Read the following chapters from : Wild, John J., Kenneth L. Wild & Jerry C.Y. Han. International Business: The Challenges of Globalization, 5th Edition. Pearson Learning Solutions
12 Analyzing International Opportunities
After studying this chapter, you should be able to
1 Explain each of the four steps in the market- and site-screening process.
2 Describe the three primary difficulties of conducting international market research.
3 Identify the main sources of secondary international data and explain their usefulness.
4 Describe the main methods used to conduct primary international research.
A LOOK BACK
Chapter 11 showed us how companies plan and organize themselves for international operations. We explored the different types of strategies and organizational structures that international companies use to accomplish their strategic goals.
A LOOK AT THIS CHAPTER
This chapter begins with an explanation of how managers screen potential new markets and new sites for operations. We then describe the main difficulties of conducting international market research. We also identify the information required in the screening process and where managers can go to obtain such information.
A LOOK AHEAD
Chapter 13 describes the selection and management issues surrounding the different entry modes available to companies going international. We examine the importance of an export strategy for exporters and the pros and cons of each entry mode.
Global Buzz Over Starbucks
Osaka, Japan — Starbucks (www.starbucks.com) began its global journey in 1996 with its first coffeehouse in Tokyo, Japan. Pictured below is a Starbucks located in the Japanese city of Osaka. Today Starbucks has around 1,500 coffeehouses in 43 markets outside North America. Although it has closed some underperforming stores, Starbucks still creates a buzz worldwide.
Starbucks brought European-style coffee to the United States and then took its American-style coffeehouses to Europe. The coffee giant was right that paper-cupped lattes and nonsmoking venues could take on Europe’s traditional cafés. Although in Britain since the late 1990s, Starbucks waited patiently before steaming into Zurich, Switzerland, in 2001 and into Paris, France, in 2004. Starbucks carefully researched Europe’s markets before opening its first European café in Zurich, and then branching out to other nations. With its multicultural and multilingual population, the Swiss market gave Starbucks a “tremendous opportunity to learn how to operate elsewhere in Europe,” revealed Mark McKeon, president of Starbucks Europe, Middle East, and Africa.
Source: © Andy Rain/CORBIS. All Rights Reserved.
At the same time, Starbucks introduced a coffee culture to tea lovers in China. Starbucks is encouraged by the fact that one-third of all Chinese households keep a jar of instant coffee on hand. Starbucks is trying to make coffee the drink of choice for the average 18- to 45-year-old Chinese consumer. “Per capita consumption of coffee in China is very small,” admitted Howard Behar, president of Starbucks Coffee International. “But what you have is a tremendous amount of people, so the market will grow.”
Starbucks founder and CEO, Howard Schultz, says that an integral component of Starbucks’ strategy is its image as a fair-trading multinational, which it acquired by promoting its “fair trade” coffee. As you read this chapter, consider how companies research, analyze, and select the international markets they will enter.1
Companies traditionally become involved in international business by choosing to enter familiar, nearby countries first. Managers feel comfortable entering nearby markets because they likely have already interacted with the people of those cultures and have at least some understanding of them. Companies in Canada, Mexico, and the United States often gain their initial international experiences in one another’s markets. Likewise, businesses in Asia often seek out opportunities in one another’s markets before pursuing investment opportunities outside the region.
Yet companies today find themselves bridging the gaps presented by space and culture far more often than in the past. For one thing, technological advances in communication and transportation continue to open markets around the globe. Some companies can realistically consider nearly every location on earth as either a potential market or as a site for business operations. The expansion of regional markets (such as the European Union) also causes companies to analyze opportunities farther from home. Businesses locate production facilities within regional markets because producing in one of a region’s countries provides duty-free access to every consumer in the trade bloc.
The rapidly changing global marketplace forces companies to view business strategies from a global perspective. Businesses today formulate production, marketing, and other strategies as components of integrated plans. For example, to provide a continuous flow of timely information into the production process, more and more firms locate research and development (R&D) facilities near their production sites abroad. Managers also find themselves screening and analyzing locations as potential markets and as potential sites for operations simultaneously. When Mercedes (www.mercedes.com) introduced the M-class sport utility vehicle to the U.S. market, executives also decided to build the vehicle there. The company did not merely estimate the size of the potential market for the vehicle, but simultaneously selected a suitable production site.
This chapter presents a systematic screening process for both markets and sites. After describing important cultural, political, legal, and economic forces affecting the screening process, we explain the difficulties of conducting international research. We then explore the central sources of existing market data and the prime methods for conducting international research firsthand.
Screening Potential Markets and Sites
Two important issues concern managers during the market- and site-screening process. First, they want to keep search costs as low as possible. Second, they want to examine every potential market and every possible location. To accomplish these two goals, managers can segment the screening of markets and sites into the following four-step process (see Figure 12.1):
1. Identify basic appeal
2. Assess the national business environment
3. Measure market or site potential
4. Select the market or site
This screening process involves spending more time, money, and effort on the markets and sites that remain in the later stages of screening. Expensive feasibility studies (conducted later in the process) are performed on a few markets and sites that hold the greatest promise. This approach creates a screening process that is cost effective yet does not overlook potential locations. Let’s now discuss each of the four steps above in detail.
Step 1: Identify Basic Appeal
We have already seen that companies go international either to increase sales (and thus profits) or to access resources. The first step in identifying potential markets is to assess the basic demand for a product. Similarly, the first step in selecting a site for a facility to undertake production, R&D, or some other activity is to explore the availability of the resources required.
FIGURE 12.1 Screening Process for Potential Markets and Sites
Determining Basic Demand
The first step in searching for potential markets means finding out whether there is a basic demand for a company’s product. Important in determining this basic appeal is a country’s climate. For example, no company would try to market snowboards in Indonesia, Sri Lanka, or Central America because they receive no snowfall. The same product, on the other hand, is well suited for markets in the Canadian Rockies, northern Japan, and the Swiss Alps. Although this stage seems simple, it cannot be taken too lightly. A classic example is when, during its initial forays into international business, Wal-Mart (www.walmart.com) found ice-fishing huts in its Puerto Rico inventory and no snowshoes at its stores in Ontario, Canada.
Certain countries also ban specific goods. Islamic countries, for instance, forbid the importation of alcoholic products, and the penalties for smuggling are stiff. Although alcohol is available on the planes of international airlines such as British Airways (www.ba.com) and KLM (www.klm.com), it cannot leave the airplane and consumption cannot take place until the plane has left the airspace of the country operating under Islamic law.
Determining Availability of Resources
Companies that require particular resources to carry out local business activities must be sure they are available. Raw materials needed for manufacturing must either be found in the national market or imported. Yet imports may encounter tariffs, quotas, or other government barriers. Managers must consider the additional costs of importing to ensure that total product cost does not rise to unacceptable levels.
The availability of labor is essential to production in any country. Many companies choose to relocate to countries where workers’ wages are lower than they are in the home country. This practice is most common among makers of labor-intensive products—those for which labor accounts for a large portion of total cost. Companies considering local production must determine whether there is enough labor available locally for production operations.
Companies that hope to secure financing in a market abroad must determine the availability and cost of local capital. If local interest rates are too high, a company might be forced to obtain financing in its home country or in other markets in which it is active. On the other hand, access to low-cost financing may provide a powerful inducement to a company that is seeking to expand internationally. British entrepreneur Richard Branson opened several of his Virgin (www.virgin.com) Megastores in Japan despite its reputation as a tough market to crack. One reason for Branson’s initial attraction to Japan was a local cost of capital that was roughly one-third its cost in Britain.
Markets and sites that fail to meet a company’s requirements for basic demand or resource availability in step 1 are removed from further consideration.
Step 2: Assess the National Business Environment
If the business environments of all countries were the same, deciding where to market or produce products would be rather straightforward. Managers could rely on data that report the performance of the local economy and analyze expected profits from proposed investments. But as we saw in earlier chapters, countries differ significantly in their cultures, politics, laws, and economies. International managers must work to understand these differences and to incorporate their understanding into market- and site-selection decisions. Let’s examine how domestic forces in the business environment actually affect the location-selection process.
Although countries display cultural similarities, they differ in language, attitudes toward business, religious beliefs, traditions, customs, and countless other ways. Some products are sold in global markets with little or no modification. These products include industrial machinery such as packaging equipment, consumer products such as toothpaste and soft drinks, and many other types of goods and services. Yet many other products must undergo extensive adaptation to suit local preferences, such as books, magazines, ready-to-eat meals, and other products.
Cultural elements can influence what kinds of products are sold and how they are sold. A company must assess how the local culture in a candidate market might affect the salability of its product. Consider Coca-Cola’s (www.cocacola.com) experience in China. Many Chinese take a traditional medicine to fight off flu and cold symptoms. As it turns out, the taste of this traditional medicine—which most people do not find appealing—is similar to that of Coke. Because of Coca-Cola’s global marketing policy of one taste worldwide, the company had to overcome the aversion to the taste of Coke among Chinese consumers. It did so by creating a marketing campaign that associated drinking a Coke with experiencing a piece of American culture. What initially looked like an unattractive market for Coke became very successful through a carefully tailored marketing campaign.
Cultural elements in the business environment can also affect site-selection decisions. When substantial product modifications are needed for cultural reasons, a company might choose to establish production facilities in the target market itself. Yet serving customers’ special needs in a target market must be offset against any potential loss of economies of scale due to producing in several locations rather than just one. Today companies can minimize such losses through the use of flexible manufacturing methods. Although cellular phone manufacturer Nokia (www.nokia.com) produces in locations worldwide, it ensures that each one of its facilities can start producing any one of its mobile phones for its different markets within 24 hours.
A qualified workforce is important to a company no matter what activity it is to undertake at a particular site. Also, a strong work ethic among the local workforce is essential to having productive operations. Managers must assess whether an appropriate work ethic exists in each potential country for the purposes of production, service, or any other business activity. An adequate level of educational attainment among the local workforce for the planned business activity is also very important. Although product-assembly operations may not require an advanced education, R&D, high-tech production, and certain services normally will require extensive higher education. If the people at a potential site do not display an appropriate work ethic or educational attainment, the site will be ruled out for further consideration.
Political and Legal Forces
Political and legal forces also influence the market and site-location decision. Important factors include government regulation, government bureaucracy, and political stability. Let’s take a brief look at each of these factors.
As we saw in earlier chapters, a nation’s culture, history, and current events cause differences in attitudes toward trade and investment. Some governments take a strong nationalistic stance, whereas others are quite receptive to international trade and investment. A government’s attitude toward trade and investment is reflected in the quantity and types of restrictions it places on imports, exports, and investment in its country.
Government regulations can quickly eliminate a market or site from further consideration. First of all, they can create investment barriers to ensure domestic control of a company or industry. One way in which a government can accomplish this is by imposing investment rules on matters such as business ownership—for example, forcing foreign companies into joint ventures. Governments can extend investment rules to bar international companies entirely from competing in certain sectors of the domestic economy. The practice is usually defended as a matter of national security. Economic sectors commonly declared off-limits include television and radio broadcasting, automobile manufacturing, aircraft manufacturing, energy exploration, military-equipment manufacturing, and iron and steel production. Such industries are protected either because they are culturally important, are engines for economic growth, or are essential to any potential war effort. Host governments often fear that losing control in these economic sectors means placing their fate in the hands of international companies.
Second, governments can restrict international companies from freely removing profits earned in the nation. This policy can force a company to hold cash in the host country or to reinvest it in new projects there. Such policies are normally rooted in the inability of the host-country government to earn the foreign exchange needed to pay for badly needed imports. For instance, Chinese subsidiaries of multinational companies must convert the local currency (renminbi) to their home currency when remitting profits back to the parent company. Multinationals can satisfy this stipulation only as long as the Chinese government agrees to provide it with the needed home-country currency.
Third, governments can impose very strict environmental regulations. In most industrial countries, factories that produce industrial chemicals as their main output or as byproducts must adhere to strict pollution standards. Regulations typically demand the installation of expensive pollution-control devices and close monitoring of nearby air, water, and soil quality. While protecting the environment, such regulations also increase short-term production costs. Many developing and emerging markets have far less strict environmental regulations. Regrettably, some companies are alleged to have moved production of toxic materials to emerging markets to take advantage of lax environmental regulations and, in turn, lower production costs. Although such behavior is roundly criticized as highly unethical, it will occur less often as nations continue cooperating to formulate common environmental protection policies.
Finally, governments can also require that companies divulge certain information. Coca-Cola actually left India when the government demanded that it disclose its secret Coke formula as a requirement for doing business there. Coca-Cola returned only after the Indian government dropped its demand.
A lean and smoothly operating government bureaucracy can make a market or site more attractive. Yet a bloated and cumbersome system of obtaining approvals and licenses from government agencies can make it less appealing. In many developing countries, the relatively simple matter of obtaining a license to establish a retail outlet often means acquiring numerous documents from several agencies. The bureaucrats in charge of these agencies generally are little concerned with providing businesses with high-quality service. Managers must be prepared to deal with administrative delays and a maze of rules. For example, country managers for Millicom International Cellular (www.millicom.com) in Tanzania needed to wait 90 days to get customs clearance on the monthly import of roughly $1 million in cellular telephone equipment. Millicom endured this bureaucratic obstacle because of the local market’s potential.
Companies will endure a cumbersome bureaucracy if the opportunity is sufficient to offset any potential delays and expenses. Companies entering China cite the patience needed to navigate a maze of government regulations that often contradict one another and complain about the large number of permissions required from different agencies. The trouble stems from the fact that China is continually revising and developing its system of business law as its economy develops. But an unclear legal framework and inefficient bureaucracy are not deterring investment in China because the opportunities for both marketers and manufacturers are simply too great to ignore.
Stability can attract international business but social unrest can severely disrupt operations and drive out international firms. Here, a man jumps over burning tires during a riot in Paranaque City south of the capital Manila in the Philippines. Riots erupted as hundreds of families who claimed they were legally allowed to occupy land resisted the demolition teams. Illegal demolition is frequent in these urban centers where many impoverished rural workers reside.
Source: © Dennis M. Sabangan/epa/CORBIS. All Rights Reserved.
Every nation’s business environment is affected to some degree by political risk. As we saw in Chapter 3, political risk is the likelihood that a society will undergo political changes that negatively affect local business activity. Political risk can threaten the market of an exporter, the production facilities of a manufacturer, or the ability of a company to remove profits from the country in which they were earned.
The key element of political risk that concerns companies is unforeseen political change. Political risk tends to rise if a company cannot estimate the future political environment with a fair degree of accuracy. An event with a negative impact that is expected to occur in the future is not, in itself, bad for companies because the event can be planned for and necessary precautions taken. It is the unforeseen negative events that create political risk for companies.
