Introduction
This chapter is concerned with three closely related topics: (1) The decision of which foreign markets to enter, when to enter them, and on what scale; (2) the choice of entry mode, and (3) the role of strategic alliances. Any firm contemplating foreign expansion must first struggle with the issue of which foreign markets to enter and the timing and scale of entry. The choice of which markets to enter should be driven by an assessment of relative long-run growth and profit potential.The company was too early.
Strategic alliances are cooperative agreements between actual or potential competitors. The term strategic alliances is often used loosely to embrace a variety of arrangements between actual or potential competitors including cross-shareholding deals, licensing arrangements, formal joint ventures, and informal cooperative arrangements.
The chapter opens with a look at how firms choose which foreign markets to enter and at the factors that are important in determining the best timing and scale of entry. Then we will review the various entry modes available, discussing the advantages and disadvantages of each option.
Basic Entry Decisions
Which Foreign Markets?
There are more than 160 nation-states in the world, but they do not all hold the same profit potential for a firm contemplating foreign expansion. Ultimately, the choice must be based on an assessment of a nation's long-run profit potential. This potential is a function of several factors, many of which we have already studied in earlier chapters.
However, this calculus is complicated by the fact that the potential long-run benefits bear little relationship to a nation's current stage of economic development or political stability. Long-run benefits depend on likely future economic growth rates, and economic growth appears to be a function of a free market system and a country's capacity for growth. This leads one to the conclusion that, other things being equal, the benefit - cost - risk trade-off is likely to be most favorable in 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. The trade-off is likely to be least favorable politically unstable developing nations that operate with a mixed or command economy or in developing nations where speculative financial bubbles have led to excess borrowing.
If the international business can offer a product that has not been widely available in that market and that satisfies an unmet need, the value of that product to consumers is likely to be much greater than if the international business simply offers the same type of product that indigenous competitors and other foreign entrants are already offering. Greater value translates into an ability to charge higher prices and/or to build sales volume more rapidly.
Timing of Entry
Once attractive markets have been identified, it is important to consider the timing of entry. The advantages frequently associated with entering a market early are commonly known as first-mover advantages. One first-mover advantage is the ability to preempt rivals and capture demand by establishing a strong brand name. A second advantage is the ability to build sales volume in that country and ride down the experience curve ahead of rivals, giving the early entrant a cost advantage over later entrants. A third advantage is the ability of early entrants to create switching costs that tie customers into their products or services. Such switching costs make it difficult for later entrants to win business.
There can also be disadvantages associated with entering a foreign market before other international businesses. These are often referred to as first-mover disadvantages. These disadvantages may give rise to pioneering costs. Pioneering costs are costs that an early entrant has to bear that a later entrant can avoid. Pioneering costs arise when the business system in a foreign country is so different from that in a firm's home market that the enterprise has to devote considerable effort, time, and expense to learning the rules of the game.
Pioneering include the costs of promoting and establishing a product offering, including the costs of educating customers. These costs can be particularly significant when the product being promoted is one that local consumers are not familiar with. In many ways.
An early entrant may be put at a severe disadvantage, relative to a later entrant, if regulations change in a way that diminishes the value of an early entrant's investments. This is a serious risk in many developing nations where the rules that govern business practices are still evolving. Early entrants can find themselves at a disadvantage if a subsequent change in regulations invalidates prior assumptions about the best business model for operating in that country.
Scale of Entry and Strategic Commitments
The final issue that an international business needs to consider when contemplating market entry is the scale of entry. Entering a market on a large scale involves the commitment of significant resources.
The consequences of entering on a significant scale are associated with the value of the resulting strategic commitments. A strategic commitment is a decision that has a long-term impact and is difficult to reverse. Deciding to enter a foreign market on a significant scale is a major strategic commitment. Strategic commitments, such as large-scale market entry, can have an important influence on the nature of competition in a market.
The value of the commitments that flow from large-scale entry into a foreign market must be balanced against the resulting risks and lack of flexibility associated with significant commitments. But strategic inflexibility can also have value. A famous example from military history illustrates the value of inflexibility. Balanced against the value and risks of the commitments associated with large-scale entry are the benefits of a small-scale entry. Small-scale entry allows a firm to learn about a foreign market while limiting the firm's exposure to that market. Small-scale entry can be seen as a way to gather information about a foreign market before deciding whether to enter on a significant scale and how best to enter.
Exporting
Advantages
Exporting has two distinct advantages. First, it avoids the often-substantial costs of establishing manufacturing operations in the host country. Second, exporting may help a firm achieve experience curve and location economies .
Disadvantages
Exporting has a number of drawbacks. First, exporting from the firm's home base may not be appropriate if there are lower-cost locations for manufacturing the product abroad . Thus, particularly for firms pursuing global or transnational strategies, it may be preferable to manufacture where the mix of factor conditions is most favorable from a value creation perspective and to export to the rest of the world from that location. This is not so much an argument against exporting as an argument against exporting from the firm's home country.
