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- 2. BASIC ENTRY DECISIONS Firms expanding internationally must decide 1.Which markets to enter 2.When to enter them and on what scale 3.Which entry mode to use – exporting – licensing or franchising to a company in the host nation – establishing a joint venture with a local company – establishing a new wholly owned subsidiary – acquiring an established enterprise 14-2
- 3. Which Foreign Markets ? • The choice of foreign markets will depend on their long run profit potential • Favorable markets – are politically stable – have free market systems – have relatively low inflation rates – have low private sector debt • Less desirable markets – are politically unstable – have mixed or command economies – have excessive levels of borrowing • Markets are also more attractive when the product in question is not widely available and satisfies an unmet need 14-3
- 4. When Should A Firm Enter? • Once attractive markets are identified, the firm must consider the timing of entry 1. Entry is early when the firm enters a foreign market before other foreign firms 2. Entry is late when the firm enters the market after firms have already established themselves in the market 14-4
- 5. Why Enter A Foreign Market Early? • First mover advantages include – the ability to pre-empt rivals by establishing a strong brand name – the ability to build up sales volume 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 products or services making it difficult for later entrants to win business 14-5
- 6. Why Enter A Foreign Market Late? • First mover disadvantages include – pioneering costs - arise when the foreign business system is so different from that in a firm’s home market that the firm must devote considerable time, effort and expense to learning the rules of the game • 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 customers 14-6
- 7. Scale of entry and strategic commitment • After choosing which market to enter and the timing of entry, firms need to decide on the scale of market entry – entering a foreign market on a significant scale is a major strategic commitment that changes the competitive playing field • Firms that enter a market on a significant scale make a strategic commitment to the market - the decision has a long term impact and is difficult to reverse – 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 14-7
- 8. Is There A “Right” Way To Enter Foreign Markets? • No, there are no “right” decisions when deciding which markets to enter, and the timing and scale of entry - just decisions that are associated with different levels of risk and reward 14-8
- 9. ENTRY MODES • These are six different ways to enter a foreign market 1. Exporting - common first step for many manufacturing firms – later, firms may switch to another mode 1. Turnkey projects - the contractor handles 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 1. Licensing - a licensor grants the rights to intangible property to the licensee for a specified time period, and in return, receives a royalty fee from the licensee – patents, inventions, formulas, processes, designs, copyrights, trademarks 14-9
- 10. 4. Franchising - 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 – used primarily by service firms 4. Joint ventures with a host country firm - a firm that is jointly owned by two or more otherwise independent firms – most joint ventures are 50:50 partnerships 4. Wholly owned subsidiary - the firm owns 100 percent of the stock – set up a new operation – acquire an established firm 14-10
- 11. What Influences The Choice Of Entry Mode? • Several factors affect the choice of entry mode including – transport costs – trade barriers – political risks – economic risks – costs – firm strategy • The optimal mode varies by situation – what makes sense for one company might not make sense for another 14-11
- 12. Why Choose Exporting? • Exporting is attractive because – it avoids the costs of establishing local manufacturing operations – it helps the firm achieve experience curve and location economies • Exporting is unattractive because – there may be lower-cost manufacturing locations – high transport costs and tariffs can make it uneconomical – agents in a foreign country may not act in exporter’s best interest 14-12
- 13. Why Choose A Turnkey Arrangement? • Turnkey projects are attractive because – they are a way of earning economic returns from the know-how required to assemble and run a technologically complex process – they can be less risky than conventional FDI • Turnkey projects are unattractive because – the firm has no long-term interest in the foreign country – the firm 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 14-13
- 14. Why Choose Licensing? • Licensing is attractive because – the firm avoids development costs and risks associated with opening a foreign market – the firm avoids barriers to investment – the firm can capitalize on market opportunities without developing those applications itself • Licensing is unattractive because – the firm doesn’t have the tight control required for realizing experience curve and location economies – the firm’s ability to coordinate strategic moves across countries is limited – proprietary (or intangible) assets could be lost • to reduce this risk, firms can use cross-licensing agreements 14-14
- 15. Why Choose Franchising? • Franchising is attractive because – it avoids the costs and risks of opening up a foreign market – firms can quickly build a global presence • Franchising is unattractive because – it inhibits the firm's ability to take profits out of one country to support competitive attacks in another – the geographic distance of the firm from franchisees can make it difficult to detect poor quality 14-15
- 16. Why Choose Joint Ventures? • Joint ventures are attractive because – firms benefit from a local partner's knowledge of local conditions, culture, language, political systems, and business systems – the costs and risks of opening a foreign market are shared – they satisfy political considerations for market entry • Joint ventures are unattractive because – the firm risks giving control of its technology to its partner – the firm may not have the tight control 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 14-16
- 17. Why Choose A Wholly Owned Subsidiary? • Wholly owned subsidiaries are attractive because – they reduce the risk of losing control over core competencies – they give a firm the tight control over operations in different countries that is necessary for engaging in global strategic coordination – they may be required in order to realize location and experience curve economies • Wholly owned subsidiaries are unattractive because – the firm bears the full cost and risk of setting up overseas operations 14-17
- 18. Which Entry Mode Is Best? Advantages and Disadvantages of Entry Modes 14-18
Editor's Notes
- Chapter 14: Entry Strategy and Strategic Alliances
- You’ve been asked to explore the potential for your company’s product in foreign markets. Which markets should you consider? How should your company enter the markets? How much commitment should your company make? These are all questions that most companies have when they consider global expansion. When Tesco, the British grocer, initially entered the U.S. market for example, it decided to commit only to a smaller level operation. You can learn more about Tesco in the Management Focus in your text. Recall from previous chapters that there are several methods of expanding into foreign markets including exporting, licensing or franchising to host country firms, establishing a joint venture with a local firm, and setting up a wholly owned subsidiary in the host market. But which method is better?
