Modes of Entry into National Markets

1. Modes of Entry into National Markets Comparing the Different Modes of Entering and Serving National Markets

2. Lesson Outline (key points) Entry modes • Comparisons of strengths and weaknesses of different entry modes • Indirect vs direct exporting, exports vs licensing vs FDI, greenfield FDI vs acquisition FDI • Selecting national markets: strategic considerations • Profit sanctuaries & black holes • Firm strategy and entry modes • Linking together firm and line of business strategies with entry modes for serving national markets

3. Exports, Licensing, Franchising • Exports occur when a seller sells goods produced in one nation to a buyer in another nation. • Licensing is a legally binding arrangement wherein a licensor sells the rights to use some kind of intellectual property to a licensee. • Franchising may be thought of as a specific kind of licensing, wherein the franchisor licenses out the rights to use trademarks, proprietary know-how, and a business plan to a franchisee. Supply agreements tend to be an important part of franchise agreements, as well. The advantages and disadvantages of franchising as a mode of entry are virtually identical to those of licensing.

4. Specialty Modes of Entry • Turnkey Projects, B-O-T Projects – A turnkey project occurs when one firm designs, builds, and equips a facility and then sells it to a buyer which will then operate the facility. For a B-O-T project, the firm Builds the facility, Operates it, then Turns over the operation in the future, all for a fee. • Management Contracts – Contracts in which a firm agrees to manage a facility or company for a fee. Important for many hotel franchise agreements, otherwise seldom used except at the behest of national governments. • Contract Manufacturing – “Outsourcing” production rather than keeping that function inside corporate boundaries.

5. Types of Exporting • Direct exporting – firm sells directly to a buyer in a country other than the one in which goods were produced. • Indirect exporting – firm finds a buyer in the same country in which the goods were produced. However, the buyer then sells those goods to somebody in a foreign country, either “as is” or in a modified form. • Intracorporate transfers – the selling of goods by a firm in one country to an affiliated firm in another country.

6. Direct Exports Usually requires up-front research and commitment of resources to cultivate relationships abroad. Maximizes the firm’s margin on product sales. More risk than indirect exporting, more knowledge required and more “hassle costs”. Can learn about foreign markets by getting feedback from abroad. Indirect Exports Often happens unconsciously. Often realize lower margins on product sales, especially when product is re-sold abroad “as is”. Requires less knowledge about how to carry out export transactions, about foreign markets. Firm will generally learn nothing, or at most very little, about foreign markets. Direct vs Indirect Exports

7. Advantages No large up-front investment, low financial risk Can be relatively quickly implemented Can enter a new market gradually, if desired Can learn about a new environment at a comfortable pace and at little expense Disadvantages Possible trade barriers Transport costs May not maximize overseas sales Exporting (vs licensing, FDI)

8. Advantages Licensor: Low financial risk Licensor: Can learn about foreign market with low resource commitment Licensor: Little effort required once agreement negotiated, beyond monitoring of partner Licensee: Acquire access to valuable intellectual property with little or no R&D cost Disadvantages Must share gains, limits market opportunities for licensor and licensee Negotiations can take many months Agreements must be drawn up with great care to avoid misunderstandings and to allow for many contingencies May lead to costly, tedious litigation Licensor: May create future competitor Licensing (vs Exporting, FDI)

9. Advantages Maximizes share of margin on sale of products Maximizes control over foreign operations, facilitating coordination across national subsidiaries Maximizes learning about and from foreign market Sidesteps trade barriers and possible hostility of host nation governments towards imports If products are built locally, sold locally, then foreign exchange risk is eliminated Disadvantages Maximum financial risk High commitment of resources needed Can face expropriation, confiscation of foreign assets by host nation governments National governments may be hostile to certain kinds of FDI Foreign Direct Investment (FDI), Wholly Owned (vs licensing, exports)

10. Greenfield FDI Involves buying or leasing land, building a new facility from scratch, and training and hiring a brand new work force. Acquisition FDI Involves buying a pre-existing firm (usually) or pre-existing assets (possibly), then using the newly purchased firm and/or assets to operate. FDI, Wholly Owned