A second drawback to exporting is that high transport costs can make exporting uneconomical, particularly for bulk products. One way of getting around this is to manufacture bulk products regionally. This strategy enables the firm to realize some economies from large-scale production and at the same time to limit its transport costs.
A thirth drawback to exporting arises when a firm delegates its marketing in each country where it does business to a local agent. There are ways around this problem, however. One way is to set up a wholly owned subsidiary in the country to handle local marketing. By doing this, the firm can exercise tight control over marketing in the country while reaping the cost advantages of manufacturing the product in a single location.
Turnkey Projects
Advantages
The know-how required to assemble and run a technologically complex process, such as refining petroleum or steel, is a valuable asset. Turnkey projects are a way of earning great economic returns from that asset. The strategy is particularly useful where FDI is limited by host-government regulations. A turnkey strategy can also be less risky than conventional FDI. In a country with unstable political and economic environments, a longer-term investment might expose the firm to unacceptable political and/or economic risks.
Disadvantages
Three main drawbacks are associated with a turnkey strategy. First, the firm that enters into a turnkey deal will have no long-term interest in the foreign country. This can be a disadvantage if that country subsequently proves to be a major market for the output of the process that has been exported. Second, the firm that enters into a turnkey project with a foreign enterprise may inadvertently create a competitor. Third, 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.
Licensing
A licensing agreement is an arrangement whereby a licensor grants the rights to intangible property to another entity for a specified period, and in return, the licensor receives a royalty fee from the licensee.
Advantages
In the typical international licensing deal, the licensee puts up most of the capital necessary to get the overseas operation going. Licensing is very attractive for firms lacking the capital to develop operations overseas. In addition, licensing can be attractive when a firm is unwilling to commit substantial financial resources to an unfamiliar or politically volatile foreign market. Licensing is also often used when a firm wishes to participate in a foreign market but is prohibited from doing so by barriers to investment.
Disadvantages
Licensing has three serious drawbacks. First, it does not give a firm the tight control over manufacturing, marketing, and strategy that is required for realizing experience curve and location economies . Licensing typically involves each licensee setting up its own production operations.
Second, competing in a global market may require a firm to coordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another . Technological know-how constitutes the basis of many multinational firms' competitive advantage. Most firms wish to maintain control over how their know-how is used, and a firm can quickly lose control over its technology by licensing it. Many firms have made the mistake of thinking they could maintain control over their know-how within the framework of a licensing agreement.
Another way of reducing the risk associated with licensing is to follow the Fuji-Xerox model and link an agreement to license know-how with the formation of a joint venture in which the licensor and licensee take an important equity stake. Such an approach aligns the interests of licensor and licensee, since both have a stake in ensuring that the venture is successful.
Franchising
Franchising is basically a specialized form of licensing in which the franchiser 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.
Advantages
The advantages of franchising as an entry mode are very similar to those of licensing. The firm is relieved of many of the costs and risks of opening a foreign market on its own. Instead, the franchisee typically assumes those costs and risks. This creates a good incentive for the franchisee to build profitable operation as quickly as possible.
Disadvantages
The disadvantages are less pronounced than in the case of licensing. Since franchising is often used by service companies, there is no reason to consider the need for coordination of manufacturing to achieve experience curve and location economies. But franchising may inhibit the firm's ability to take profits out of one country to support competitive attacks in another.
A more significant disadvantage of franchising is quality control. The foundation of franchising arrangements is that the firm's brand name conveys a message to consumers about the quality of the firm's product. One way around this disadvantage is to set up a subsidiary in each country in which the firm expands. The subsidiary might be wholly owned by the company or a joint venture with a foreign company. The subsidiary assumes the rights and obligations to establish franchises throughout the particular country or region.
Joint Ventures
A joint venture entails establishing a firm that is jointly owned by two or more otherwise independent firms.
Advantages
Joint ventures have a number of advantages. First, a firm benefits from a local partner's knowledge of the host country's competitive conditions, culture, language, political systems, and business systems. Second, when the development costs and risks of opening a foreign market are high, a firm might gain by sharing these costs and/or risks with a local partner. Third, in many countries, political considerations make joint ventures the only feasible entry mode.
Disadvantages
Despite these advantages, there are two major disadvantages with joint ventures. First, as with licensing, a firm that enters into a joint venture risks giving control of its technology to its partner. A second disadvantage is that a joint venture does not give a firm the tight control over subsidiaries that it might need to realize experience curve or location economies. Nor does it give a firm the tight control over a foreign subsidiary that it might need for engaging in coordinated global attacks against its rivals.
A third disadvantage with joint ventures is that the shared ownership arrangement can lead to conflicts and battles for control between the investing firms if their goals and objectives change or if they take different views as to what the strategy should be.