- Which market should we enter? Given that there are more than 200 countries in the world, firms need some guidelines when they’re deciding which markets to enter, and a system to narrow down the choices. Ultimately, the firm wants to enter the markets with the greatest long term potential. The more favorable markets are usually those that are politically stable with free market systems, and where there is a stable rate of inflation and private sector debt. Politically unstable countries with mixed or command economies, or countries where speculative financial bubbles have led to excessive borrowing are usually less desirable. Companies should also consider the competition. They’re more likely to be successful in markets where the product is not widely available and where it satisfies an unmet need. So, countries like China or India would be considered attractive because of their size, but less attractive because of their level of economic development.
- Another decision a firm needs to make involves the timing of entry. We say a firm is early if it enters a market before other foreign firms, and late if it enters the market after foreign firms are already established. A firm that gets to market early can capitalize on first mover advantages like establishing a strong brand name before other firms get there, but also incurs first mover disadvantages like the costs and risks involved in learning the rules of the game that other firms can avoid.
- Let’s look at this more closely. The advantages associated with entering a market early are called first mover advantages and include the ability to pre-empt rivals and capture market share by establishing a strong brand, the ability to build up sales volume in the foreign market and ride down the experience curve ahead of rivals and by doing so, gain cost advantages over later entrants, and the ability to create switching costs that tie customers to their products or services making it difficult for later entrants to break into the market.
- But keep in mind that being first to market is always a good thing! The disadvantages associated with entering a foreign market before other companies are called first mover disadvantages and include pioneering costs or the costs that an early entrant has to bear that a later entrant can avoid. Studies have shown that the probability of failure is lower if a company enters a market after several other firms have already successfully entered the market. What makes these pioneering costs so critical? Well, pioneering costs arise when a business system in a foreign market is so different from that in a firm’s home country that the company has to devote lots of resources like time, and capital to learning the rules of the game. The costs include business failure costs if the firm makes major mistakes, and the costs of promoting and establishing a product offering, as well as the costs of educating consumers about the product.
- On what scale should a firm enter a market? Should the company devote the resources necessary to enter the market in a big way, or should it expand more slowly? To answer these questions, the firm has to look at the strategic commitments involved in entering the market, or the decisions that have long term consequences and are difficult to reverse. You probably already know that entering a market on a significant scale involves a major strategic commitment that can affect the competitive playing field, while small scale entry lets the firm learn about the market before it’s exposed to significant levels of risk.
- Remember, there aren’t any right or wrong answers when making these decisions -- firms just have to decide on the trade-offs involved with the different levels of risks and rewards. For example, Jollibee, a fast food company from the Philippines, managed to become a global player in the industry by differentiating its product and learning from existing companies even though it was a late entrant with limited resources. You can follow Jollibee’s success story in the Management Focus in your text.
- How should a firm enter a market? Recall, that once a company has made the decision to expand internationally, it has to decide how to enter the market. Should it export or establish a wholly owned subsidiary for example? As we said earlier, sometimes companies don’t have much choice in the matter, but other times, they have more flexibility. There are six different ways to enter a market, exporting, turnkey projects, licensing, franchising, joint ventures, and wholly owned subsidiaries. Most companies begin their global expansion with exporting, and then later switch to other methods. In some cases, turnkey projects make sense. In a turnkey project, the contractor agrees to handle all the details of the foreign project for the firm, even down to training employees. At the end of the project, the client is handed the key to the plant that is ready to operate. This type of arrangement is common in the chemical, pharmaceutical, petroleum refining, and metal refining industries. Licensing is another way that companies can enter foreign markets. When a firm enters a licensing agreement it gives the licensee the rights to intangible property for a specified period of time in exchange for royalties. What is intangible property? It includes things like patents, inventions, formulas, processes, designs, copyrights, and trademarks.
