ltd (TCL). TCL, an acquiring company(a buyer), survived after merger while TFL, an acquired company (a seller), ceased to exist. TFL transferred its assets, liabilities and shares to TCL.

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• Merger through Consolidation:- A consolidation is a combination of two or more companies into a 'new company'. In this form of merger, all companies are legally dissolved and a new entity is created . Here, the acquired company transfers its assets, liabilities and shares to the acquiring company for cash or exchange of shares.

• For example, merger of Hindustan Computers Ltd, Hindustan Instruments Ltd, Indian Software Company Ltd and Indian Reprographics Ltd into an entirely new company called HCL Ltd.

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• Acquisitions and Takeovers• An acquisition may be defined as an act of

acquiring effective control by one company over assets or management of another company without any combination of companies.

• Thus, in an acquisition two or more companies may remain independent, separate legal entities, but there may be a change in control of the companies.

• When an acquisition is 'forced' or 'unwilling', it is called a takeover. In an unwilling acquisition, the management of 'target' company would oppose a move of being taken over. But, when managements of acquiring and target companies mutually and willingly agree for the takeover, it is called acquisition or friendly takeover.

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Acquirer Target Company

Country targeted

Deal Value ($ ml)

Industry

Tata Steel Corus Group

UK 12,000 Steel

Hindalco Novelis Canada 5982 Steel

Videocon Daewoo Electronics Corp

Korea 729 Electronics

Dr. Reddy Labs

Betapharm Germany 592 Pharmaceuticals

HPCL Kenya Petroleum Refinery Ltd

Kenya 500 Oil and Gas

Ranbaxy Labs

Terapia SA Romania 324 Pharmaceuticals

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Joint Ventures

• Joint Ventures tend to be equity-based i.e. a new company is set up with parties owning a proportion of the new business. There are many reasons why companies set up Joint Ventures to assist them to enter a new international market:

• Access to technology, core competences or management skills. For example, Honda's relationship with Rover in the 1980's.

• To gain entry to a foreign market. For example, any business wishing to enter China needs to source local Chinese partners.

• Access to distribution channels, manufacturing and R&D are most common forms of Joint Venture.

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COLLABORATION

• While a joint venture deals with the project in totality, in financial terms and the proportionate partnership commitments, collaboration deals with only a part of the functions. For example , Bajaj Auto has a technological collaboration with Kawasaki of Japan, who offer technology for two wheelers. Other well known technological collaborations in India are Ind-Suzuki, Kinetic-Honda and Hero-Honda.

• The world famous Kellogg business school has collaborated with Indian Business School (IBS) by offering teaching technology. Likewise, there may be financial collaborations, human resource collaborations, systems collaborations and strategic collaborations.

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FOREIGN DIRECT INVESTMENT

The flow of funds from one destination to another is called investment. Companies which are constantly involved in international business, invest their money in manufacturing and marketing bases through ownership and control. KELLOGG, PEPSI, COCA COLA AND HYATT GROUP OF HOTELS are willing to invest even if the profits are returned after a long gestation period.

Foreign firms adopt certain methods as mentioned

below: They control the operations through subsidiaries to

achieve strategic synergies. They haver control through technology, manufacturing

expertise, intellectual property rights and brand name. One permanent person in the country of operation is

appointed to monitor day to day operations.

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• The most attractive part of the operation is the direct investment, which contributes to optimization of resources in the host country, generating employment opportunities and enhancing the standard of living.

• The other major development which have taken place during the past two decades are exposure of the host countries to advance technology and quality products. It is a boon to the host country since capital is a great resource and it is coming through investment.

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• The main disadvantages are lack of clarity of repatriation of profit, imposition of restrictions by host countries and elimination of small and medium industries due to the financial power of the investor. A number of south American countries like Argentina and few south east Asian countries like Indonesia fell prey to the dominant forces of overseas investors. They feel that old colonialism may re-emerge through investments.

• Generally foreign investments took place on full swing in developing countries only in the past two decades. China, Taiwan, India, Brazil, Argentina and other developing countries have started attracting huge foreign investments . If it takes place in specific sectors like infrastructure , mining, marine technology and agro –processing it is highly beneficial to both the host country and investor.