Wholly Owned Subsidiaries
Advantages
There are three clear advantages of wholly owned subsidiaries. First, when a firm's competitive advantage is based on technological competence, a wholly owned subsidiary will often be the preferred entry mode, because it reduces the risk of losing control over that competence. Second, a wholly owned subsidiary gives a firm the tight control over operations in different countries that is necessary for engaging in global strategic coordination .Third, a wholly owned subsidiary may be required if a firm is trying to realize location and experience curve economies .The various operations must be prepared to accept centrally determined decisions as to how they will produce, how much they will produce, and how their output will be priced for transfer to the next operation.
Disadvantages
Establishing a wholly owned subsidiary is generally the most costly method of serving a foreign market. Firms doing this must bear the full costs and risks of setting up overseas operations. The risks associated with learning to do business in a new culture are less if the firm acquires an established host-country enterprise. However, acquisitions raise additional problems, including those associated with trying to marry divergent corporate cultures.
Selecting an Entry Mode
Core Competencies and Entry Mode
The optimal entry mode for these firms depends to some degree on the nature of their core competencies. A distinction can be drawn between firms whose core competency is in technological know-how and those whose core competency is in management know-how.
Technological Know-How
This rule should not be viewed as hard and fast, however. One exception is when a licensing or joint venture arrangement can be structured so as to reduce the risks of a firm's technological know-how being expropriated by licensees or joint venture partners. We will see how this might be achieved later in the chapter when we examine the structuring of strategic alliances. Another exception exists when a firm perceives its technological advantage to be only transitory, when it expects rapid imitation of its core technology by competitors. In such cases, the firm might want to license its technology as rapidly as possible to foreign firms to gain global acceptance for its technology before the imitation occurs.
Management Know-How
The competitive advantage of many service firms is based on management know-how. For such firms, the risk of losing control over their management skills to franchisees or joint venture partners is not that great. These firms' valuable asset is their brand name, and brand names are generally well protected by international laws pertaining to trademarks. Given this, many of the issues arising in the case of technological know-how are of less concern here.
Pressures for Cost Reductions and Entry Mode
The greater the pressures for cost reductions are, the more likely a firm will want to pursue some combination of exporting and wholly owned subsidiaries. By manufacturing in those locations where factor conditions are optimal and then exporting to the rest of the world, a firm may be able to realize substantial location and experience curve economies.
Strategic Alliances
Strategic alliances refer to cooperative agreements between potential or actual competitors.
The Advantages of Strategic Alliances
First, as noted earlier in the chapter, strategic alliances may facilitate entry into a foreign market. Second an alliance is a way to bring together complementary skills and assets that neither company could easily develop on its own. Third , it can make sense to form an alliance that will help the firm establish technological standards for the industry that will benefit the firm. The issue was important because Sony had developed a competing "mini compact disk" technology that it hoped to establish as the new technical standard. Since the two technologies did very similar things, there was at most only room for one new standard. Philips saw its alliance with Matsushita as a tactic for winning the race.
The Disadvantages of Strategic Alliances
The advantages we have discussed can be very significant. Despite this, some commentators have criticized strategic alliances on the grounds that they give competitors a low-cost route to new technology and markets.
Making Alliances Work
Partner Selection
First, a good partner helps the firm achieve its strategic goals, whether they are market access, sharing the costs and risks of new-product development, or gaining access to critical core competencies. Second, a good partner shares the firm's vision for the purpose of the alliance. Third, a good partner is unlikely to try to opportunistically exploit the alliance for its own ends; that is, to expropriate the firm's technological know-how while giving away little in return.
To increase the probability of selecting a good partner, the firm should:
1. Collect as much pertinent, publicly available information on potential allies as possible.
2. Collect data from informed third parties. These include firms that have had alliances with the potential partners, investment bankers who have had dealings with them, and former employees.
3. Get to know the potential partner as well as possible before committing to an alliance.
Alliance Structure
Having selected a partner, the alliance should be structured so that the firm's risks of giving too much away to the partner are reduced to an acceptable level. First, alliances can be designed to make it difficult to transfer technology not meant to be transferred. The design, development, manufacture, and service of a product manufactured by an alliance can be structured so as to wall off sensitive technologies to prevent their leakage to the other participant. Second, contractual safeguards can be written into an alliance agreement to guard against the risk of opportunism by a partner. Third, both parties to an alliance can agree in advance to swap skills and technologies that the other covets, thereby ensuring a chance for equitable gain. Fourth, the risk of opportunism by an alliance partner can be reduced if the firm extracts a significant credible commitment from its partner in advance.
Managing the Alliance
Once a partner has been selected and an appropriate alliance structure has been agreed on, the task facing the firm is to maximize its benefits from the alliance. As in all international business deals, an important factor is sensitivity to cultural differences. Many differences in management style are attributable to cultural differences, and managers need to make allowances for these in dealing with their partner.
Building Trust
Managing an alliance successfully seems to require building interpersonal relationships between the firms' managers.
Learning from Partners
To maximize the learning benefits of an alliance, a firm must try to learn from its partner and then apply the knowledge within its own organization. It has been suggested that all operating employees should be well briefed on the partner's strengths and weaknesses and should understand how acquiring particular skills will bolster their firm's competitive position.
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