Managers’ perceptions of a market’s political risk are often affected by their memories of past political unrest in the market. Yet managers cannot let past events blind them to future opportunities. International companies must try to monitor and predict political events that threaten operations and future profits. By investigating the political environment proactively, managers can focus on political risk and develop action plans for dealing with it.
But where do managers get the information to answer such questions? They may assign company personnel to gather information on the level of political risk in a country, or they may obtain it from independent agencies that specialize in providing political-risk services. The advice of country and regional specialists who are knowledgeable about the current political climate of a market can be especially helpful. Such specialists can include international bankers, political consultants, reporters, country-risk specialists, international relations scholars, political leaders, union leaders, embassy officials, and other local businesspeople currently working and living in the country in question.
Economic and Financial Forces
Managers must carefully analyze a nation’s economic policies before selecting it as a new market or site for operations. The poor fiscal and monetary policies of a nation’s central bank can cause high rates of inflation, increasing budget deficits, a depreciating currency, falling productivity levels, and flagging innovation. Such consequences typically lower investor confidence and force international companies to scale back or cancel proposed investments. For instance, India’s government finally reduced its restrictive trade and investment policies and introduced more open policies. These new policies encouraged investment by multinationals in production facilities and R&D centers, especially in the computer software industry.
Currency and liquidity problems pose special challenges for international companies. Volatile currency values make it difficult for firms to predict future earnings accurately in terms of the home-country currency. Wildly fluctuating currency values also make it difficult to calculate how much capital a company needs for a planned investment. Unpredictable changes in currency values can also make liquidating assets more difficult because the greater uncertainty will likely reduce liquidity in capital markets—especially in countries with relatively small capital markets, such as Bangladesh and Slovakia.
In addition to their home government’s resources, managers can obtain information about economic and financial conditions from institutions such as the World Bank, the International Monetary Fund, and the Asian Development Bank. Other sources of information include all types of business and economic publications and the many sources of free information on the Internet.
Transport costs and country image also play important roles in the assessment of national business environments. Let’s take a brief look at each of these forces.
COST OF TRANSPORTING MATERIALS AND GOODS
The cost of transporting materials and finished goods affects any decision about where to locate manufacturing facilities. Some products cost very little to transport through the production and distribution process, yet others cost a great deal. Logistics refers to management of the physical flow of products from the point of origin as raw materials to end users as finished products. Logistics weds production activities to the activities needed to deliver products to buyers. It includes all modes of transportation, storage, and distribution.
Management of the physical flow of products from the point of origin as raw materials to end users as finished products.
To realize the importance of efficient logistics, consider that global logistics is a $400 billion industry. We often think of the United States as an efficient logistics market because of its extensive interstate road system and rail lines that stretch from east to west. But because of overcrowded highways, 2 billion people-hours are lost to gridlock each year. That translates into $48 billion in lost productivity. Transport companies and cargo ports strenuously advertise their services precisely because of the high cost to businesses of inefficient logistics.
Because country image embodies every facet of a nation’s business environment, it is highly relevant to the selection of sites for production, R&D, or any other activity. For example, country image affects the location of manufacturing or assembly operations because products must typically be stamped with labels identifying where they were made or assembled—such as “Made in China” or “Assembled in Brazil.” Although such labels do not affect all products to the same degree, they can present important positive or negative images and boost or dampen sales.
Products made in relatively developed countries tend to be evaluated more positively than products from less developed countries.2 This relation is due to the perception among consumers that the workforces of certain nations have superior skills in making particular products. For example, consumer product giants Procter & Gamble (www.pg.com) and Unilever (www.unilever.com) have manufacturing facilities in Vietnam. But Vietnamese consumers tend to shun these companies’ locally made Close-Up toothpaste and Tide detergent, and instead they seek the identical products and brands produced in neighboring countries, such as Thailand. As one young Vietnamese shopper explained, “Tide from Thailand smells nicer.” A general perception among Vietnamese consumers is that goods from Japan or Singapore are the best, followed by Thai goods. Unfortunately for Procter & Gamble and Unilever in Vietnam, many goods from other countries are smuggled in and sold on the black market, thereby denying the companies local sales revenue.
A country’s image can be positive in one product class but negative in another. For example, the fact that Volkswagen’s (www.volkswagen.com) new Beetle is made in Mexico for the U.S. market has not hurt the Beetle’s sales. But would affluent consumers buy a hand-built Rolls-Royce (www.rolls-roycemotorcars.co.uk) automobile if it were produced in Mexico? Because Rolls-Royce buyers pay for the image of a brilliantly crafted luxury car, the Rolls-Royce image probably would not survive intact if the company were to produce its cars in Mexico.
Finally, note that country image can and does change over time. For example, “Made in India” has traditionally been associated with low-technology products such as soccer balls and many types of textile products. But today world-class computer software companies increasingly rely on the software-development skills of engineers located in and around Madras and Bangalore in southern India.
Throughout our discussion of step 2 of the screening process (assessing the national business environment), we have presented many factors central to traditional business activities. To explore issues specific to entering international markets successfully over the Internet, see the Global Manager’s Briefcase titled, “Conducting Global e-Business.”
GLOBAL MANAGER’S BRIEFCASE Conducting Global e-Business
Generating sales in new geographic markets over the Internet is an increasingly popular method of expansion for large multinationals and entrepreneurs alike. Here are some issues managers should consider when entering new markets using the Internet.
■ Infrastructure. Before investing heavily in e-business, investigate whether your potential customers have easy access to the Internet. Determine whether their government is developing advanced digital networks.
■ Content. Companies must be informed about the different policies of each country through which their information travels in order to avoid liability. Key topics are truth in advertising; fraud prevention; and violent, seditious, or graphic materials.
■ Standards. It’s not always entirely clear which country has the power to establish standards of operations for e-business. Standards might be set up as trade barriers to keep international companies out of a domestic market.
■ Privacy. One strength of e-business is that consumer data can be collected easily and used to generate sales. But consumer groups in some countries view the collection of such data as an invasion of privacy. Consumers are particularly vehement if they are unaware this information is being collected and how it is being used.
■ Security. Companies must ensure their data communications are safe from unauthorized access or modification. Security technology, such as encryption, password controls, and firewalls, still needs support from a global infrastructure.
■ Intellectual property. International agreements govern and protect copyrights, databases, patents, and trademarks. Yet these issues will remain a global concern for e-business until a widely accepted legal framework is established for the Internet.
■ Electronic payments. Online use of credit cards remains a security concern for many consumers. Global electronic payment systems such as stored-value, smart cards, and other systems are in various stages of development and will alleviate many security issues.
■ Tariffs and taxation. International policies regarding which party in an international e-business transaction owes taxes to which nation are not yet fully developed. Countries differ widely on how these matters should be treated.
1. What are the four steps in the screening process?
2. Identify the main factors to investigate when identifying the basic appeal of a market or site for operations.
3. What key forces should be examined when assessing a nation’s business environment?
4. How do transport costs and country image affect the location decision?
Step 3: Measure Market or Site Potential
Markets and sites passing the first two steps in the screening process undergo further analysis to arrive at a more manageable number of potential locations. Despite the presence of a basic need for a product and an adequately stable national business environment, potential customers might not be ready or able to buy a product for a variety of reasons. Despite the availability of resources, certain sites may be unable to supply a given company with the level of resources it needs. Let’s now explore the factors that further influence the potential suitability of markets and sites for operations.
Measuring Market Potential
As barriers to trade are reduced worldwide, companies are looking to increase sales in industrialized and emerging markets alike. But businesses can seldom create one marketing plan for every market in which they sell their products. Nations enjoy different levels of economic development that affect what kinds of goods are sold, the manner in which they are sold, and their inherent features. Likewise, different levels of economic development require varying approaches to researching market potential. But how do managers estimate potential demand for particular products? Let’s take a look at the factors managers consider when analyzing industrialized markets and then examine a special tool for analyzing emerging markets.
The information needed to estimate the market potential for a product in industrialized nations tends to be more readily available than in emerging markets. In fact, for the most developed markets, research agencies exist for the sole purpose of supplying market data to companies. Euromonitor (www.euromonitor.com) is one such company with an extensive global reach in consumer goods. The company sells reports and does company-specific studies for many international corporations and entrepreneurs. Some of the information in a typical industry analysis includes:
■ Names, production volumes, and market shares of the largest competitors
■ Volume of exports and imports of the product
■ Structure of the wholesale and retail distribution networks
■ Background on the market, including population figures and key social trends
■ Total expenditure on the product (and similar products) in the market
■ Retail sales volume and market prices of the product
■ Future outlook for the market and potential opportunities
The value of such information supplied by specialist agencies is readily apparent—these reports provide a quick overview of the size and structure of a nation’s market for a product. Reports vary in their cost (depending on the market and product), but many can be had for around $750 to $1,500. The company also allows online purchase of reports in small segments for as little as $20 each. We discuss other sources for this type of market data later in this chapter.
Thus companies that enter the market in industrialized countries often have a great deal of data available on that particular market. What becomes important then is the forecast for the growth or contraction of a potential market. One way of forecasting market demand is determining a product’s income elasticity—the sensitivity of demand for a product relative to changes in income. The income-elasticity coefficient for a product is calculated by dividing a percentage change in the quantity of a product demanded by a percentage change in income. A coefficient greater than 1.0 conveys an income-elastic product, or one for which demand increases more relative to an increase in income. These products tend to be discretionary purchases, such as computers, video games, jewelry, or expensive furniture—generally not considered essential items. A coefficient less than 1.0 conveys an income-inelastic product, or one for which demand increases less relative to an increase in income. These products are considered essential and include food, utilities, and beverages. To illustrate, if the income-elasticity coefficient for carbonated beverages is 0.7, the demand for carbonated beverages will increase 0.7 percent for every 1.0 percent increase in income. Conversely, if the income-elasticity coefficient for MP3 players is 1.3, the demand for MP3 players will increase 1.3 percent for every 1.0 percent increase in income.
Sensitivity of demand for a product relative to changes in income.
The biggest emerging markets are more important today than ever. Nearly every large company engaged in international business is either already in or is considering entering the big emerging markets such as China and India. With their large consumer bases and rapid growth rates, they whet the appetite of marketers around the world. Although these markets are surely experiencing speed bumps along their paths of economic development, in the long term they cannot be ignored.
Companies considering entering emerging markets often face special problems related to a lack of information. Data on market size or potential may not be available, for example, because of undeveloped methods for collecting such data in a country. But there are ways companies can assess potential in emerging markets. One way is for them to rank different locations by developing a so-called market-potential indicator for each. This method is, however, only useful to companies considering exporting. Companies considering investing in an emerging market must look at other factors that we examine next in the discussion of measuring site potential. The main variables commonly included in market-potential analyses are:3
■ Market Size. This variable provides a snapshot of the size of a market at any point in time. It does not estimate the size of a market for a particular product, but rather the size of the overall economy. Market-size data allow managers to rank countries from largest to smallest, regardless of a particular product. Market size is typically estimated from a nation’s total population or the amount of energy it produces and consumes.
■ Market Growth Rate. This variable reflects the fact that, although the overall size of the market (economy) is important, so too is its rate of growth. It helps managers avoid markets that are large but shrinking and target those that are small but rapidly expanding. It is generally obtained through estimates of growth in gross domestic product (GDP) and energy consumption.
■ Market Intensity. This variable estimates the wealth or buying power of a market from the expenditures of both individuals and businesses. It is estimated from per capita private consumption and/or per capita gross domestic product (GDP) at purchasing power parity (see Chapter 4).
■ Market Consumption Capacity. The purpose of this variable is to estimate spending capacity. It is often estimated from the percentage of a market’s population in the middle class, thereby concentrating on the core of an economy’s buying power.
■ Commercial Infrastructure. This factor attempts to assess channels of distribution and communication. Variables may include the number of telephones, televisions, fax machines, or personal computers per capita; the density of paved roads or number of vehicles per capita; and the population per retail outlet. An increasingly important variable for businesses relying on the Internet for sales is the number of Internet hosts per capita. But because these data become outdated quickly, care must be taken to ensure accurate information from the most current sources.
■ Economic Freedom. This variable attempts to estimate the extent to which free-market principles predominate. It is typically a summary of government trade policies, government involvement in business, the enforcement of property rights, and the strength of the black market. A useful resource is the annual Freedom in the World report published by Freedom House (www.freedomhouse.org).
■ Market Receptivity. This variable attempts to estimate market “openness.” One way it can be estimated is by determining a nation’s volume of international trade as a percentage of gross domestic product (GDP). If a company wants to see how receptive a market is to goods from its home country, it can ascertain the amount of per capita imports entering the market from the home country. Managers can also examine the growth (or decline) in these imports.
■ Country Risk. This variable attempts to estimate the total risk of doing business, including political, economic, and financial risks. Some market-potential estimation techniques include this variable in the market-receptivity variable. This factor is typically obtained from one of the many services that rate the risk of different countries, such as Political Risk Services (www.prsgroup.com).
After each of these factors is analyzed, they are assigned values according to their importance to the demand for a particular product. Potential locations are then ranked (assigned a market-potential indicator value) according to their appeal as a new market. As you may recall, we discussed several of these variables earlier under the topics of national and international business environments. For example, country-risk levels are shown in Map 3.1 (pages 88–89), economic freedom is shown in Map 4.1 (pages 124–125), and market receptivity (or openness) is shown in Map 5.1 (pages 146–147). Map 12.1 captures one other variable, commercial infrastructure, by showing the number of fixed-line and mobile phone subscribers per 1,000 people in each nation. This variable is an important indicator of a nation’s overall economic development. Other variables that are also good proxies for this variable include the portion of a nation’s roads that are paved or the number of personal computers, fax machines, and Internet hosts it has. One key cautionary note, however, is that emerging markets often either lack such statistics or, in the case of paved roads, international comparison is difficult.
Measuring Site Potential
In this step of the site-screening process, managers must carefully assess the quality of the resources that they will use locally. For many companies, the most important of these will be human resources—both labor and management. Wages are lower in certain markets because labor is abundant, relatively less skilled (though perhaps well-educated), or both. Employees may or may not be adequately trained to manufacture a given product or to perform certain R&D activities. If workers are not adequately trained, the site-selection process must consider the additional money and time needed to train them.
Training local managers also requires a substantial investment of time and money. A lack of qualified local managers sometimes forces companies to send managers from the home market to the local market. This adds to costs because home-country managers must often receive significant bonuses for relocating to the local market. Companies must also assess the productivity of local labor and managers. After all, low wages tend to reflect low productivity levels of a workforce.
Managers should also examine the local infrastructure, including roads, bridges, airports, seaports, and telecommunications systems, when assessing site potential. Each of these systems can have a major impact on the efficiency with which a company transports materials and products. Of chief importance to many companies today is the state of a country’s telecommunications infrastructure. Much business today is conducted through e-mail, and many businesses relay information electronically on matters such as sales orders, inventory levels, and production strategies that must be coordinated among subsidiaries in different countries. Managers, therefore, must examine each potential site to determine how well it is prepared for contemporary communications.
