1. CHAPTER TWELVE
COUNTRY EVALUATION AND SELECTION
OBJECTIVES
• To grasp company strategies for sequencing the penetration of countries
• To see how scanning techniques can help managers both limit geographic
alternatives and consider otherwise overlooked areas
• To discern the major opportunity and risk variables a company should consider when
deciding whether and where to expand abroad
• To know the methods and problems when collecting and comparing information
internationally
• To understand some simplifying tools for helping to decide where to operate
• To consider how companies allocate emphasis among the countries where they
operate
• To comprehend why location decisions do not necessarily compare different
countries’ possibilities
CHAPTER OVERVIEW
The country evaluation and selection process determines the geographical opportunities
firms choose to pursue. Chapter Twelve first discusses the challenges of marketing and
production site location. It goes on to carefully examine the process by describing the
choice and weighting of variables used for opportunity and risk analysis as well as the
inherent problems associated with data collection and analysis. The chapter then
introduces the use of grids and matrices for country comparison purposes, discusses
resource allocation possibilities, and concludes by noting the different factors considered
as part of start-up, acquisition, and expansion decisions.
CHAPTER OUTLINE
OPENING CASE: Carrefour
[See Figure 12.1, Map 12.1]
This case explores the location, pattern, and reasons for Carrefour’s international
operations. Carrefour opened its first store in 1960 and is now the largest retailer in
Europe and Latin America and the second largest worldwide. Its stores depend on food
items for nearly 60 percent of sales and on a wide variety of non-food items for the
remainder. Carrefour plans to accelerate its growth between 2006 and 2008 after opening
one million square meters of new space in 2005. Worldwide Carrefour has five different
types of outlets: hypermarkets, supermarkets, hard discount stores, cash-and-carry stores
and convenience stores. Country selection criteria include a country’s economic
evolution, sufficient size to justify additional store locations and the availability of a
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2. viable partner. Aside from financial resources, Carrefour brings to a partnership expertise
on store layout, clout in dealing with global suppliers, highly efficient direct e-mail links
with suppliers and the ability to export unique bargain items from one country to another.
Carrefour also considers whether a country or regional location within a country can
justify sufficient additional store expansion to gain economies of scale in buying and
distribution. Recently, Carrefour has used acquisition as a way to capture additional
scale economies. Carrefour depends primarily on locally produced goods but also
engages in global purchasing when capable suppliers are found. Whether Carrefour can
ultimately succeed as a global competitor without a significant presence in the United
States and the United Kingdom remains to be seen.
Teaching Tip: Review the PowerPoint slides for Chapter Twelve 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 and tables in the text.
I. INTRODUCTION
Because companies lack the resources to take advantage of all international
opportunities they identify, they must determine both the order of country entry as
well as the rates of resource allocation across countries. In choosing geographic
sites, a firm must determine both where to market and where to produce. The answer
can be one and the same place if transportation costs are high and/or government
regulations make local production a necessity. In many industries, facilities must be
located near foreign customers; in others, market and production sites are continents
away. Developing a site location strategy that helps a firm maximize its resources
and competitive position is very challenging, given that many estimates and
assumptions about factors such as future costs and prices and competitors’ reactions
must be made. Figure 12.3 shows the major steps international business managers
must take in making these decisions.
II. SCANNING AND DETAILED EXAMINATION COMPARED
Scanning is useful insofar as a company might otherwise consider either too few or
too many possibilities. Through the use of scanning, decision makers can perform a
detailed analysis of a manageable number of geographic locations. Managers can
usually complete the scanning process without having to incur the expense of
visiting foreign countries. Instead they rely on analyzing information found on the
Internet and other publicly available sources, as well as communicating with people
familiar with the foreign countries they are interested in. The more time and money
companies invest in examining an alternative, the more likely they are to accept it
regardless of its merits—a phenomenon known as escalation of commitment.
Companies should be careful about taking forced actions based on peer and/or media
pressure and should instead carefully weigh important variables when comparing
countries of interest.
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3. III. WHAT INFORMATION IS IMPORTANT?
Environmental climate—the external conditions in a host country that could
significantly affect an enterprise’s success or failure—reveals both opportunities and
risk whose combination should determine what actions to take.
A. Opportunities
Opportunities are determined by competitiveness and profitability factors.