11. Advantages Start with a clean slate, no inherited problems Can pick best location for firm’s needs, may have a much wider array of sites to choose from Can often negotiate substantial financial and other incentives from host nation governments, regional and local officials Can expend resources and acclimate to the new national business culture at firm’s own pace Disadvantages A lot of time and patience needed (ie: up to several years) Desired locations may be unavailable or very expensive Firm most likely to be perceived as “foreign” and unwelcome (EuroDisney) Many local and national regulations to comply with while building factory Must recruit and train workforce FDI, Wholly Owned: Greenfield (vs Acquisition)

12. Advantage “Buy today, operate tomorrow”. Quickly gain control over foreign operations, employees, technology, brand names, and a distribution network Disadvantages Buy liabilities and weaknesses, along with assets Potential clash between corporate and national cultures Usually must pay a substantial sum up front, often at a hefty premium over “market value” as suggested by stock price FDI, Wholly Owned:Acquisition (vs Greenfield)

13. Selecting National Markets: Strategic Considerations Profit Sanctuaries & “Black Holes”

14. Strategic Considerations: Profit Sanctuaries • If a firm does not capture significant market share in national markets which are profit sanctuaries for key competitors, then competitor profits and cash flow generated in those profit sanctuaries can be used against the firm in a variety of ways. • Therefore, want to gain significant market share in nations which are profit sanctuaries for key competitors. Then, competitor profits and cash flow can be substantially reduced by starting a price war in that market, all at little cost to the firm which does not rely on that market to generate profits and positive cash flow.

15. Strategic Considerations: Profit Sanctuaries, Cont’d • Invasion of another firm’s profit sanctuary is normally difficult to counter. Consider the case of Firm A, which has gained a 20% share of a given national market, and Firm B, which has 65% of that same market and generates substantial profits and positive cash flow from sales in that nation. If Firm A starts a price war, then Firm B must choose between two unattractive alternatives. • First, Firm B can match the lower prices of Firm A to preserve its 65% share of the market. But, the loss of profits and cash flow for Firm B will be much higher than for Firm A because of Firm B’s higher sales in that market. • Second, Firm B can refuse to match the lower prices of Firm A. However, by refusing to match Firm A’s lower prices Firm B will likely see its share of that national market decline, which will also hurt profits and cash flow, especially in the long run. • Essentially, firm B must choose between “heads I lose, tails you win”. Either way, Firm A improves its global competitive position.

16. Strategic Considerations: “Black Holes” • Sometimes it proves necessary to operate in a given nation even though there is no realistic chance of making profits. Such subsidiaries could be termed “black holes” because they keep absorbing cash and other resources. • As an example, Japanese consumers have long been the lead adopters of new consumer electronics products. It is therefore necessary to have a presence in Japan to keep up on new developments in consumer electronics. So, Phillips NV of the Netherlands has kept a subsidiary in Japan even though they have never captured a significant share of the Japanese market and that subsidiary has remained a perennial, loss-making “black hole”.

17. Firm strategy and entry modes Relating strategy for the firm, and for lines of business, to specific modes of serving national markets

18. Firm strategy and entry modes • International, global, multidomestic, and transnational strategies require different levels of responsiveness to local conditions and/or different levels of coordination on a global basis, across and between national subsidiaries. • The above leads to differences across strategy choices regarding the degree of centralization of control over national subsidiaries, the degree of coordination required across national subsidiaries, and different requirements with respect to learning about and adapting to differences in specific national markets.

19. Firm strategy and entry modes • As well as involving different levels of risk and resource commitment, different modes of entry provide differing levels of control over foreign operations and sales, facilitate or militate against coordination between national subsidiaries, and provide differing opportunities to learn about and adapt to foreign national markets. • Because strategy choices and entry modes all have implications for the same kinds of things (learning about and adaptation to foreign markets, degree of centralization of control over operations, degree of coordination between and across national subsidiaries), there will tend to be a connection between strategy choices for the firm and preferred modes for organizing overseas operations and for serving individual national markets.