Step 4: Select the Market or Site
This final step in the screening process involves the most intensive efforts yet of assessing remaining potential markets and sites—typically less than a dozen, sometimes just one or two. At this stage, managers normally want to visit each remaining location to confirm earlier expectations and to perform a competitor analysis. In the final analysis, managers normally evaluate each potential location’s contribution to cash flows by undertaking a financial evaluation of a proposed investment. The specialized and technical nature of this analysis can be found in most textbooks on corporate finance.
MAP 12.1 Nations’ Commercial Infrastructures
The importance of top managers making a personal visit to each remaining potential market or site cannot be overstated. Such trips typically involve attending strings of meetings and engaging in tough negotiations. The trip represents an opportunity for managers to see firsthand what they have so far seen only on paper. It gives them an opportunity to experience the culture, observe in action the workforce that they might soon employ, or make personal contact with potential new customers and distributors. Any remaining issues tend to be thoroughly investigated during field trips so that the terms of any agreement are known precisely in the event that a particular market or site is chosen. Managers can then usually return to the chosen location to put the terms of the final agreement in writing.
Because competitor analysis was covered in detail in Chapter 11, we offer only a few comments here. Intensely competitive markets typically put downward pressure on the prices that firms can charge their customers. In addition, intensely competitive sites for production and R&D activities often increase the costs of doing business. Naturally, lower prices and higher costs due to competitive forces must be balanced against the potential benefits offered by each market and site under consideration. At the very least, then, competitor analysis should address the following issues:
■ Number of competitors in each market (domestic and international)
■ Market share of each competitor
■ Whether each competitor’s product appeals to a small market segment or has mass appeal
■ Whether each competitor focuses on high quality or low price
■ Whether competitors tightly control channels of distribution
■ Customer loyalty commanded by competitors
■ Potential threat from substitute products
■ Potential entry of new competitors into the market
■ Competitors’ control of key production inputs (such as labor, capital, and raw materials)
So far we have examined a model that many companies follow when selecting new markets or sites for operations. We’ve seen what steps companies take in the screening process, but we have yet to learn how they undertake such a complex task. Let’s now explore the types of situations companies encounter when conducting research in an international setting and the specific tools used in their research.
1. What is the significance of income elasticity in measuring market potential?
2. Identify each component of a market-potential indicator. Why is it useful in assessing emerging markets?
3. What are the most important factors to consider when measuring site potential?
4. Explain why a field trip and competitor analysis are useful in the final stage of the screening process.
Conducting International Research
Increasing global competition forces companies to engage in high-quality research and analysis before selecting new markets and sites for operations. Companies are finding that such research helps them to better understand both buyer behavior and business environments abroad. Market research is the collection and analysis of information used to assist managers in making informed decisions. We define market research here to apply to the assessment of both potential markets and sites for operations. International market research provides information on national business environments, including cultural practices, politics, regulations, and the economy. It also informs managers about a market’s potential size, buyer behavior, logistics, and distribution systems.
Collection and analysis of information used to assist managers in making informed decisions.
Conducting market research on new markets is helpful in designing all aspects of marketing strategy and understanding buyer preferences and attitudes. What works in France, for example, might not work in Singapore. Market research also lets managers learn about aspects of local business environments such as employment levels, wage rates, and the state of the local infrastructure before committing to the new location. It supplies managers with timely and relevant market information to anticipate market shifts, changes in current regulations, and the potential entry of new competitors.
In this section, we first learn about several common problems that confront companies when conducting international research. We then explore some actual sources that managers use to assess potential new locations. We then examine some methods commonly used for conducting international research firsthand.
Difficulties of Conducting International Research
Market research serves essentially the same function in all nations. Unique conditions and circumstances, however, present certain difficulties that often force adjustments in the way research is performed in different nations. It is important for companies that are conducting market research themselves to be aware of potential obstacles so that their results are reliable. Companies that hire outside research agencies must also be aware of such difficulties. After all, they must evaluate the research results and assess their relevance to the location-selection decision. The three main difficulties associated with conducting international market research that we will now examine are:
1. Availability of data
2. Comparability of data
3. Cultural differences
Availability of Data
When trying to target specific population segments, marketing managers require highly detailed information. Fortunately, companies are often spared the time, money, and effort of collecting firsthand data for the simple reason that it has already been gathered. This is particularly true in highly industrialized countries, including Australia, Canada, Japan, those in Western Europe, and the United States, where both government agencies and private research firms supply information. Three of these information suppliers are Information Resources Incorporated (www.usa.infores.com), Survey Research Group (www.surveyresearchgroup.com), and ACNielsen (www2.acnielsen.com).
In many emerging and developing countries, however, previously gathered quality information is hard to obtain. Even when market data are available, their reliability is questionable. For example, analysts sometimes charge the governments of certain emerging markets with trying to lure investors by overstating estimates of gross income and consumption levels. In addition to deliberate misrepresentation, tainted information can also result from improper local collection methods and analysis techniques. But research agencies in emerging and developing markets that specialize in gathering data for clients in industrialized countries are developing higher-quality techniques of collection and analysis. For example, information supplier and pollster Gallup (www.gallup.com) is aggressively expanding its operations throughout Southeast Asia in response to the need among Western companies for more accurate market research.
Comparability of Data
Data obtained from other countries must be interpreted with great caution. Because terms such as poverty, consumption, and literacy differ greatly from one country to another, such data must be accompanied by precise definitions. In the United States, for example, a family of four is said to be below the poverty line if its annual income is less than around $21,000. The equivalent income for a Vietnamese family of four would place it high in the upper class.
The different ways in which countries measure data also affect comparability across borders. For instance, some countries state the total quantity of foreign direct investment in their nations in terms of its monetary value. Others specify it in terms of the number of investment projects implemented during the year. But a single foreign direct investment into an industrialized nation can be worth many times what several or more projects are worth in a developing nation. Thus to gather a complete picture of a nation’s investments, researchers will often need to obtain both figures. Moreover, reported statistics may not distinguish between foreign direct investment (accompanied by managerial control) and portfolio investment (which is not accompanied by managerial control). Misinterpreting data because one does not know how they are compiled or measured can sabotage even the best marketing plans and production strategies.
Marketers who conduct research in unfamiliar markets must pay attention to the ways in which cultural variables influence information. Perhaps the single most important variable is language. For example, if researchers are unfamiliar with a language in the market they are investigating, they might be forced to rely on interpreters. Interpreters might unintentionally misrepresent certain comments or be unable to convey the sentiment with which statements are made.
Researchers might also need to survey potential buyers through questionnaires written in the local language. To avoid any misstatement of questions or results, questionnaires must be translated into the language of the target market and the responses then translated back into the researcher’s language. Written expressions must be highly accurate so that results do not become meaningless or misleading. The potential to conduct written surveys is also affected by the illiteracy rates among the local population. A written survey is generally impossible to conduct in countries with high illiteracy rates such as Morocco (48 percent), Nigeria (31 percent), and Pakistan (50 percent).4 Researchers would probably need to choose a different information-gathering technique, such as personal interviews or observing retail purchases.
Companies that have little experience in an unfamiliar market often hire local agencies to perform some or all of their market research. Local researchers know the cultural terrain. They understand which practices are acceptable and which types of questions can be asked. And they typically know whom to approach for certain types of information. Perhaps most importantly, they know how to interpret the information they gather and are likely to understand its reliability. But a company that decides to conduct its own market research must, if necessary, adapt its research techniques to the local market. Many cultural elements that are taken for granted in the home market must be reassessed in the host business environment.
Sources of Secondary International Data
Companies can consult a variety of sources to obtain information on a nation’s business environment and markets. The particular source that managers should consult depends on the company’s industry, the national markets it is considering, and how far along it is in its location-screening process. The process of obtaining information that already exists within the company or that can be obtained from outside sources is called secondary market research. Managers often use information gathered from secondary research activities to broadly estimate market demand for a product or to form a general impression of a nation’s business environment. Secondary data are relatively inexpensive because they have already been collected, analyzed, and summarized by another party. Let’s now take a look at the main sources of secondary data that help managers make more informed location-selection decisions.
secondary market research
Process of obtaining information that already exists within the company or that can be obtained from outside sources.
There are excellent sources of much free and inexpensive information about product demand in particular countries. For example, the International Trade Statistics Yearbook published by the United Nations (www.un.org) lists the export and import volumes of different products for each country. It also furnishes information on the value of exports and imports on an annual basis for the most recent five-year period. The International Trade Center (www.intracen.org), based in Geneva, Switzerland, also provides current import and export figures for more than 100 countries.
International development agencies, such as the World Bank (www.worldbank.org), the International Monetary Fund (www.imf.org), and the Asian Development Bank (www.adb.org), also provide valuable secondary data. For example, the World Bank publishes annual data on each member nation’s population and economic growth rate. Today, most secondary sources supply data on CD-ROM, through the Internet, or through traditional printed versions.
Initial analyses of foreign market potential do not involve sending researchers to distant markets. Instead, companies acquire market research that has already been collected—called secondary market research. Obtaining secondary data is a cost-effective way to begin exploring potential markets. From its home base, a company can get an initial feel for buyer behavior in an unfamiliar market, such as these shoppers on Florianska Street in Krakow, Poland.
Source: © Robert Harding/CORBIS. All Rights Reserved.
Commerce departments and international trade agencies of most countries typically supply information about import and export regulations, quality standards, and the size of various markets. These data are normally available directly from these departments, from agencies within each nation, and from the commercial attaché in each country’s embassy abroad. In fact, visiting embassies and attending their social functions while visiting a potential location are excellent ways of making contact with potential future business partners.
Granted, the attractively packaged information supplied by host nations often ignores many potential hazards in a nation’s commercial environment—governments typically try to present their country in the best possible light. By the same token, such sources are prone to paint incomplete or one-sided portraits of the home market. It is important for managers to seek additional sources that take a more objective view of a potential location.
One source that takes a fairly broad view of markets is the Central Intelligence Agency’s World Factbook (www.cia.gov). This source can be a useful tool throughout the entire market- or site-screening process because of its wealth of facts on each nation’s business environment. It identifies each nation’s geography, climate, terrain, natural resources, land use, and important environmental issues in detail. It also examines each nation’s culture, system of government, and economic conditions, including government debt and exchange-rate conditions. It also provides an overview of the quality of each country’s transportation and communication systems.
The Trade Information Center (TIC) (www.export.gov) operated by the U.S. Department of Commerce is a first stop for many importers and exporters. The TIC details product standards in other countries and offers advice on opportunities and best prospects for U.S. companies in individual markets. It also offers information on federal export-assistance programs that can be essential for first-time exporters. Other TIC information includes:
■ National trade laws and other regulations
■ Trade shows, trade missions, and special events
■ Export counseling for specific countries
■ Import tariffs and customs procedures
■ The value of exports to other countries
The Chilean Trade Commission within Chile’s Ministry of Foreign Affairs has been particularly aggressive in recent years in promoting Chile to the rest of the world. ProChile (www.chileinfo.com) has 35 commercial offices worldwide. The organization assists in developing the export process, establishing international business relationships, fostering international trade, attracting investment, and forging strategic alliances. It offers a wealth of information on all of Chile’s key industries and provides business environment information such as risk ratings. It also provides details on important trade regulations and standards of which exporters, importers, and investors must be aware.5
Commercial offices of the states and provinces of many countries also typically have offices in other countries to promote trade and investment. These offices usually encourage investment in the home market by companies from other countries and will sometimes even help companies in other countries export to the home market. For example, the Lorraine Development Corporation in Atlanta is the investment-promotion office of the Lorraine region of France. This corporation helps U.S. companies evaluate location opportunities in the Lorraine region—a popular area for industrial investment. It supplies information on sites, buildings, financing options, and conditions in the French business environment and conducts 10 to 20 site-selection studies per year for investors.
Finally, many governments open their research libraries to businesspeople from all countries. For example, the Japanese External Trade Organization (JETRO) (www.jetro.go.jp) in central Tokyo has a large library full of trade data that is available to international companies already in Japan. In addition, the JETRO Web site is useful for companies screening the potential of the Japanese market for future business activities from any location. The organization is dedicated to serving companies interested in exporting to or investing in Japan in addition to assisting Japanese companies in going abroad.
Industry and Trade Associations
Companies often join associations composed of firms within their own industry or trade. In particular, companies trying to break into new markets join such associations to make contact with others in their field. The publications of these organizations keep members informed about current events and help managers to keep abreast of important issues and opportunities. Many associations publish special volumes of import and export data for domestic markets. They frequently compile directories that list each member’s top executives, geographic scope, and contact information such as phone numbers and addresses. Today, many associations also maintain informative Web sites. Two interesting examples are the Web sites of the National Pasta Association (www.ilovepasta.org) and the National Onion Association (www.onions-usa.org).
Sometimes industry and trade associations commission specialized studies of their industries, the results of which are then offered to their members at subsidized prices. These types of studies typically address particularly important issues or explore new opportunities for international growth. The National Confectioners Association (www.chocolateusa.org) of the United States together with the state of Washington’s Washington Apple Commission (www.bestapples.com) once hired a research firm to study the sweet tooth of Chinese consumers. The findings of the study were then made available to each organization’s members to act on as they saw fit.
Many international service organizations in fields such as banking, insurance, management consulting, and accounting offer information to their clients on cultural, regulatory, and financial conditions in a market. For example, the accounting firm of Ernst & Young (www.ey.com) publishes a “Doing Business In” series for most countries. Each booklet contains information on a nation’s business environment, regulations regarding foreign investment, legal forms of businesses, labor force, taxes, and culture. Other companies provide specific and overall information on world markets. One can consult such organizations for specialized reports on market demographics, lifestyles, consumer data, buyer behavior, and advertising.
Internet and World Wide Web
Companies engaged in international business are quickly realizing the wealth of secondary research information available on the Internet and the World Wide Web. These electronic resources are usually user-friendly and have vast amounts of information.
LEXIS-NEXIS (www.lexisnexis.com) is a leading online provider of market information. The LEXIS-NEXIS database of full-text news reports from around the world is updated continuously. It also offers special services such as profiles of executives and products and information on the financial conditions, marketing strategies, and public relations of many international companies. Other popular online providers of global information include DIALOG (www.dialog.com), and Dow Jones (www.dj.com). Internet search engines such as Google (www.google.com), and Yahoo! (www.yahoo.com) are also helpful in narrowing down the plethora of information available electronically.