Variables weighing heavily on the selection of market and production sites
would include market size, ease and compatibility of operations, costs, resource
availability and red tape.
1. Market Size. Market size is determined by sales potential. In some
instances, past and current sales for either an existing product or a similar or
complementary product are available on a country-by-country basis. In
addition, data such as GNP, per capita income, population, income
distribution, economic growth rates, and levels of economic development
will also be useful. Other important economic variables pertaining to
market size include:
• Obsolescence and leapfrogging of products. Consumers in some
emerging economies skip entire generations of technology in favor of
more recent technologies, such as Chinese consumers going from
having no telephones to using cellular phones almost exclusively.
• Prices. The relative prices of essential and non-essential good can
have a significant impact on consumption patterns. Higher prices for
necessary goods leave less discretionary income for non-essentials.
• Income elasticity. Market potential can be calculated by dividing
the percentage of change in product demand by the percentage of
change in income in a give country. Income elasticity varies by
product and income level, with demand for necessities being less elastic
than demand for luxuries.
• Substitution. Depending on local conditions, consumers in some
countries may be more willing to substitute some products or services
for others. For example, people in high population density areas
typically substitute mass transit for automobiles.
• Income inequality. Even in areas where per capita incomes are
low, there may be middle- and upper-income people with substantial
income to spend due to income inequality.
• Cultural factors and taste. Countries with similar income levels
may exhibit different demand patterns based on differences in cultural
values and tastes.
• Existence of trading blocs. Countries with small populations
and/or low per capita incomes may have a much larger market due to
participation in a regional trading block.
2. Ease and Compatibility of Operations. Companies are naturally
attracted to countries that are located nearby, share the same language and
offer market conditions similar to those in their home countries. Beyond
that, proposals may then be limited to those countries that offer, among
other factors, the appropriate plant size, the local availability of resources,
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4. an acceptable percentage of ownership and the sufficient repatriation of
profits.
3. Costs and Resource Availability. Costs are a critical factor in
production-location decisions. Productivity-related factors include the cost
of labor, the cost of inputs, tax rates, and available capital, utilities, real
estate, and transportation. When companies move into emerging economies
because of labor cost differences alone, their advantages may be short-lived.
Competitors often follow leaders into low-wage areas, there is little first-in
advantage for low-labor cost production migration, and the costs can rise
quickly as a result of pressure on wage or exchange rates. The quality of a
country’s infrastructure can be very important in location decisions. Firms
often need to locate in an area that will allow them to move supplies and
finished products very efficiently. If a given production site will be used to
serve multiple markets, the cost and ease of moving materials and products
in and out the country will be especially important.
4. Red Tape and Corruption. Red tape includes the difficulty of
getting permission to operate, bringing in expatriate personnel, obtaining
licenses to produce and market goods and satisfying government agencies
on matters such as taxes, labor conditions and environmental compliance.
Government corruption may include requirements of payments to win a
contract or receive government services, such as mail delivery or visa
issuance. Although not always a directly measurable cost, red tape and
corruption increase the cost of doing business.
B. Risks
Is it ever rational for a firm to invest in a country with high economic and
political risk ratings? Such questions must be carefully weighed when
making international capital-investment decisions.
1. Risk and Uncertainty. Firms usually experience higher risk and
uncertainty when they operate abroad. Firms use a variety of financial
techniques to compare potential investments, including discounted cash
flows, economic value added, payback period, net present value, return on
sales, return on equity, return on assets employed, internal rate of return and
the accounting rate of return. Given the same expected return, most decision
makers prefer a more certain outcome to a less certain one. Companies may
reduce risk or uncertainty by insuring, however, insuring against things
such as nonconvertibility of funds or expropriation is likely to be costly. As
part of a feasibility study, the degree of acceptable risk should be
determined so a firm does not incur unacceptable costs.
2. Liability of Foreignness. The liability of foreignness refers to the
fact that foreign firms have a lower rate of survival than local firms for the
initial years after the start of operations. However, those foreign firms that
manage to overcome their initial problems have long-term survival rates
comparable to those of local firms.