- If you’re thinking that licensing sounds a lot like franchising, and you’re right! Franchising is just a specialized form of licensing where the franchisor not only sells intangible property to the franchisee, but also requires the franchisee to abide by strict rules of how to do business. Another way to enter markets is through joint ventures. A joint venture is the establishment of a firm that is jointly owned by two or more otherwise independent firms. While most joint ventures are 50-50 arrangements, some companies choose different equity distributions like 60-40. Should a company establish a wholly owned subsidiary? Recall that the firm owns 100 percent of the equity in a wholly owned subsidiary. Firms can establish a wholly owned subsidiary either by setting up an entirely new operation, or by merging with or acquiring an existing firm. Let’s look more closely at the advantages and disadvantages of each entry mode.
- How attractive each of these entry methods are depends on several factors including transportation costs and trade barriers, political and economic risks, and the firm’s strategy. While it might make sense for one company to export, another company might choose a different entry method.
- Exporting has two main advantages. First, exporting lets the firm avoid the costs of establishing manufacturing operations in the host country, and second, exporting can help a firm achieve experience curve and location economies. However, by exporting, companies may be missing out on opportunities for low cost manufacturing elsewhere, they may incur significant transportation costs or tariff barriers, and they take the chance that agents in the foreign market don’t act in their best interests.
- Why are turnkey projects attractive? The advantage of a turnkey operation is that it allows firms to earn a return from the know-how involved in assembling and running technologically complex processes. They make sense in countries where political or economic conditions make it risky to make longer term investments. Keep in mind however, that a company that enters into turnkey deal won’t have a long-term interest in a country, and so forfeits potential profits. In addition, because of the nature of the arrangement, the company might create a competitor, particularly if the firm’s process technology is a source of competitive advantage. Remember, that by selling the process technology through the turnkey project, the firm is essentially selling its competitive advantage!
- Why is licensing attractive? The advantage of a licensing agreement is that the firm doesn’t have to incur the costs and risk of opening a foreign market, it avoids barriers to investment, and firms can capitalize on market opportunities that might be associated with its intangible property, that it doesn’t want to develop itself. What are the disadvantages of licensing? One disadvantage is that it doesn’t give the firm the tight control over manufacturing, marketing, and strategy that’s required for realizing experience curve and location economies. Instead, each licensee sets up its own production operations. A second disadvantage of licensing is that it limits the firm’s ability to coordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another. Licensees will want to keep their own profits. Third, the company risks losing proprietary information.
- What are the advantages of franchising? The advantages of franchising are similar to those of licensing in that franchising allows firms to avoid many of the costs and risks of opening up a foreign market. Companies like McDonald’s can use franchising to quickly establish a global presence without incurring significant cost or risk. Keep in mind however, that like licensing, franchising limits a firm’s ability to take profits out of one country to support competitive attacks in another. In addition, the physical distance between the franchisor and the franchisee can make it difficult for the franchisor to detect quality problems with the franchisee.
- Why form a joint venture? There are several reasons. First, a joint venture allows a firm to benefit from the local partner’s knowledge of the host country’s competitive conditions, culture, political systems, and business systems. Second, by forming a joint venture, a firm can share the costs and risks of opening the foreign market. Finally, in some cases, joint ventures make the most sense from a political standpoint. As you might recall from the Opening Case, General Electric has captured many of these benefits through its joint ventures with firms in foreign markets. You might have already guessed however, that with these benefits comes the risk of giving away control over technology. Companies have to be careful how they structure agreements to minimize this risk. Other disadvantages include the inability to realize experience curve or location economies because firms don’t have tight control over subsidiaries. Finally, shared ownership can lead to conflicts and battles for control if goals and objectives change over time.
- What are the advantages of setting up a wholly owned subsidiary? There are several advantages. A wholly owned subsidiary reduces the risk of losing control over core competencies, and it gives the firms the tight control over operations in different countries that’s necessary for a global strategic coordination approach where profits from one market are used to support competitive attacks in other markets. A wholly owned subsidiary might also be important to firms that are trying to realize location and experience curve economies. This might be particularly important for firms following global or transnational strategies. A big downside of a wholly owned subsidiary though, is that the firm bears the full costs and risks of setting up foreign operations.
- So, which entry method should a firm choose? The answer is that a firm has to consider the trade-offs involved with each choice. As we’ve discussed, there are advantages and disadvantages associated with each method.