The Internet can be especially useful in seeking information about potential production sites. Because field trips to most likely candidates are expensive, online information can be enormously helpful in saving both time and money. For example, you can begin a search for information on a particular country or region with most large online information providers. Narrowing your search to a more manageable list of subjects—say, culture, economic conditions, or perhaps a specific industry—can yield clues about sites that are promising and those that are not.
1. Identify the benefits associated with conducting international secondary market research.
2. What are the three main difficulties of conducting research in international markets? Explain each briefly.
3. Identify some of the main sources of secondary market research data.
Methods of Conducting Primary International Research
Although secondary information is very useful in the early stages of the screening process, sometimes more tailored data on a location are needed. Under such circumstances, it might be necessary to conduct primary market research—the process of collecting and analyzing original data and applying the results to current research needs. This type of information is very helpful in filling in the blanks left by secondary research. Yet it is often more expensive to obtain than secondary research data because studies must be conducted in their entirety. Let’s explore some of the more common methods of primary research used by companies in the location-screening process.
primary market research
Process of collecting and analyzing original data and applying the results to current research needs.
Trade Shows and Trade Missions
An exhibition at which members of an industry or group of industries showcase their latest products, study activities of rivals, and examine recent trends and opportunities is called a trade show. Trade shows are held on a continuing basis in virtually all markets and normally attract companies from around the globe. They are typically held by national or global industry trade associations or by government agencies. An excellent source of trade shows and exhibitions worldwide is Expo Central (www.expocentral.com).
Exhibition at which members of an industry or group of industries showcase their latest products, study activities of rivals, and examine recent trends and opportunities.
Not surprisingly, the format and scope of trade shows differ from country to country. For example, because of its large domestic market, shows in the United States tend to be oriented toward business opportunities within the U.S. market. In line with U.S. culture, the atmosphere tends to be fairly informal. Conversely, because of the relatively smaller market of Germany and its participation in the European Union, trade shows there tend to showcase business opportunities in markets all across Europe and tend also to be quite formal. To learn how small companies can use trade shows and other tools to be successful abroad, see this chapter’s Entrepreneur’s Toolkit titled, “Is the World Your Oyster?”
A trade mission is an international trip by government officials and businesspeople that is organized by agencies of national or provincial governments for the purpose of exploring international business opportunities. Businesspeople who attend trade missions are typically introduced both to important business contacts and well-placed government officials.
International trip by government officials and businesspeople that is organized by agencies of national or provincial governments for the purpose of exploring international business opportunities.
Small and medium-sized companies often find trade missions very appealing for two reasons. First, the support of government officials gives them additional clout in the target country as well as access to officials and executives whom they would otherwise have little opportunity to meet. Second, although such trips can sometimes be expensive for the smallest of businesses, they are generally worth the money because they almost always reap cost-effective rewards. Trade missions to faraway places sometimes involve visits to several countries to maximize the return for the time and money invested. For instance, a trade mission for European businesspeople to Latin America may include stops in Argentina, Brazil, Chile, and Mexico. A trade mission to Asia for North American or European companies might include stops in China, Hong Kong, Japan, South Korea, and Thailand.
Interviews and Focus Groups
Although industry data are useful to companies early in the screening process for potential markets, subsequent steps must assess buyers’ emotions, attitudes, and cultural beliefs. Industry data cannot tell us how individuals feel about a company or its product. This type of buyer information is required when deciding whether to enter a market and when developing an effective marketing plan. Therefore, many companies supplement the large-scale collection of country data with other types of research such as interviews with prospective customers. Interviews, of course, must be conducted carefully if they are to yield reliable and unbiased information. Respondents in some cultures might be unwilling to answer certain questions or may intentionally give vague or misleading answers to avoid getting too personal. For example, although individuals in the United States are renowned for their willingness to divulge all sorts of information about their shopping habits and even their personal lives, this is very much the exception among other countries.
ENTREPRENEUR’S TOOLKIT: Is the World Your Oyster?
How can an entrepreneur or small business succeed in international markets? How can they compete with the more competitive pricing and sales efforts of large multinationals? It isn’t easy, but it can be done. Small companies must first do lots of homework before jumping into the global marketplace. Going international is a long-term investment and preparedness is a critical success factor. Companies must plan on investing a good deal of cash. A typical small business can expect to pay anywhere from $10,000 to $20,000 to perform basic market research, to attend a trade show, and to visit one or two countries. Here are the tales of how two small companies are exploiting international opportunities at different stages of going international.
■ Lucille Farms, Inc. of Montville, New Jersey, produces and markets cheese products. Alfonso Falivene, Lucille’s chief executive, is taking a cautious approach to going international. He recently joined the U.S. Dairy Export Council, which offers members, among other things, international trips to study new business opportunities and the competition. The council also offers its members a great deal of free information on international markets. Notes Falivene, “I have stacks of information in my office. If I had to go out and get the information on my own, it would cost me thousands and thousands of dollars.”
■ Meter-Man, Inc. of Winnebago, Minnesota, manufactures agricultural measuring devices. When Meter-Man decided to go international, it saw trade shows as a great way to gain market intelligence and establish contacts. At a five-day agricultural fair in Paris, company executives held 21 meetings with potential customers and sealed an agreement with a major distributor that covers the Parisian market for Meter-Man’s products. James Neff, Meter-Man’s sales and marketing director, was on a flight to a trade show in Barcelona, Spain, and struck up a conversation with the man next to him. The man wound up ordering $200,000 of Meter-Man’s products and is today a major South American distributor for the company.
An unstructured but in-depth interview of a small group of individuals (8 to 12 people) by a moderator to learn the group’s attitudes about a company or its product is called a focus group. Moderators guide a discussion on a topic and interfere as little as possible with the free flow of ideas. The interview is recorded for later evaluation to identify recurring or prominent themes among the participants. This type of research helps marketers to uncover negative perceptions among buyers and to design corrective marketing strategies. Because subtle differences in verbal and body language could go unnoticed, focus group interviews tend to work best when moderators are natives of the countries in which the interview is held. Ironically, it is sometimes difficult to conduct focus groups in collectivist cultures (see Chapter 2) because people have a tendency to agree with others in the group. In such instances, it might be advisable to conduct a consumer panel—research in which people record in personal diaries, information on their attitudes, behaviors, or purchasing habits.
Unstructured but in-depth interview of a small group of individuals (8 to 12 people) by a moderator to learn the group’s attitudes about a company or its product.
Research in which people record in personal diaries information on their attitudes, behaviors, or purchasing habits.
Research in which an interviewer asks current or potential buyers to answer written or verbal questions to obtain facts, opinions, or attitudes is called a survey. For example, if Reebok (www.reebok.com) wants to learn about consumer attitudes toward its latest women’s aerobics shoe in Britain, it could ask a sample of British women about their attitudes toward the shoe. Verbal questioning could be done in person or over the telephone, whereas written questioning could be done in person, through the mail, or through forms completed at Reebok’s Web site. The results would then be tabulated, analyzed, and applied to the development of a marketing plan.
Research in which an interviewer asks current or potential buyers to answer written or verbal questions to obtain facts, opinions, or attitudes.
The single greatest advantage of survey research is the ability to collect vast amounts of data in a single sweep. But as a rule, survey methods must be adapted to local markets. For example, survey research can be conducted by any technological means in industrialized markets, such as over the telephone or the Internet. But telephone interviewing would yield poor results in Bangladesh because only a small percentage of the general population has telephones. Also, although a survey at a Web site is an easy way to gather data, it must be remembered that even in some industrialized nations users still represent mostly middle- to upper-income households.
Written surveys can also be hampered by other problems. Some countries’ postal services are unreliable to the point that parcels are delivered weeks or months after arriving at post offices, or never arrive at all because they are stolen or simply lost. Naturally, written surveys are impractical to conduct in countries with high rates of illiteracy, although this problem can perhaps be overcome by obtaining verbal responses to spoken questions.
An ongoing process of gathering, analyzing, and dispensing information for tactical or strategic purposes is called environmental scanning. The environmental scanning process entails obtaining both factual and subjective information on the business environments in which a company is operating or considering entering. The continuous monitoring of events in other locations keeps managers aware of potential business opportunities and threats. Environmental scanning contributes to making well-informed decisions and the development of effective strategies. It also helps companies develop contingency plans for a particularly volatile environment.
Ongoing process of gathering, analyzing, and dispensing information for tactical or strategic purposes.
1. How does primary market research differ from secondary market research?
2. Describe each main method used to conduct primary market research.
3. What are some of the difficulties of conducting international market research?
A Final Word
To keep pace with an increasingly hectic and competitive global business environment, companies should follow a systematic screening process that incorporates high-quality research methods. This chapter provided a systematic way to screen potential locations as new markets or sites for business operations. But these issues constitute only the first step in the process of “going international.” The next step involves actually accomplishing the task of entering selected markets and establishing operations abroad. In the following chapters, we survey the types of entry modes available to companies, how they acquire the resources needed to carry out their activities, and how they manage their sometimes far-flung international business operations.
1. Explain each of the four steps in the market- and site-screening process.
■ Step 1 involves identifying basic appeal for potential markets (e.g., basic product demand) and/or assessing availability of resources for production (e.g., raw materials, labor, capital).
■ Step 2 involves examining the local culture, political and legal forces (e.g., government bureaucracy, political stability), and economic variables (e.g., fiscal and monetary policies).
■ Step 3 is to measure the potential of each market (e.g., market size and growth, market-potential indicator) and/or suitability of a site for operations (e.g., availability of workers, managers, raw materials, infrastructure).
■ Step 4 involves visiting each remaining location to make a final decision (e.g., competitor analysis, financial evaluation).
2. Describe the three primary difficulties of conducting international market research.
■ Unique conditions and circumstances often force adjustments in the way market research is performed in different nations.
■ Availability of data: In addition to the problem of deliberate misrepresentation, it can be difficult to obtain high-quality, untainted, and reliable information because of improper collection methods and analysis techniques.
■ Comparability of data: Definitions of terms such as poverty, consumption, and literacy differ across markets and so do ways of measuring variables.
■ Cultural differences: Companies entering unfamiliar markets often hire local agencies to do their market research for them because locals understand acceptable practices, types of questions to ask, and how to interpret information and its reliability.
3. Identify the main sources of secondary international data and explain their usefulness.
■ Secondary market research is the process of obtaining information that already exists within the company or that can be obtained from outside sources.
■ International organizations that offer free or inexpensive information about product demand in a particular country include international development agencies, such as the World Bank and the International Monetary Fund.
■ Government agencies such as commerce departments and international trade agencies have information on import–export regulations, quality standards, and the sizes of markets.
■ Industry and trade associations of firms within an industry or trade often publish reports to keep managers abreast of important issues and opportunities.
■ International service organization in fields such as banking, insurance, management consulting, and accounting offer clients information on a market’s cultural, regulatory, and financial conditions.
4. Describe the main methods used to conduct primary international research.
■ Primary market research is the process of collecting and analyzing original data and applying the results to current research needs.
■ A trade show is an exhibition where members of an industry or group of industries showcase their latest products, see what rivals are doing, and learn about recent trends and opportunities.
■ A trade mission is an international trip by government officials and businesspeople that is organized by agencies of national or provincial governments for the purpose of exploring international business opportunities.
■ Companies can use interviews to assess potential buyers’ emotions, attitudes, and cultural beliefs.
■ A focus group is an unstructured but in-depth interview of a small group of individuals by a moderator to learn the group’s attitudes about a company or its product.
■ In surveys, interviewers obtain facts, opinions, or attitudes by asking current or potential buyers to answer written or verbal questions.
■ Ongoing gathering, analyzing, and dispensing information for tactical or strategic purposes is called environmental scanning.
Talk It Over
1. For many global companies, China represents a highly attractive market in terms of size and growth rate. Yet China ranks lower in terms of economic freedom and higher in political risk than do some other countries. Despite these risks, hundreds of companies have established manufacturing operations in China. In large part this is because the Chinese government makes selling in China contingent on a company’s willingness to locate production there. The government wants Chinese companies to learn modern management skills from non-Chinese companies and to acquire technology. Some believe that Western companies are bargaining away important industry know-how in exchange for sales today by agreeing to such conditions. Should companies go along with China’s terms, or should they risk losing sales by refusing to transfer technology? What do you think might be the long-term results of either solution?
2. Although Sony’s (www.sony.com) MiniDisc recorder/player was a huge hit in Japan, initial response to the MiniDisc in the U.S. market was lukewarm. When Sony mounted its third official attempt to launch its MiniDisc in the United States, it thought it finally had the right formula. A Sony executive noted, “This time around, we’ve done our homework, and we’ve found out what’s in consumers’ heads.” What type of research do you think Sony used to “get inside the heads” of its target market? Do you think different cultures prefer to conduct certain types of market research? Explain.
3. What are some of the benefits of “soft” market research data gathered using techniques such as focus groups and observation. What are the benefits of using “hard” data such as statistics on consumers’ buying habits and figures on market size? When might each kind of data be preferred and why?
1. Research Project. As a group, visit your college’s library and consult the Encyclopedia of Associations or a similar organization on the Web. Select one or two industry associations of interest to your group. Write or call the association(s) and request an information packet and compile a summary of the information received from them. Compare the information your group receives with information sent by trade associations researched by the other student groups. Rank the trade associations in terms of the usefulness of their information.
2. Emerging Markets Project. Select an emerging market that your team would like to learn more about. Start by compiling fundamental country data, then do additional research to flesh out the nature of the market opportunity offered by this country or its suitability as a manufacturing site following the steps in this chapter. Make a list of the international companies pursuing market opportunities in the country, and identify the products or brands that the companies are marketing. Are their reasons for doing business in the country consistent with the market opportunity as you have researched it? Determine whether these companies have established facilities for manufacturing, sales, or both.
consumer panel (p. 345)
environmental scanning (p. 345)
focus group (p. 345)
income elasticity (p. 333)
logistics (p. 331)
market research (p. 339)
primary market research (p. 343)
secondary market research (p. 340)
survey (p. 345)
trade mission (p. 343)
trade show (p. 343)
Take It to the Web
1. Video Report. Visit this book’s channel on YouTube (YouTube.com/MyIBvideos). Click on “Playlists” near the top of the page and click on the set of videos labeled “Ch 12: Analyzing International Opportunities.” Watch one video from the list and summarize it in a half-page report. Reflecting on the contents of this chapter, which aspects of analyzing international opportunities can you identify in the video? How might a company engaged in international business act on the information contained in the video?
2. Web Site Report. Because the U.S. market absorbs the vast majority of Mexico’s exports, it is no surprise that the fates of the two economies are closely related. Yet the relative high cost of Mexico’s economy means that some Western companies are heading instead to Asia.
Research Mexico’s economy on the Internet (both Mexican and U.S. publications if possible) and update its performance using the business press and statistical databases. (Hint: You may begin your Internet research by visiting some of the many Web sites listed in this chapter.) If wages are rising, why are companies still investing in Mexico? If wages are rising, is it across the board or just in specific sectors? From what sectors are investments flowing into Mexico, and from where are they coming?