3. Competitive Risk. A firm’s innovative advantage may be short-lived.
When pursuing a strategy known as imitation lag, a firm moves first
to those countries most likely to adapt and catch up to the advantage. In
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5. some instances firms may seek those countries where they are least likely to
confront significant competition; in others they may gain advantages by
moving into countries where competitors are already present. By being the
first major competitor in a market, companies can more easily gain the best
partners, best locations, and best suppliers—a strategy to gain first mover
advantage. Companies may also reduce risk by avoiding overcrowded
markets, or conversely, they may purposely crowd a market to prevent
competitors from gaining advantages therein that they can use to improve
their competitive positions elsewhere, a situation known as oligopolistic
reaction. Firms may also seek “clusters” like Silicon Valley that attract
multiple suppliers, customers and highly trained personnel in order to gain
access to new products, technologies, and markets.
4. Monetary Risk. If a firm’s expansion occurs through foreign-direct
investment, foreign-exchange rates and access to investment capital and
earnings are key considerations. Liquidity preference refers to the theory
investors want some of the holdings to be in highly liquid assets on which
they are willing to take a lower return. Firms must carefully evaluate a
country’s present capital controls, recent exchange-rate stability, balance-of-
payments account, inflation rate, and level of government spending.
5. Political Risk. Political risk reflects the expectation the political
climate in a given country will change in such a way that a firm’s operating
position will deteriorate. It relates to changes in political leaders’ opinions
and policies, civil disorder, and animosity between a home and host
country. When evaluating political risk, decision makers refer to past
patterns in a given country, expert opinions and country analysts. They also
look for economic and social conditions that could lead to political
instability, but there is no consensus as to what constitutes dangerous
instability or how it can be predicted.
DOES GEOGRAPHY MATTER?
Don’t Fool with Mother Nature
Natural disasters have a huge impact on people and property every year, often
hitting the poorest nations of the world hardest. Companies should take the risk
of natural disasters and their potential impact into account when choosing
locations for doing business. The United Nations Development Programme is
developing a Disaster Risk Index that could be used as a tool for companies to
compare and prepare for disaster risk. Natural disasters can also trigger outbreaks
of disease, which should also be considered when choosing locations for global
operations.
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6. IV. COLLECT AND ANALYZE DATA
Firms perform research to reduce uncertainties in their decision processes, to expand
or narrow the alternatives they consider and to assess the merits of their existing
programs. The costs of data collection should always be weighed against the
probable payoffs in terms of revenue gains or cost savings.
A. Problems with Research Results and Data
Numerous countries have agreed to standards for collecting and publishing
various categories of national data. However, the lack, obsolescence and
inaccuracy of data on other countries can make research difficult and expensive
to undertake. Further, data discrepancies further increase uncertainty in
decision-making.
1. Reasons for Inaccuracies. For the most part, incomplete or
inaccurate data result from the inability of governments to collect the
needed information. Both economic and educational factors will affect the
quantity and quality of available data. Of equal concern, however, is the
publication of false or purposely misleading information, as well as the non-reporting
or under-reporting of information people wish to hide or distort.
2. Comparability Problems. Comparability problems result from
definitional differences across countries (e.g., family categories, literacy
levels, accounting rules), differences in base years, distortions in foreign
currency conversions, the measurement of investment flows, the presence of
black market activities, etc.
B. External Sources of Information
Both the specificity and cost of information will vary by source.
1. Individualized Reports. Market research and business consulting
firms conduct country studies for a fee. The fact that a firm can specify the
information it wants may make the cost worthwhile.
2. Specialized Studies. Certain research organizations generate
specific studies about countries, regions, industries, issues, etc., that they
make available for general purchase. The price is much lower than for an
individualized study.
3. Service Companies. Most international service-related firms
publish reports that are usually geared toward either the conduct of business
in a given country or region or about some specific subject of general
interest, such as tax or trademark legislation.
4. Government Agencies. Governments and their agencies publish
tomes of information designed to stimulate business activity both at home
and abroad.
5. International Organizations and Agencies. The UN, the WTO,
the IMF, the OECD, and the EU are but a few of the multilateral
organizations and agencies that collect and disseminate data. Many of the
international development banks even help fund investment feasibility
studies.
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7. 6. Trade Associations. Many trade associations collect, evaluate, and
disseminate a wide variety of data dealing with competitive and technical
factors in their industries. Their reports may or may not be available to non-members.
7. Information Service Companies. Certain companies offer
information-retrieval services; they maintain databases from hundreds of
sources from which they will access data for a fee, or sometimes for free at
public libraries.
