Mode of entry

chapter
Entering Foreign
Markets
McGraw-Hill/Irwin
Global Business Today, 5e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
12

12 - 3
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 - 4
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 - 5
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 - 6
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 - 7
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 - 8
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 - 9
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 - 10
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 - 11
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 - 12
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 - 13
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 - 14
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 - 15
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 - 16
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 - 17
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 - 18
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 - 19
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 - 20
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 - 21
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 - 22
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 - 23
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 know-
how to the firm in addition to a royalty payment

12 - 24
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 - 25
Foreign Markets
Advantages
•The firm avoids many costs and risks
of opening up a foreign market

12 - 26
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 - 27
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 - 28
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 - 29
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 - 30
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 - 31
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 - 32
Foreign Markets
Disadvantage
• Firms bear the full costs and risks of setting up overseas
operations

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

12 - 34
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 - 35
Foreign Markets
The advantages and disadvantages of the various entry modes are
shown in Table 12.1.

12 - 36
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 - 37
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 - 38
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 - 39
Foreign Markets
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 - 40
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 - 41
Foreign Markets
Pros and Cons of Acquisition
Benefits of Acquisitions
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 green-
field ventures

12 - 42
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 - 43
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 - 44
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 - 45
Foreign Markets
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 - 46
Foreign Markets
CRITICAL THINKING AND DISCUSSION QUESTIONS
1. Review the Management Focus on ING. 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 - 47
Foreign Markets
2. Licensing propriety technology to foreign competitors is the
best way to give up a firm's competitive advantage. Discuss.

12 - 48
Foreign Markets
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 - 49
Foreign Markets
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.

Mode of entry

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to Mode of entry

Similar to Mode of entry (20)

Recently uploaded

Recently uploaded (20)

Mode of entry