Select a country that competes with Mexico for foreign direct investment. What characteristics make Mexico a better production base? What makes it a worse production base? Compare the two countries in terms of their long-term market potential.
1. You are a member of the Council of Economic Advisors to the U.S. president. The Council is asked to assess the moral basis for outsourcing to low-wage countries. Many globalization protesters argue that multinational corporations from wealthy countries endanger the global economic system by investing capital in developing countries and laying off workers at home. They say globalization pits the interests of more prosperous workers in wealthy countries against the interests of lower-paid workers in developing countries. It is also claimed that the practice pits nations against one another as companies move from one developing country to another in search of lower wages or bigger market opportunities. Do multinationals have an ethical obligation to try to preserve jobs for workers in their home-country markets? How do you believe the council should advise the president on this issue? Justify your advice.
2. You are the CEO of a large multinational company that has become highly profitable by investing in a Latin American country. As a catalyst in mobilizing the nation’s low-cost labor force, your company has helped the nation achieve double-digit economic growth. Following a political upheaval, however, a military government takes control. Workers’ rights are being violated, as are those of individual citizens. As CEO, it is up to you to decide on a course of action. Do you pull out of the country, effectively abandoning your employees? Do you publicly and directly confront the leaders of the new government and insist that they respect workers’ rights? Do you proceed more discreetly and pursue diplomacy out of the public’s eye? Or do you advise a different course of action? Can you make an ethical decision that is also a good business decision?
3. You are the executive director of Qualitative Research Consultants Association (QRCA), an organization designed to assist market research practitioners. As part of their membership agreement, QRCA members agree to abide by a nine-point code of ethics that forbids practices such as discriminating in respondent recruitment and offering kickbacks or other favors in exchange for business. The code also calls for research to be conducted for legitimate research purposes, and not as a front for product promotion. Why do you think the QRCA and other market research organizations create such codes? Do you believe they are helpful in reducing unethical research practices? As QRCA director, what other areas of marketing research do you believe should be covered by ethical codes of conduct?
PRACTICING INTERNATIONAL MANAGEMENT CASE Vietnam’s Emerging Market Potential
Around twenty years ago Vietnam’s government first introduced doi moi. This “renewal” policy initiated free-market reforms while preserving a communist political system. In 1990, Vietnam’s communist government announced that non-Vietnamese manufacturers were welcome to set up shop in the Southeast Asian country. South Korea’s Daewoo (www.dm.co.kr) quickly established itself as the number-one investor in Vietnam. Other well-known companies, including Toshiba (www.toshiba.co.jp), Peugeot (www.peugeot.com), and British Petroleum (www.bp.com) also took Hanoi up on its invitation.
The absence of trade and diplomatic relations between the United States and Vietnam, however, meant that U.S. companies had to sit on the sidelines. Nearly four years later, the U.S. government lifted the trade embargo with Vietnam, paving the way for a host of U.S. companies to pursue opportunities in Vietnam. Vietnam’s location in the heart of Asia and the presence of a literate, low-wage workforce are powerful magnets for international companies.
Today, there are many challenges for investors in Vietnam. The population of around 82 million is very poor, with an annual per capita income (at purchasing power parity) of only about $2,500. The infrastructure is undeveloped: Only 25 percent of roads are paved, electricity sources are somewhat unreliable, there is roughly one telephone per 100 people (though mobile phone use is growing rapidly), and the banking system is undeveloped. And although Vietnam holds tremendous long-term potential, it may be two decades before Vietnam reaches the level of economic development found even in Thailand today.
In addition, the Communist Party of Vietnam is struggling to adapt to the principles of a market economy, and the layers of bureaucracy built up over decades of communist rule slow the pace of change. Despite the efforts of the State Committee for Cooperation and Investment, the government sometimes still conducts itself in a way that leaves international investors scratching their heads. In one incident, Hanoi embarked on a “social evils crackdown” that included pulling down or painting over any sign or billboard printed in a language other than Vietnamese. And laws concerning taxes and foreign exchange are in constant flux.
Yet an emerging entrepreneurial class in Vietnam has developed a taste for expensive products such as Nikon (www.nikon.co.jp) cameras and Ray Ban (www.rayban.com) sunglasses—both of which are available in stores. Says Do Duc Dinh of the Institute on the World Economy, “There is a huge unofficial economy. For most people, we can live only 5 days or 10 days a month on our salary. But people build houses. Where does the money come from? Even in government ministries, there are two sets of books—one for the official money and one for unofficial.”
In late 2001, Vietnam and the United States signed a trade deal that gave Vietnam normal trade status with the United States. This meant that Vietnam could ship goods to the U.S. market at the lowest possible tariff rates. Meanwhile, U.S. companies are gaining continually greater access to Vietnam. As a result, Vietnam’s export activity (worth around $20 billion in 2003) is booming, due largely to its cheap, efficient workforce and growing foreign investment. Vietnam’s exports to the United States are doubling each year. The diversified nature of the country’s exports—including commodities, agricultural products, and manufactured goods—means it is somewhat immune to large swings in the price of any one export. Vietnam is now the world’s largest exporter of pepper, it may soon overtake Thailand in rice exports, and it even exports tea to India.
Aside from China, Vietnam has become one of Asia’s best-performing economies. Over the past decade, Vietnam grew nearly 8 percent a year and shows little sign of slowing down. In fact, throughout the currency crisis that gripped Southeast Asia in the late 1990s, Vietnam’s economic growth rate never dipped below 4.8 percent. The nation’s trade-driven economic boom has lifted many Vietnamese out of poverty. Whereas the World Bank labeled as much as 70 percent of the population poor in the 1980s, that number was just under 20 percent by 2008.
1. Update the political, legal, and economic situation in Vietnam; then select a product of your choosing and evaluate Vietnam’s potential both as a market and as a manufacturing site.
2. What, if anything, can Western countries do to help improve the political climate for doing business in Vietnam? Give specific examples.
3. What problems might a company encounter while conducting market research in Vietnam? Explain your answer.
4. What would be your perception of a product with the label “Made in Vietnam”? Do you think the type of product would play a role in forming your perception? If so, why?
“Half-Way from Rags to Riches,” Special Report of The Economist, April 26, 2008, pp. 1–16; “Good Morning at Last,” The Economist, August 5, 2006, pp. 37–38; “Vietnam’s Export Worth $22.3 Billion,” Vietnam Ministry of Trade press release, July 25, 2006; “Scandal In Vietnam,” The Economist (www.economist.com), April 27, 2006.
Wild, John J., Kenneth L. Wild & Jerry C.Y. Han. International Business: The Challenges of Globalization, 5th Edition. Pearson Learning Solutions. <vbk:0558570569#outline(19)>.
13 Selecting and Managing Entry Modes
After studying this chapter, you should be able to
1 Explain how companies use exporting, importing, and countertrade.
2 Explain the various means of financing export and import activities.
3 Describe the different contractual entry modes that are available to companies.
4 Explain the various types of investment entry modes.
5 Discuss the important strategic factors in selecting an entry mode.
A LOOK BACK
Chapter 12 explained how companies analyze international business opportunities. We learned how managers screen and research both potential markets and sites for operations.
A LOOK AT THIS CHAPTER
This chapter introduces the different entry modes companies use to “go international.” We discuss the important issues surrounding the selection and management of: (1) exporting, importing, and countertrade; (2) contractual entry modes; and (3) investment entry modes.
A LOOK AHEAD
Chapter 14 explains the international marketing efforts of companies. We identify the key elements that influence how companies promote, price, and distribute their products.
License to Thrill
London, England — Marvel Enterprises (www.marvel.com) is a global character-based entertainment licensing company that for nearly 70 years has developed a library of over 5,000 characters.
Marvel has come a long way since its days of bankruptcy in the 1990s. It was then that Marvel discovered licensing and vowed to be more than just a comics and toys company. Marvel has already brought top comic-book characters—including Iron Man, Spider-Man, Blade, X-Men, and Hulk—to the big screen, and more are on the way. Although the films are enormously successful, they generate little of Marvel’s revenue. They function instead as vehicles for popularizing the company’s comicbook characters.
Source: © Melissa Moseley/Sony Pictures/CORBIS. All Rights Reserved.
Driving much of Marvel’s earnings in recent years are its character-based licensing agreements for products such as lunchboxes, toys, and video games. Marvel’s licensing business includes a deal with Toy Biz Worldwide (www.toybiz.com) of Hong Kong to distribute action figures based on Marvel characters. Marvel earns royalties on all its toys sold through Toy Biz. Marvel’s 50/50 joint venture with Sony (www.sony.com) oversees all licensing and merchandising activities for the film Spider-Man, as well as Sony’s animated TV series titled Spider-Man. Marvel went solo with Iron Man and took the film to the big screen all on its own.
But the company is not resting easy, marveling at its past success. Marvel International, based in England, is charged with developing the firm’s licensing business in strategic international markets. Referring to the new venture, Marvel’s then-CEO, Allen Lipson said, “This is a major strategic initiative for the company. Marvel’s international growth is largely untapped.” As you read this chapter, consider why companies go international, the different market entry modes available to them, and when each mode is appropriate.1
The decision of how to enter a new market abroad must take into account many factors, including the local business environment and a company’s own core competency. An entry mode is the institutional arrangement by which a firm gets its products, technologies, human skills, or other resources into a market. Companies seeking entry to new markets for manufacturing and/or marketing purposes have many potential entry modes at their disposal. The specific mode chosen depends on many factors, including experience in a market, amount of control managers desire, and potential size of the market. In this chapter we explore the following three categories of entry modes:
Institutional arrangement by which a firm gets its products, technologies, human skills, or other resources into a market.
1. Exporting, importing, and countertrade
2. Contractual entry
3. Investment entry
Exporting, Importing, and Countertrade
The most common method of buying and selling goods internationally is exporting and importing. Companies often import products in order to obtain less expensive goods or those that are simply unavailable in the domestic market. Companies export products when the international marketplace offers opportunities to increase sales and, in turn, profits. Companies worldwide (from both developed and developing countries) often see the United States as a great export opportunity because of the size of the market and the strong buying power of its citizens. Figure 13.1 showcases the top 10 exporters to the United States in terms of the value of goods sold.
Because this chapter focuses on how companies take their goods and services to the global marketplace, the following discussion concentrates on exporting. Following the presentation of exporting, we explain how companies use countertrade to conduct product exchanges across borders when cash transactions are not possible. Because importing is a sourcing decision for most firms, it is covered in Chapter 15.
Why Companies Export
In the global economy, companies increasingly sell goods and services to wholesalers, retailers, industrial buyers, and consumers in other nations. Generally speaking, there are three main reasons why companies begin exporting:
1. Expand Sales. Most large companies use exporting as a means of expanding total sales when the domestic market has become saturated. Greater sales volume allows them to spread the fixed costs of production over a greater number of manufactured products, thereby lowering the cost of producing each unit of output. In short, going international is one way to achieve economies of scale.
FIGURE 13.1 Land of Opportunity
Source: International Trade Statistics 2007 (Geneva, Switzerland: World Trade Organization, November 2007), Table II.24, p. 60.
2. Diversify Sales. Exporting permits companies to diversify their sales. In other words, they can offset slow sales in one national market (perhaps due to a recession) with increased sales in another. Diversified sales can level off a company’s cash flow, making it easier to coordinate payments to creditors with receipts from customers.
3. Gain Experience. Companies often use exporting as a low-cost, low-risk way of getting started in international business. Owners and managers of small companies, which typically have little or no knowledge of how to conduct business in other cultures, use exporting to gain valuable international experience.
Developing an Export Strategy: A Four-Step Model
Companies are often drawn into exporting when customers in other countries solicit their goods. In this way, companies become aware of their product’s international potential and get their first taste of international business.
Yet a company should not fall into the habit of simply responding to random international requests for its products. A more logical approach is to research and analyze international opportunities and to develop a coherent export strategy. A business with such a strategy actively pursues export markets rather than sitting back and waiting for international orders to come in. Let’s take a look at the four steps in developing a successful export strategy.
Step 1: Identify a Potential Market
To identify whether demand exists in a particular target market, a company should perform market research and interpret the results (see Chapter 12). Novice exporters should focus on one or only a few markets. For example, a first-time Brazilian exporter might not want to export simultaneously to Argentina, Britain, and Greece. A better strategy would likely be to focus on Argentina because of its cultural similarities with Brazil (despite having a different, though related, language). The company could then expand into more diverse markets after it gains initial international experience in a nearby country. The would-be exporter should also seek expert advice on the regulations and general process of exporting and any special issues related to a selected target market.
Step 2: Match Needs to Abilities
The next step is to determine whether the company is capable of satisfying the needs of the market. Suppose a market located in a region with a warm, humid climate for much of the year displays the need for home air-conditioning equipment. If a company recognizes this need but makes only industrial-sized air-conditioning equipment, it might not be able to satisfy demand with its current product. But if the company is able to use its smallest industrial air-conditioning unit to satisfy the needs of several homes, it might have a market opportunity. If there are no other options or if consumers want their own individual units, the company will likely need to design a smaller air-conditioning unit or rule out entry into that market.
Step 3: Initiate Meetings
Holding meetings early with potential local distributors, buyers, and others is a must. Initial contact should focus on building trust and developing a cooperative climate among all parties. The cultural differences between the parties will come into play already at this stage. Beyond building trust, successive meetings are designed to estimate the potential success of any agreement if interest is shown on both sides. At the most advanced stage, negotiations take place and details of agreements are finalized.
For example, a group of environmental technology companies in Arizona was searching for markets abroad. A delegation from Taiwan soon arrived in the Arizona desert to survey the group’s products. Although days were busy with company visits, formal meetings, and negotiations, evenings were designed to build relationships. There were outdoor barbecues, hayrides, line dancing, and frontier-town visits to give the visitors a feel for local culture and history. To make their counterparts from Taiwan feel comfortable, nighttime schedules included visits to karaoke spots and Chinese restaurants where a good deal of singing took place. Follow-up meetings resulted in several successful deals.
Step 4: Commit Resources
After all the meetings, negotiations, and contract signings, it is time to put the company’s human, financial, and physical resources to work. First, the objectives of the export program must be clearly stated and should extend out at least three to five years. For small firms, it may be sufficient to assign one individual the responsibility for drawing up objectives and estimating resources. Yet as companies expand their activities to include more products and/or markets, many firms discover the need for an export department or division. The head of this department usually has the responsibility (and authority) to formulate, implement, and evaluate the company’s export strategy. See Chapter 11 for a detailed discussion of organizational design issues to consider at this stage.