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8. C. Internal Generation of Data
When firms have to conduct studies in foreign countries, they may find
traditional data gathering and analytical methods do not reveal critical insights.
In that case, a researcher must be extremely imaginative and observant. In some
instances, useful information may be found by analyzing indirect or
complementary indicators.
POINT—COUNTERPOINT:
Should Companies Forego Direct Investments in Violent Areas?
POINT: MNEs should not make investments in violent areas because it puts MNE
personnel at risk. MNEs are visible and therefore vulnerable to attack by anti-globalization
groups, kidnappers, groups opposed to foreigners, as well as others. It is
unethical to put employees in excessively dangerous situations. Employees who will take
dangerous assignments are usually either difficult to control, excessively naïve, or
addicted to the thrill of danger. Any country subject to extreme violence is not the kind
of country to do business in.
COUNTERPOINT: Where there’s risk, there are usually rewards. Companies need to
take risks, as they have in the past, to develop markets. Violence is only one of many
risks and should not be looked at in isolation. Risks from activities such as terrorism are
the same whether you are in London, Madrid, Caracas, or New York. All areas have
their risks, and many countries traditionally viewed as risky may actually be less risky
than the United States or Britain. Some industries, such as petroleum, have to operate in
violent areas because that is where the resources are. MNEs should operate anywhere
there are opportunities, and develop plans to manage and react to risks as effectively as
possible.
V. COUNTRY COMPARISON TOOLS
Two common tools for analyzing information collected via scanning are grids and
matrices. Also, once a firm commits to a location, it will need continuous updates
regarding external conditions that might affect its operations there.
A. Grids [See Table 12.2]
A grid can be used to make country comparisons according to a wide variety of
relevant factors, such as ownership rules, potential returns, and perceived risk.
Variables can be ranked and weighted according to specific criteria that reflect a
firm’s situation and objectives. Although useful for establishing minimum
scores and for ranking countries, grids often obscure interrelationships among
countries.
B. Matrices [See Figure 12.7]
One matrix frequently used when doing country comparisons is the opportunity-risk
matrix. When using this matrix, the manager plots a country according to
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9. the perceived value of the opportunity the country offers, on the one hand, and
the expected level of risk associated with operating in that country on the other.
Which factors are good indicators of risk and opportunity and the weight
assigned to each must be identified and assigned by the firm. Once scores are
determined for each country being considered, they can be plotted and reviewed
from a comparative perspective. A useful application of this technique is to
develop both present and future scores for countries (e.g., five years hence)
because a significant shift in a score in the future could have serious
implications with respect to the country selection process.
VI. ALLOCATING AMONG LOCATIONS
Over time, most of the value of a firm’s FDI comes from reinvestment. Thus, in
deciding where to invest, firms must consider whether to reinvest or harvest, to what
degree there is interdependence among their locations and whether they should
diversify or concentrate their activities.
A. Reinvestment versus Harvesting
Once a firm makes an initial investment, it will then need to decide whether to
continue investing in that operation or to harvest the earnings (and possibly
divest the assets) and use them elsewhere.
1. Reinvestment Decisions. Reinvestment refers to the use of retained
earnings to replace depreciated assets or to add to a firm’s existing stock of
capital. Aside from competitive factors, a company may need several years
of almost total reinvestment (and often allocation of additional funds) in
order to realize its objectives at a given location.
2. Harvesting. Harvesting or divesting refers to the reduction in the amount
of an investment; a firm may choose to simply harvest the earnings of an
operation or divest the assets there as well. If an operation no longer fits a
company’s overall strategy, or if better opportunities exist elsewhere, it
must determine how to exit that operation. When selling or closing
facilities, firms must consider possible government performance contracts
as well as potential adverse publicity, plus the possible difficulty in re-establishing
operations in that country in the future.
B. Interdependence of Locations
It is often difficult to assess the true impact a particular foreign subsidiary has on
other operations within an MNE if several operations are interdependent. In the
case of intra-firm sales, transfer pricing strategy will definitely affect the relative
profitability of one unit as compared to another. Likewise, the net value of a
particular operation may be similarly distorted for corporate profit maximization
purposes.