Degree of Export Involvement
Companies of all sizes engage in exporting but not all companies become involved in exporting to the same extent. Some companies (usually entrepreneurs and small and medium-sized firms) perform few or none of the activities necessary to get their products in a market abroad. Instead, they use intermediaries that specialize in getting products from one market into another. Other companies (usually only the largest companies) perform all of their export activities themselves, with an infrastructure that bridges the gap between the two markets. Let’s take a closer look at the two basic forms of export involvement—direct exporting and indirect exporting.
Some companies become deeply involved in the export of their products. Direct exporting occurs when a company sells its products directly to buyers in a target market. Direct exporters operate in many industries, including aircraft (Boeing) (www.boeing.com), industrial equipment (John Deere) (www.deere.com), apparel (Lands’ End) (www.landsend.com), and bottled beverages (Evian) (www.evian.com). Bear in mind that “direct exporters” need not sell directly to end users. Rather, they take full responsibility for getting their goods into the target market by selling directly to local buyers and not going through intermediary companies. Typically, they rely on either local sales representatives or distributors.
Practice by which a company sells its products directly to buyers in a target market
A sales representative (whether an individual or an organization) represents only its own company’s products, not those of other companies. They promote those products in many ways, such as by attending trade fairs and making personal visits to local retailers and wholesalers. They do not take title to the merchandise. Rather, they are hired by a company and normally are compensated with a fixed salary plus commissions based on the value of their sales.
Alternatively, a direct exporter can sell in the target market through distributors, who take ownership of the merchandise when it enters their country. As owners of the products, they accept all the risks associated with generating local sales. They sell either to retailers and wholesalers or to end users through their own channels of distribution. Typically, they earn a profit equal to the difference between the price they pay and the price they receive for the exporter’s goods. Although using a distributor reduces an exporter’s risk, it also weakens an exporter’s control over the price buyers are charged. A distributor who charges very high prices can stunt the growth of an exporter’s market share. Exporters should choose, if possible, distributors who are willing to invest in the promotion of their products and who do not sell directly competing products.
Some companies have few resources available to commit to exporting activities. Others simply find exporting a daunting task because of a lack of contacts and experience. Fortunately, there is an option for such firms. Indirect exporting occurs when a company sells its products to intermediaries who then resell to buyers in a target market. The choice of an intermediary depends on many factors, including the ratio of the exporter’s international sales to its total sales, the company’s available resources, and the growth rate of the target market. Let’s take a closer look at several different types of intermediaries: agents, export management companies, and export trading companies.
Practice by which a company sells its products to intermediaries who then resell to buyers in a target market
Individuals or organizations that represent one or more indirect exporters in a target market are called agents. Agents typically receive compensation in the form of commissions on the value of sales. Because establishing a relationship with an agent is relatively easy and inexpensive, it is a fairly common approach to indirect exporting. Agents should be chosen very carefully because it can be costly and difficult to terminate an agency relationship if problems arise. Careful selection is also essential because agents often represent several indirect exporters simultaneously. Agents might focus their promotional efforts on the products of the company paying the highest commission rather than on the company with the better products.
Individuals or organizations that represent one or more indirect exporters in a target market
EXPORT MANAGEMENT COMPANIES
A company that exports products on behalf of an indirect exporter is called an export management company (EMC). An EMC operates contractually, either as an agent (being paid through commissions based on the value of sales) or as a distributor (taking ownership of the merchandise and earning a profit from its resale).
export management company (EMC)
Company that exports products on behalf of indirect exporters
An EMC will usually provide additional services on a retainer basis, charging set fees against funds deposited on account. Typical EMC services include gathering market information, formulating promotional strategies, performing specific promotional duties (such as attending trade fairs), researching customer credit, making shipping arrangements, and coordinating export documents. It is common for an EMC to exploit contacts predominantly in one industry (say, agricultural goods or consumer products) or in one geographic area (such as Latin America or the Middle East). Indeed, the biggest advantage of an EMC is usually a deep understanding of the cultural, political, legal, and economic conditions of the target market. Its staff works comfortably and effectively in the cultures of both the exporting and the target nation. The average EMC tends to deploy a wide array of commercial and political contacts to facilitate business activities on behalf of its clients.
Perhaps the only disadvantage of hiring an EMC is that the breadth and depth of its service can potentially hinder the development of the exporter’s own international expertise. But an exporter and its EMC typically have such a close relationship that an exporter often considers its EMC as a virtual exporting division. When this is the case, exporters learn a great deal about the intricacies of exporting from their EMC. Then, after the EMC contract expires, it is common for a company to go it alone in exporting its products.
EXPORT TRADING COMPANIES
A company that provides services to indirect exporters in addition to activities directly related to clients’ exporting activities is called an export trading company (ETC). Whereas an EMC is restricted to export-related activities, an ETC assists its clients by providing import, export, and countertrade services; developing and expanding distribution channels; providing storage facilities; financing trading and investment projects; and even manufacturing products.
export trading company (ETC)
Company that provides services to indirect exporters in addition to activities related directly to clients’ exporting activities
European trading nations first developed the ETC concept centuries ago. More recently, the Japanese have refined the concept, which they call sogo shosha. The Japanese ETC can range in size from small, family-run businesses to enormous conglomerates such as Mitsubishi (www.mitsubishi.com), Mitsui (www.mitsui.com), and ITOCHU (www.itochu.co.jp). An ETC in South Korea is called a chaebol and includes well-known companies such as Samsung (www.samsung.com) and Hyundai (www.hyundaigroup.com).
Japanese and South Korean ETCs have become formidable competitors because of their enormous success in gaining global market share. These Asian companies quickly came to rival the dominance of the largest U.S. multinationals, which lobbied U.S. lawmakers for assistance in challenging Asian ETCs in global markets. The result was the Export Trading Company Act passed in 1982. Despite this effort, the ETC concept never really caught on in the United States. Operations of the typical ETC in the United States remain small and are dwarfed by those of their Asian counterparts. One reason for the lack of interest in the ETC concept in the United States relative to Asia is that governments, financial institutions, and companies have much closer working relationships in Asia. The formation of huge conglomerates that engage in activities ranging from providing financing to manufacturing to distribution is easier to accomplish there. By contrast, the regulatory environment in the United States is wary of such cozy business arrangements, and the lines between companies and industries are more clearly drawn.
Avoiding Export and Import Blunders
There are several errors common to companies new to exporting. First, many businesses fail to conduct adequate market research before exporting. In fact, many companies begin exporting by responding to unsolicited requests for their products. If a company enters a market in this manner, it should quickly devise an export strategy to manage its export activities effectively and not strain its resources.
Second, many companies fail to obtain adequate export advice. National and regional governments are often willing and able to help managers and small-business owners understand and cope with the vast amounts of paperwork required by each country’s export and import laws. Naturally, more experienced exporters can be extremely helpful as well. They can help novice exporters avoid embarrassing mistakes by guiding them through unfamiliar cultural, political, and economic environments.
To better ensure that it will not make embarrassing blunders, an inexperienced exporter might also want to engage the services of a freight forwarder—a specialist in export-related activities such as customs clearing, tariff schedules, and shipping and insurance fees. Freight forwarders also can pack shipments for export and take responsibility for getting a shipment from the port of export to the port of import.
Specialist in export-related activities such as customs clearing, tariff schedules, and shipping and insurance fees
1. Briefly describe each of the four steps involved in building an export strategy.
2. How does direct exporting differ from indirect exporting?
3. Compare and contrast export management companies and export trading companies.
Barter, or trueque, became a way of life in Argentina when the nation’s economy was mired in a seemingly endless recession. Here, residents of Buenos Aires, Argentina, barter goods using “Ticket Trueque,” or “Barter Vouchers” in English. In this market near Buenos Aires, you can swap music CDs, films on DVD, clothing, fruit, plumbing supplies, and vegetables. Local newspapers run ads for such things as apartments, cars, and washing machines, all offered on a barter basis.
Source: © Reuters/Rickey Rogers/CORBIS. All Rights Reserved.
Companies are sometimes unable to import merchandise in exchange for financial payment. The reason is that the government of the importer’s nation either lacks the hard currency to pay for imports, or it intentionally restricts the convertibility of its currency. Fortunately, there is a way for firms to trade by using either a small amount of hard currency or even none at all. Selling goods or services that are paid for, in whole or part, with other goods or services is called countertrade. Although countertrade often requires an extensive network of international contacts, even smaller companies can take advantage of its benefits.
Practice of selling goods or services that are paid for, in whole or part, with other goods or services
Nations that have long used countertrade are found mostly in Africa, Asia, Eastern Europe, and the Middle East. A lack of adequate hard currency often forced those nations to use countertrade to exchange oil for passenger aircraft and military equipment. Today, because of insufficient hard currency, developing and emerging markets frequently rely on countertrade to import goods. The greater involvement of firms from industrialized nations in those markets is expanding the use of countertrade.
Types of Countertrade
There are several different types of countertrade: barter, counterpurchase, offset, switch trading, and buyback. Let’s take a brief look at each of these.
■ Barter is the exchange of goods or services directly for other goods or services without the use of money. It is the oldest known form of countertrade.
Exchange of goods or services directly for other goods or services without the use of money
■ Counterpurchase is the sale of goods or services to a country by a company that promises to make a future purchase of a specific product from that country. This type of agreement is designed to allow the country to earn back some of the currency that it paid for the original imports.
Sale of goods or services to a country by a company that promises to make a future purchase of a specific product from the country
■ Offset is an agreement that a company will offset a hard-currency sale to a nation by making a hard-currency purchase of an unspecified product from that nation in the future. It differs from a counterpurchase in that this type of agreement does not specify the type of product that must be purchased, just the amount that will be spent. Such an arrangement gives a business greater freedom in fulfilling its end of a countertrade deal.
Agreement that a company will offset a hard-currency sale to a nation by making a hard-currency purchase of an unspecified product from that nation in the future
■ Switch trading is countertrade whereby one company sells to another its obligation to make a purchase in a given country. For example, in return for market access, a firm that wants to enter a target market might promise to buy a product for which it has no use. The company then sells this purchase obligation to a large trading company that makes the purchase itself because it has a use for the merchandise. If the trading company has no use for the merchandise, it can arrange for yet another buyer who needs the product to make the purchase.
Practice in which one company sells to another its obligation to make a purchase in a given country
■ Buyback is the export of industrial equipment in return for products produced by that equipment. This practice usually typifies long-term relationships between the companies involved.
Export of industrial equipment in return for products produced by that equipment
Thus countertrade can provide access to markets that are otherwise off-limits because of a lack of hard currency. It can also cause headaches. Much countertrade involves commodity and agricultural products such as oil, wheat, or corn—products whose prices on world markets tend to fluctuate a good deal. A problem arises when the price of a bartered product falls on world markets between the time that a deal is arranged and the time at which one party tries to sell the product. Fluctuating prices generate the same type of risk that is encountered in currency markets. Managers might be able to hedge some of this risk on commodity futures markets similar to how they hedge against currency fluctuations in currency markets (see Chapter 9).
International trade poses risks for both exporters and importers. Exporters run the risk of not receiving payment after their products are delivered. Importers fear that delivery might not occur once payment is made for a shipment. Accordingly, a number of export/import financing methods are designed to reduce the risk to which exporters and importers are exposed. These include advance payment, documentary collection, letter of credit, and open account. Let’s take a closer look at each of these methods and the risk each holds for exporters and importers.
Export/import financing in which an importer pays an exporter for merchandise before it is shipped is called advance payment. This method of payment is common when two parties are unfamiliar with each other, the transaction is relatively small, or the buyer is unable to obtain credit because of a poor credit rating at banks. Payment normally takes the form of a wire transfer of money from the bank account of the importer directly to that of the exporter. Although prior payment eliminates the risk of nonpayment for exporters, it creates the complementary risk of nonshipment for importers—importers might pay for goods but never receive them. Thus advance payment is the most favorable method for exporters but the least favorable for importers (see Figure 13.2).
Export/import financing in which an importer pays an exporter for merchandise before it is shipped
Export/import financing in which a bank acts as an intermediary without accepting financial risk is called documentary collection. This payment method is commonly used when there is an ongoing business relationship between two parties. The documentary collection process can be broken into three main stages and nine smaller steps (see Figure 13.3).
Export/import financing in which a bank acts as an intermediary without accepting financial risk
1. Before shipping merchandise, the exporter (with its banker’s assistance) draws up a draft (bill of exchange)—a document ordering the importer to pay the exporter a specified sum of money at a specified time. A sight draft requires the importer to pay when goods are delivered. A time draft extends the period of time (typically 30, 60, or 90 days) following delivery by which the importer must pay for the goods. (When inscribed “accepted” by an importer, a time draft becomes a negotiable instrument that can be traded among financial institutions.)
draft (bill of exchange)
Document ordering an importer to pay an exporter a specified sum of money at a specified time
2. Following creation of the draft, the exporter delivers the merchandise to a transportation company for shipment to the importer. The exporter then delivers to its banker a set of documents that includes the draft, a packing list of items shipped, and a bill of lading—a contract between the exporter and shipper that specifies merchandise destination and shipping costs. The bill of lading is proof that the exporter has shipped the merchandise. An international ocean shipment requires an inland bill of lading to get the shipment to the exporter’s border and an ocean bill of lading for water transport to the importer nation. An international air shipment requires an air way bill that covers the entire international journey.
bill of lading
Contract between an exporter and a shipper that specifies merchandise destination and shipping costs
3. After receiving appropriate documents from the exporter, the exporter’s bank sends the documents to the importer’s bank. After the importer fulfills the terms stated on the draft and pays its own bank, the bank issues the bill of lading (which becomes title to the merchandise) to the importer.
FIGURE 13.2 Risk of Alternative Export/Import Financing Methods
FIGURE 13.3 Documentary Collection Process
Documentary collection reduces the importer’s risk of nonshipment because the packing list details the contents of the shipment and the bill of lading is proof that the merchandise was shipped. The exporter’s risk of nonpayment is increased because, although the exporter retains title to the goods until the merchandise is accepted, the importer does not pay until all necessary documents have been received. Although importers have the option of refusing the draft (and, therefore, the merchandise), this action is unlikely. Refusing the draft—despite all terms of the agreement being fulfilled—would make the importer’s bank unlikely to do business with the importer in the future.
Letter of Credit
Export/import financing in which the importer’s bank issues a document stating that the bank will pay the exporter when the exporter fulfills the terms of the document is called letter of credit. A letter of credit is typically used when an importer’s credit rating is questionable, when the exporter needs a letter of credit to obtain financing, and when a market’s regulations require it.
letter of credit
Export/import financing in which the importer’s bank issues a document stating that the bank will pay the exporter when the exporter fulfills the terms of the document
Before a bank issues a letter of credit, it checks on the importer’s financial condition. Banks normally issue letters of credit only after an importer has deposited on account a sum equal in value to that of the imported merchandise. The bank is still required to pay the exporter, but the deposit protects the bank if the importer fails to pay for the merchandise. Banks will sometimes waive this requirement for their most reputable clients.
There are several types of letters of credit:
■ An irrevocable letter of credit allows the bank issuing the letter to modify its terms only after obtaining the approval of both exporter and importer.
■ A revocable letter of credit can be modified by the issuing bank without obtaining approval from either the exporter or the importer.
■ A confirmed letter of credit is guaranteed by both the exporter’s bank in the country of export and the importer’s bank in the country of import.
The le tter of credit process for payment of exports is shown in Figure 13.4. After the issuance of a letter of credit, the importer’s bank informs the exporter (through the exporter’s bank) that a letter of credit exists and that it may now ship the merchandise. The exporter then delivers a set of documents (according to the terms of the letter) to its own bank. These documents typically include an invoice, customs forms, a packing list, and a bill of lading. The exporter’s bank ensures that the documents are in order and pays the exporter.
FIGURE 13.4 Letter of Credit Process
When the importer’s bank is satisfied that the terms of the letter have been met, it pays the exporter’s bank. At that point, the importer’s bank is responsible for collecting payment from the importer. Letters of credit are popular among traders because banks assume most of the risks. The letter of credit reduces the importer’s risk of nonshipment (as compared with advance payment) because the importer receives proof of shipment before making payment. Although the exporter’s risk of nonpayment is slightly increased, it is a more secure form of payment for exporters because the nonpayment risk is accepted by the importer’s bank when it issues payment to the exporter’s bank.
Export/import financing in which an exporter ships merchandise and later bills the importer for its value is called open account. Because some receivables may not be collected, exporters should reserve shipping on open account only for their most trusted customers. This payment method is often used when the parties are very familiar with each other or for sales between two subsidiaries within an international company. The exporter simply invoices the importer (as in many domestic transactions), stating the amount and date due. This method reduces the risk of nonshipment faced by the importer under the advance payment method.
Export/import financing in which an exporter ships merchandise and later bills the importer for its value
By the same token, the open account method increases the risk of nonpayment for the exporter. Thus open account is the least favorable for exporters but the most favorable for importers. For some insights on how small exporters can increase the probability of getting paid for a shipment, see the Entrepreneur’s Toolkit titled, “Collecting International Debts.”
ENTREPRENEUR’S TOOLKIT Collecting International Debts
What is the point of working hard to make an international sale if the buyer does not pay? There are seldom easy answers when an exporter is stuck without payment. Here are several pointers on what small businesses can do to reduce the likelihood of not receiving payment.
■ Knowledge of the market you are exporting to is your first and best defense. Understanding its culture, the language spoken, and its legal system is ideal. You should also understand if there is typically a payment lag for business debts and customary debt collection procedures.
■ Be aware of which countries are commonly a problem when it comes to debt collection. Regularly consult the many free sources of information available on the Internet to learn which countries are problems. Avoid doing business with them and seek markets elsewhere.
■ Essential to preventing later collection problems is both parties clearly understanding the payment terms in your export sales agreement. Also be sure the buyer knows precisely when payment is to be issued.
■ Do not wait too long to begin collecting a past due account. Exporters who delay will likely never receive payment. Begin with firmly worded communications via phone, fax, e-mail, and letter.
■ Consult an international trade attorney or hire an international debt collection agency if necessary. If you are encouraged to accept arbitration as a way to resolve the issue, this often poses your best chance of seeing at least partial payment.
1. Why do companies engage in countertrade? List each of its five types.
2. What are the four main methods of export/import financing?
3. Describe the various risks that each financing method poses for exporters and importers.
Contractual Entry Modes
The products of some companies simply cannot be traded in open markets because they are intangible. Thus a company cannot use importing, exporting, or countertrade to exploit opportunities in a target market. Fortunately, there are other options for this type of company. A company can use a variety of contracts—licensing, franchising, management contracts, and turnkey projects—to market highly specialized assets and skills in markets beyond its nations’ borders.
Companies sometimes grant other firms the right to use an asset that is essential to the production of a finished product. Licensing is a contractual entry mode in which a company that owns intangible property (the licensor) grants another firm (the licensee) the right to use that property for a specified period of time. Licensors typically receive royalty payments based on a percentage of the licensee’s sales revenue generated by the licensed property. The licensors might also receive a one-time fee to cover the cost of transferring the property to the licensee. Commonly licensed intangible property includes patents, copyrights, special formulas and designs, trademarks, and brand names. Thus licensing often involves granting companies the right to use process technologies inherent to the production of a particular good.
Practice by which one company owning intangible property (the licensor) grants another firm (the licensee) the right to use that property for a specified period of time
Here are a few examples of successful licensing agreements:
■ Novell (United States) licensed its software to three Hong Kong universities that installed it as the campus-wide standard.
■ Hitachi (Japan) licensed from Duales System Deutschland (Germany) technology to be used in the recycling of plastics in Japan.
■ Hewlett-Packard (United States) licensed from Canon (Japan) a printer engine for use in its monochrome laser printers.
An exclusive license grants a company the exclusive rights to produce and market a property, or products made from that property, in a specific geographic region. The region can be the licensee’s home country or may extend to worldwide markets. A nonexclusive license grants a company the right to use a property but does not grant it sole access to a market. A licensor can grant several or more companies the right to use a property in the same region.
Cross licensing occurs when companies use licensing agreements to exchange intangible property with one another. For example, Fujitsu (www.fujitsu.com) of Japan signed a five-year cross-licensing agreement with Texas Instruments (www.ti.com) of the United States. The agreement allowed each company to use the other’s technology in the production of its own goods—thus lowering R&D costs. It was a very extensive arrangement, covering all but a few semiconductor patents owned by each company. Because asset values are seldom exactly equal, cross licensing also typically involves royalty payments from one party to the other.
Practice by which companies use licensing agreements to exchange intangible property with one another
Advantages of Licensing
There are several advantages to using licensing as an entry mode into new markets. First, licensors can use licensing to finance their international expansion. Most licensing agreements require licensees to contribute equipment and investment financing, whether by building special production facilities or by using existing excess capacity. Access to such resources can be a great advantage to a licensor who wants to expand but lacks the capital and managerial resources to do so. And because it need not spend time constructing and starting up its own new facilities, the licensor earns revenues sooner than it would otherwise.
Second, licensing can be a less risky method of international expansion for a licensor than other entry modes. Whereas some markets are risky because of social or political unrest, others defy accurate market research for a variety of reasons. Licensing helps shield the licensor from the increased risk of operating its own local production facilities in markets that are unstable or hard to assess accurately.
Third, licensing can help reduce the likelihood that a licensor’s product will appear on the black market. The side streets of large cities in many emerging markets are dotted with tabletop vendors eager to sell bootleg versions of computer software, Hollywood films, and recordings of internationally popular musicians. Producers can, to some extent, foil bootleggers by licensing local companies to market their products at locally competitive prices. Royalties will be lower than the profits generated by sales at higher international prices, but lower profits are better than no profits at all—which is what owners get from bootleg versions of their products.
Finally, licensees can benefit by using licensing as a method of upgrading existing production technologies. For example, manufacturers of plastics and other synthetic materials in the Philippines attempted to meet the high standards demanded by the local subsidiaries of Japanese electronics and office equipment producers. To do this, D&L Industries of the Philippines upgraded its manufacturing process by licensing materials technology from Nippon Pigment of Japan.
Disadvantages of Licensing
There also are important disadvantages to using licensing. First, it can restrict a licensor’s future activities. Suppose a licensee is granted the exclusive right to use an asset but fails to produce the sort of results that a licensor expected. Because the license agreement is exclusive, the licensor cannot simply begin selling directly in that particular market to meet demand itself or contract with another licensee. A good product and lucrative market, therefore, do not guarantee success for a producer entering a market through licensing.
The automobile industry relies on franchising to exploit international opportunities. Franchising allows German carmaker, Volkswagen, to maintain strict control over its Chinese dealerships. In this way, Volkswagen ensures that dealerships meet company guidelines on matters such as sales, service, and financing. Volkswagen is the leading carmaker in China with around 20 percent of the passenger car market. Can you think of other industries that employ franchising?
Source: Getty Images.
Second, licensing might reduce the global consistency of the quality and marketing of a licensor’s product in different national markets. A licensor might find the development of a coherent global brand image an elusive goal if each of its national licensees is allowed to operate in any manner it chooses. Promoting a global image might later require considerable amounts of time and money to change the misconceptions of buyers in the various licensed markets.
Third, licensing might amount to a company “lending” strategically important property to its future competitors. This is an especially dangerous situation when a company licenses assets on which its competitive advantage is based. Licensing agreements are often made for several years and perhaps even a decade or more. During this time, licensees often become highly competent at producing and marketing the licensor’s product. When the agreement expires, the licensor might find that its former licensee is capable of producing and marketing a better version of its own product. Licensing contracts can (and should) restrict licensees from competing in the future with products based strictly on licensed property. But enforcement of such provisions works only for identical or nearly identical products, not when substantial improvements are made.
Franchising is a contractual entry mode in which one company (the franchiser) supplies another (the franchisee) with intangible property and other assistance over an extended period. Franchisers typically receive compensation as flat fees, royalty payments, or both. The most popular franchises are those with widely recognized brand names, such as Mercedes (www.mercedes.com), McDonald’s (www.mcdonalds.com), and Starbucks (www.starbucks.com). In fact, the brand name or trademark of a company is normally the single most important item desired by the franchisee. This is why smaller companies with lesser known brand names and trademarks have greater difficulty locating interested franchisees.
Practice by which one company (the franchiser) supplies another (the franchisee) with intangible property and other assistance over an extended period
Franchising differs from licensing in several ways. First, franchising gives a company greater control over the sale of its product in a target market. Franchisees must often meet strict guidelines on product quality, day-to-day management duties, and marketing promotions. Second, although licensing is fairly common in manufacturing industries, franchising is primarily used in service industries such as auto dealerships, entertainment, lodging, restaurants, and business services. Third, although licensing normally involves a one-time transfer of property, franchising requires ongoing assistance from the franchiser. In addition to the initial transfer of property, franchisers typically offer startup capital, management training, location advice, and advertising assistance to their franchisees.
Some examples of the kinds of companies involved in international franchising include:
■ Ozemail (Australia) awarded Magictel (Hong Kong) a franchise to operate its Internet phone and fax service in Hong Kong.
■ Jean-Louis David (France) awarded franchises to more than 200 hairdressing salons in Italy.
■ Brooks Brothers (United States) awarded Dickson Concepts (Hong Kong) a franchise to operate Brooks Brothers stores across Southeast Asia.
Companies based in the United States dominate the world of international franchising. U.S. companies perfected the practice of franchising in their large, homogeneous domestic market having low barriers to interstate trade and investment. Yet franchising is growing in the European Union, with the advent of a single currency and a unified set of franchise laws. Many European managers with comfortable early-retirement packages have discovered franchising to be an appealing second career. Franchising across much of Europe is expected to grow for the foreseeable future.2
Despite projections for robust growth, European franchise managers often misunderstand the franchising concept. One example is when Holiday Inn’s franchise expansion in Spain was moving more slowly than expected. According to the company’s development director in Spain, Holiday Inn found that it needed to convince local managers that Holiday Inn did not want to “take control” of their hotels.3 In some eastern European countries, local managers do not understand why they must continue to pay royalties to brand and trademark owners. Franchise expansion in eastern European markets also suffers from a lack of local capital, high interest rates, high taxes, bureaucratic obstacles, restrictive laws, and corruption.4
Advantages of Franchising
There are several important advantages of franchising. First, franchisers can use franchising as a low-cost, low-risk entry mode into new markets. Companies following global strategies rely on consistent products and common themes in worldwide markets. Franchising allows them to maintain consistency by replicating the processes for standardized products in each target market. Many franchisers, however, will make small modifications in products and promotional messages when marketing specifically to local buyers.
Second, franchising is an entry mode that allows for rapid geographic expansion. Firms often gain a competitive advantage by being first in seizing a market opportunity. For example, Microtel Inns & Suites (www.microtelinn.com) of Atlanta, Georgia, is using franchising to fuel its international expansion. Microtel is boldly entering Argentina and Uruguay and eyeing opportunities in Brazil and Western Europe. Rooms cost around $75 per night and target business travelers who cannot afford $200 per night.5
Finally, franchisers can benefit from the cultural knowledge and know-how of local managers. This helps lower the risk of business failure in unfamiliar markets and can create a competitive advantage.
Disadvantages of Franchising
Franchising can also pose problems for both franchisers and franchisees. First, franchisers may find it cumbersome to manage a large number of franchisees in a variety of national markets. A major concern is that product quality and promotional messages among franchisees will not be consistent from one market to another. One way to ensure greater control is by establishing in each market a so-called master franchisee, which is responsible for monitoring the operations of individual franchisees.
Second, franchisees can experience a loss of organizational flexibility in franchising agreements. Franchise contracts can restrict their strategic and tactical options, and they may even be forced to promote products owned by the franchiser’s other divisions. For years PepsiCo (www.pepsico.com) owned the well-known restaurant chains Pizza Hut, Taco Bell, and KFC. As part of their franchise agreements with PepsiCo, restaurant owners were required to sell only PepsiCo beverages to their customers. Many franchisees worldwide were displeased with such restrictions on their product offerings and were relieved when PepsiCo spun off the restaurant chains.
Under the stipulations of a management contract, one company supplies another with managerial expertise for a specific period of time. The supplier of expertise is normally compensated with either a lump-sum payment or a continuing fee based on sales volume. Such contracts are commonly found in the public utilities sectors of developed and emerging markets. Two types of knowledge can be transferred through management contracts—the specialized knowledge of technical managers and the business-management skills of general managers.
Practice by which one company supplies another with managerial expertise for a specific period of time
Two examples of management contracts include:
■ DBS Asia (Thailand) awarded a management contract to Favorlangh Communication (Taiwan) to set up and run a company supplying digital television programming in Taiwan.
■ Lyonnaise de Eaux (France) and RWE Aqua (Germany) agreed to manage drinking-water quality and client billing and to maintain the water infrastructure for the city of Budapest, Hungary, for 25 years.
Advantages of Management Contracts
Management contracts can benefit organizations and countries. First, a firm can award a management contract to another company and thereby exploit an international business opportunity without having to place a great deal of its own physical assets at risk. Financial capital can then be reserved for other promising investment projects that would otherwise not be funded.
Second, governments can award companies management contracts to operate and upgrade public utilities, particularly when a nation is short of investment financing. That is why the government of Kazakhstan contracted with a group of international companies called ABB Power Grid Consortium to manage its national electricity-grid system for 25 years. Under the terms of the contract, the consortium paid past wages owed to workers by the government and is to invest more than $200 million during the first three years of the agreement. The Kazakhstan government had neither the cash flow to pay the workers nor the funds to make badly needed improvements.