C. Geographic Diversification versus Concentration
A firm may take different paths en route to gaining a sizable presence in most
countries. At one end of the spectrum is a diversification strategy, whereby a
firm moves rapidly into many foreign countries and then gradually builds its
presence in each. At the other end of the spectrum is a concentration strategy,
whereby a firm moves into a limited number of countries and develops a strong
competitive position there before moving into others. When deciding which
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10. strategy, or perhaps some hybrid of the two, is desirable, a firm must consider a
number of variables (see Table 12.3).
1. Growth Rate in Each Market. When the growth rate in each market
is high, a firm will likely concentrate on a few markets because of the cost
of keeping up with market expansion.
2. Sales Stability in Each Market. The more stable sales and profits
are within a single market, the less advantageous a diversification strategy
will be.
3. Competitive Lead Time. Sequential entry into multiple markets is
more common than simultaneous entry. If a firm has a long lead time before
competitors can copy or supercede its advantages, then it may be able to
follow a concentration strategy and still beat competitors to other markets.
4. Spillover Effects. Spillover effects represent situations in which a
marketing program in one country results in the awareness of a product in
other countries. When a single marketing program can reach many countries
(via cross-country media, for example), a diversification strategy is
advantageous.
5. Need for Product, Communication, and Distribution
Adaptation. When companies find it necessary to alter products,
promotion and/or distribution strategies in foreign markets, a concentration
strategy will be advantageous because the associated costs cannot be spread
over sales in other countries to capture economies of scale.
6. Program Control Requirements. The more a company needs
control over a foreign operation, the more appropriate a concentration
strategy because additional resources will be required to maintain that
control.
7. Extent of Constraints. When a firm is constrained by limited
resources, it will likely follow a concentration strategy because spreading
resources too thinly can be a recipe for failure.
VII. NONCOMPARATIVE DECISION MAKING
Companies often examine one opportunity at a time rather than ranking a set of
foreign operating proposals using predetermined criteria. This sequential process
leads to go-no-go decisions and is often necessary due to the speed with which
companies need to respond to opportunities as they arise. Decision makers often
need to react quickly for both offensive and defensive motives. The cost of
conducting an extensive analysis of multiple opportunities simultaneously can also
sometimes be prohibitive.
VIII. MAKING FINAL COUNTRY SELECTIONS
At some point, firms must make resource allocation decisions. For new investments
they will need to develop detailed estimates of all costs and expenses and consider
whether to enter a particular venture alone or with a partner. For acquisitions, firms
will need to examine financial statements in great detail. For expansion within
countries where they are already operating, country managers will most likely submit
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11. capital budget requests that include details of expected returns. To maximize
expected gains, decisions must be made in a timely fashion.
LOOKING TO THE FUTURE:
Will the Prime Locations Change?
There are several important demographic shifts that are expected to occur over the next
several decades. Population growth in high income countries is expected to slow and
populations are actually expected to decline in countries such as Japan and Italy.
Meanwhile, population growth in low-income countries is expected to be robust. Since
there is a positive relationship between the changes in the size of the working-age
population and per capita GDP, the growth in per capita GDP should be higher in today’s
emerging economies than in today’s high-income countries. These changes could have
significant implications for the location of markets and the location of labor forces.
Another trend that could influence country selection is the propensity of innovative
people to converge on places that develop reputations for facilitating creativity and
innovation. Even with technologies that allow people to work from home or in virtual
office environments, face-to-face contact will continue to be important—especially
among the best and brightest.
CLOSING CASE: FDI in South Africa [See Map 12.2]
Many expected that the post-apartheid government of South Africa would take revenge
against the previous elites of the country, including foreign companies, and discourage
new foreign investment. Instead, the new government has adopted a largely pro-business
attitude and has actively courted FDI. The results of this policy have been somewhat
mixed. Despite enormous opportunity, many foreign investors have been reluctant to
enter the South African market due to low economic growth rates, continued political
instability, and high security risks.
Questions
1. What are the costs and benefits to South Africa of having more foreign direct
investment? Of having less?
Due to its traditionally high unemployment rates, jobs are perhaps the biggest benefit
to South Africa from increases in FDI. Economic growth would also be increased
through FDI, especially since South Africa’s internal savings and investment rates
have been too low to finance much business expansion. FDI in state-owned
enterprises could also improve the quality of goods and services produced by these
companies, and competition from foreign firms could provide incentive to local
firms to innovate more. Finally, FDI would help diversify the South African
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12. economy. Less foreign investment would likely mean fewer jobs, slower growth,
lower quality goods and services, less innovation, and a less diverse economy.
2. How might a company try to weigh fairly the opportunities and risks of investing in
South Africa?
Managers need to look at a comprehensive array of economic, political, and
geographic factors in assessing the suitability of South Africa for investment.
Market size is a positive in South Africa, but economic growth has been erratic and
slow at times. The political situation is relatively stable and government corruption
is low, but crime rates are high, including the highest murder rate in the world.
Getting expatriates to relocate to South Africa has been challenging for many foreign
companies. Still, opportunities in Africa are only likely to improve in the future and
South Africa could serve as an effective base for future expansion into other African
markets.
3. If South Africa is to receive more foreign direct investment, how should it prioritize
policies to attract it?
The most important thing the South African government could do in the short term
would be to reduce the crime rate and improve the security situation in the country.
Also, easing restrictions and regulations that hamper FDI would help as well.
Finally, South Africa needs to do a better job of marketing its investment
opportunities to foreigners. An aggressive public relations campaign on a global
scale could help to raise awareness of the positive aspects of investing in South
Africa and improve the image of the country in the minds of foreigners.
4. Assume you represent a non-South African company and are considering foreign
expansion. What factors would you consider when comparing South Africa with
other emerging markets where you might locate? What about in terms of developed
markets? What about in terms of other African markets?
As a non-South African company, I would look at investing in South Africa from
two perspectives. My analysis of the country would focus on the market size and
potential demand for my products and/or services, as well as the viability of South
Africa as a site for those goods or services to be produced and possibly exported to
other countries within Africa and beyond. The market potential of the country is
large due to the relatively large population. Higher income growth would make this
market even more attractive. I would also look at South Africa as an attractive
jumping off spot for serving other emerging markets in Africa. I would be
concerned, however, about the security situation and quality of life issues. I would
also prefer a more friendly welcome from the government, with incentives such as
tax breaks and infrastructure improvements. South Africa compares favorably to
other African markets, but continues to lag behind most developed markets.
WEB CONNECTION
Teaching Tip: Visit www.prenhall.com/daniels for additional information and
links relating to the topics presented in Chapter Twelve. Be sure to refer your
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13. students to the online study guide, as well as the Internet exercises for Chapter
Twelve.
_________________________
CHAPTER TERMINOLOGY:
environmental climate, p. 418
liability of foreignness, p. 424
imitation lag, p. 426
first mover advantage, p. 426
oligopolistic reaction, p. 426
liquidity preference, p. 427
grids, p. 435
divesting, p. 435
harvesting, p. 437
diversification strategy, p. 438
concentration strategy, p. 438
spillover effects, p. 439
_________________________
ADDITIONAL EXERCISES: Country Evaluation and Selection
Exercise 12.1. As the phenomenon of economic integration progresses, the process
of country selection takes on new dimensions. Ask students to compare and contrast
the opportunities and risks associated with establishing operations in the European
Union to those in the NAFTA region. Would such investments be primarily
resource- or market-seeking? Be sure students explain and give examples to support
their ideas.
Exercise 12.2. Ask students to compare the costs and benefits of investing in an
industrialized economy to the costs and benefits of investing in a developing
economy from the standpoint of an MNE. Then ask the students to debate the idea
that MNEs have a responsibility to work toward developing global efficiency, i.e.,
that economic considerations should be weighted more heavily than other factors in
the country selection process.
Exercise 12.3. During the 1970s, a number of MNEs such as Coca-Cola and IBM
made decisions to abandon operations in certain developing countries and not to
enter others because of government restrictions. Ask the students to discuss the
likelihood that MNEs will face such decisions in the future, given the progress of the
WTO and movements toward economic integration in many parts of the world. Do
the students foresee other factors that might cause more divestments in the future?
Exercise 12.4. Have the students use the simplified grid to compare countries for
market penetration (Table 12.2) to compare South Africa, Ireland, and Argentina for
a possible investment. Encourage them to use outside data sources such as
www.doingbusiness.org, www.worldbank.org, and www.nationmaster.com to gather
information and make meaningful comparisons. Which of these three countries
would be most suitable for investment? Why?
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