Third, governments use management contracts to develop the skills of local workers and managers. ESB International (www.esb.ie) of Ireland signed a three-year contract not only to manage and operate a power plant in Ghana, Africa, but also to train local personnel in the skills needed to manage it at some point in the future.
Disadvantages of Management Contracts
Unfortunately, management contracts also pose two disadvantages for suppliers of expertise. First of all, although management contracts reduce the exposure of physical assets in another country, the same is not true for the supplier’s personnel; political or social turmoil can threaten managers’ lives.
Second, suppliers of expertise may end up nurturing a formidable new competitor in the local market. After learning how to conduct certain operations, the party that had originally needed assistance may be capable of competing on its own. Firms must weigh the financial returns from a management contract against the potential future problems caused by a newly launched competitor.
When one company designs, constructs, and tests a production facility for a client, the agreement is called a turnkey (build–operate–transfer) project. The term turnkey project is derived from the understanding that the client, who normally pays a flat fee for the project, is expected to do nothing more than simply “turn a key” to get the facility operating. The company awarded a turnkey project completely prepares the facility for its client.
turnkey (build–operate–transfer) project
Practice by which one company designs, constructs, and tests a production facility for a client firm
Similar to management contracts, turnkey projects tend to be large-scale and often involve government agencies. But unlike management contracts, turnkey projects transfer special process technologies or production-facility designs to the client. They typically involve the construction of power plants, airports, seaports, telecommunication systems, and petrochemical facilities that are then turned over to the client. Under a management contract, the supplier of a service retains the asset—the managerial expertise.
Two examples of international turnkey projects include:
■ Telecommunications Consultants India constructed telecom networks in both Madagascar and Ghana—two turnkey projects worth a combined total of $28 million.
■ Lubei Group (China) agreed with the government of Belarus to join in the construction of a facility for processing a fertilizer byproduct into cement.
Advantages of Turnkey Projects
Turnkey projects provide benefits to providers and recipients. First, turnkey projects permit firms to specialize in their core competencies and to exploit opportunities that they could not undertake alone. Exxon Mobil (www.exxonmobil.com) awarded a turnkey project to PT McDermott Indonesia (www.mcdermott.com) and Toyo Engineering (toyo-eng.co.jp) of Japan to build a liquid natural gas plant on the Indonesian island of Sumatra. The providers are responsible for constructing an offshore production platform, laying a 100-kilometer underwater pipeline, and building an on-land liquid natural gas refinery. The $316 million project is feasible only because each company contributes unique expertise to the design, construction, and testing of the facilities.
A turnkey project is a venture in which one organization designs, builds, and tests a facility for another, which then merely “turns the key” to get things underway. The liquefied natural gas plant shown here on Bonny Island, Nigeria, was built by a global consortium of engineering firms from France, Italy, and Japan. The turnkey contract included construction of the gas plant, its transmission system, and the residential area. What other types of operations are appropriate for a turnkey project?
Source: © George Steinmetz/CORBIS. All Rights Reserved.
Second, turnkey projects allow governments to obtain designs for infrastructure projects from the world’s leading companies. For instance, Turkey’s government enlisted two separate consortiums of international firms to build four hydroelectric dams on its Coruh River. The dams combine the design and technological expertise of each company in the two consortiums. The Turkish government also awarded a turnkey project to Ericsson (www.ericsson.com) of Sweden to expand the country’s mobile telecommunication system.
Disadvantages of Turnkey Projects
Among the disadvantages of turnkey projects is the fact that a company may be awarded a project for political reasons rather than for technological know-how. Because turnkey projects are often of high monetary value and awarded by government agencies, the process of awarding them can be highly politicized. When the selection process is not entirely open, companies with the best political connections often win contracts, usually at inflated prices—the costs of which are typically passed on to local taxpayers.
Second, like management contracts, turnkey projects can create future competitors. A newly created local competitor could become a major supplier in its own domestic market and perhaps even in other markets where the supplier operates. Therefore, companies try to avoid projects in which there is danger of transferring their core competencies to others.
1. Identify the advantages and disadvantages of licensing for the licensor and the licensee.
2. Describe how franchising differs from licensing. What are its main benefits and drawbacks?
3. When is a management contract useful? Identify two types of knowledge it is used to transfer.
4. What is a turnkey project? Describe its main advantages and disadvantages.
Investment Entry Modes
Investment entry modes entail direct investment in plant and equipment in a country coupled with ongoing involvement in the local operation. Entry modes in this category take a company’s commitment in a market to a higher level. Let’s now explore three common forms of investment entry: wholly owned subsidiaries, joint ventures, and strategic alliances.
Wholly Owned Subsidiaries
As the term suggests, a wholly owned subsidiary is a facility entirely owned and controlled by a single parent company. Companies can establish a wholly owned subsidiary either by forming a new company and constructing entirely new facilities (such as factories, offices, and equipment) or by purchasing an existing company and internalizing its facilities. Whether an international subsidiary is purchased or newly created depends to a large extent on its proposed operations. When a parent company designs a subsidiary to manufacture the latest high-tech products, it typically must build new facilities. The major drawback of creation from the ground up is the time it takes to construct new facilities, hire and train employees, and launch production.
wholly owned subsidiary
Facility entirely owned and controlled by a single parent company
Conversely, finding an existing local company capable of performing marketing and sales will be easier because special technologies are typically not needed. By purchasing the existing marketing and sales operations of an existing firm in the target market, the parent can have the subsidiary operating relatively quickly. Buying an existing company’s operations in the target market is a particularly good strategy when the company to be acquired has a valuable trademark, brand name, or process technology.
Advantages of Wholly Owned Subsidiaries
There are two main advantages to entering a market using a wholly owned subsidiary. First, managers have complete control over day-to-day operations in the target market and access to valuable technologies, processes, and other intangible properties within the subsidiary. Complete control also decreases the chance that competitors will gain access to a company’s competitive advantage, which is particularly important if it is technology-based. Managers also retain complete control over the subsidiary’s output and prices. Unlike licensors and franchisers, the parent company also receives all profits generated by the subsidiary.
Second, a wholly owned subsidiary is a good mode of entry when a company wants to coordinate the activities of all its national subsidiaries. Companies using global strategies view each of their national markets as one part of an interconnected global market. Thus the ability to exercise complete control over a wholly owned subsidiary makes this entry mode attractive to companies that are pursuing global strategies.
Disadvantages of Wholly Owned Subsidiaries
Wholly owned subsidiaries also present two primary disadvantages. First, they can be expensive undertakings because companies must typically finance investments internally or raise funds in financial markets. Obtaining the necessary funds can be difficult for small and medium-sized companies, but relatively easy for the largest companies.
Second, risk exposure is high because a wholly owned subsidiary requires substantial company resources. One source of risk is political or social uncertainty or outright instability in the target market. Such risks can place both physical assets and personnel in serious jeopardy. The sole owner of a wholly owned subsidiary also accepts the risk that buyers will reject the company’s product. Parent companies can reduce this risk by gaining a better understanding of consumers prior to entering the target market.
Under certain circumstances, companies prefer to share ownership of an operation rather than take complete ownership. A separate company that is created and jointly owned by two or more independent entities to achieve a common business objective is called a joint venture. Joint venture partners can be privately owned companies, government agencies, or government-owned companies. Each party may contribute anything valued by its partners, including managerial talent, marketing expertise, market access, production technologies, financial capital, and superior knowledge or techniques of research and development.
Separate company that is created and jointly owned by two or more independent entities to achieve a common business objective
Examples of joint ventures include:
■ A joint venture between Suzuki Motor Corporation (Japan) and the government of India to manufacture a small-engine car specifically for the Indian market
■ A joint venture between a group of Indian companies and a Russian partner to produce television sets in Russia for the local market
■ Biltrite Corporation (United States) and Shenzhen Petrochemical (China) created a shoe-soling factory as a joint venture in China to supply international shoe manufacturers located in China
Joint Venture Configurations
As we see in Figure 13.5, there are four main joint venture configurations.6 Although we illustrate each of these as consisting of just two partners, each configuration can also apply to ventures of several or more partners.
FORWARD INTEGRATION JOINT VENTURE
Figure 13.5(a) outlines a joint venture characterized by forward integration. In this type of joint venture, the parties choose to invest together in downstream business activities—activities farther along in the “value system” that are normally performed by others. For instance, two household appliance manufacturers opening a retail outlet in a developing country would be a joint venture characterized by forward integration. The two companies now perform activities normally performed by retailers farther along in the product’s journey to buyers.
BACKWARD INTEGRATION JOINT VENTURE
Figure 13.5(b) outlines a joint venture characterized by backward integration. In other words, the joint venture signals a move by each company into upstream business activities—activities earlier in the value system that are normally performed by others. Such a configuration would result if two steel manufacturers formed a joint venture to mine iron ore. The companies now engage in an activity that is normally performed by mining companies.
FIGURE 13.5 Alternative Joint Venture Configurations
Peter Buckley and Mark Casson, “A Theory of Cooperation in International Business,” in Farok J. Contractor and Peter Lorange (eds.), Cooperative Strategies in International Business (Lexington, MA: Lexington Books, 1988), pp. 31–53.
BUYBACK JOINT VENTURE
Figure 13.5(c) outlines a joint venture whose input is provided by, and whose output is absorbed by, each of its partners. A buyback joint venture is formed when each partner requires the same component in its production process. It might be formed when a production facility of a certain minimum size is needed to achieve economies of scale, but neither partner alone enjoys enough demand to warrant building it. However, by combining resources the partners can construct a facility that serves their needs while achieving savings from economies of scale production. For instance, this was one reason behind the $500 million joint venture between Chrysler (www.chrysler.com) and BMW (www.bmw.com) to build small-car engines in Latin America. Each party benefited from the economies of scale offered by the plant’s annual production capacity of 400,000 engines—a volume that neither company could absorb alone.
MULTISTAGE JOINT VENTURE
Figure 13.5(d) outlines a joint venture that features downstream integration by one partner and upstream integration by another. A multistage joint venture often results when one company produces a good or service required by another. For example, a sporting goods manufacturer might join with a sporting goods retailer to establish a distribution company designed to bypass inefficient local distributors in a developing country.
Advantages of Joint Ventures
Joint ventures offer several important advantages to companies going international. Above all, companies rely on joint ventures to reduce risk. Generally, a joint venture exposes fewer of a partner’s assets to risk than would a wholly owned subsidiary—each partner risks only its own contribution. That is why a joint venture entry might be a wise choice when market entry requires a large investment or when there is significant political or social instability in the target market. Similarly, a company can use a joint venture to learn about a local business environment prior to launching a wholly owned subsidiary. In fact, many joint ventures are ultimately bought outright by one of the partners after it gains sufficient expertise in the local market.
Second, companies can use joint ventures to penetrate international markets that are otherwise off-limits. Some governments either require nondomestic companies to share ownership with local companies or provide incentives for them to do so. Such requirements are most common among governments of developing countries. The goal is to improve the competitiveness of local companies by having them team up with and learn from international partner(s).
Third, a company can gain access to another company’s international distribution network through the use of a joint venture. The joint venture between Caterpillar (www.caterpillar.com) of the United States and Mitsubishi Heavy Industries (www.mitsubishi.com) of Japan was designed to improve the competitiveness of each against a common rival, Komatsu (www.komatsu.com) of Japan. While Caterpillar gained access to Mitsubishi’s distribution system in Japan, Mitsubishi got access to Caterpillar’s global distribution network—helping it to compete more effectively internationally.
Finally, companies form international joint ventures for defensive reasons. Entering a joint venture with a local government or government-controlled company gives the government a direct stake in the venture’s success. In turn, the local government will be less likely to interfere if it means that the venture’s performance will suffer. This same strategy can also be used to create a more “local” image when feelings of nationalism are running strong in a target country.
Disadvantages of Joint Ventures
Among its disadvantages, joint venture ownership can result in conflict between partners. Conflict is perhaps most common when management is shared equally—that is, when each partner supplies top managers in what is commonly known as a “50–50 joint venture.” Because neither partner’s managers have the final say on decisions, managerial paralysis can result, causing problems such as delays in responding to changing market conditions. Conflict can also arise from disagreements over how future investments and profits are to be shared. Parties can reduce the likelihood of conflict and indecision by establishing unequal ownership, whereby one partner maintains 51 percent ownership of the voting stock and has the final say on decisions. A multiparty joint venture (commonly referred to as a consortium) can also feature unequal ownership. For example, ownership of a four-party joint venture could be distributed 20–20–20–40, with the 40 percent owner having the final say on decisions.
Second, loss of control over a joint venture’s operations can also result when the local government is a partner in the joint venture. This situation occurs most often in industries considered culturally sensitive or important to national security, such as broadcasting, infrastructure, and defense. Thus a joint venture’s profitability could suffer because of local government motives based on cultural preservation or security.
Sometimes companies who are willing to cooperate with one another do not want to go so far as to create a separate jointly owned company. A relationship whereby two or more entities cooperate (but do not form a separate company) to achieve the strategic goals of each is called a strategic alliance. Similar to joint ventures, strategic alliances can be formed for relatively short periods or for many years, depending on the goals of the participants. Strategic alliances can be established between a company and its suppliers, its buyers, and even its competitors. In forming such alliances, sometimes each partner purchases a portion of the other’s stock. In this way, each company has a direct stake in its partner’s future performance. This decreases the likelihood that one partner will try to take advantage of the other.
Relationship whereby two or more entities cooperate (but do not form a separate company) to achieve the strategic goals of each
Examples of strategic alliances include:
■ An alliance between Siemens (Germany) and Hewlett-Packard (United States) to create and market devices used to control telecommunications systems
■ A strategic alliance between Nippon Life Group (Japan) and Putnam Investments (United States) to permit Putnam to develop investment products and manage assets for Nippon
Advantages of Strategic Alliances
Strategic alliances offer several important advantages to companies. First, companies use strategic alliances to share the cost of an international investment project. For example, many firms are developing new products that not only integrate the latest technologies but also shorten the life spans of existing products. In turn, the shorter life span is reducing the number of years during which a company can recoup its investment. Thus many companies are cooperating to share the costs of developing new products. For example, Toshiba (www.toshiba.com) of Japan, Siemens (www.siemens.com) of Germany, and IBM (www.ibm.com) of the United States shared the $1 billion cost of developing a facility near Nagoya, Japan, to manufacture small, efficient computer memory chips.
Second, companies use strategic alliances to tap into competitors’ specific strengths. Some alliances formed between Internet portals and technology companies are designed to do just that. For example, an Internet portal provides access to a large, global audience through its Web site, while the technology company supplies its know-how in delivering, say, music over the Internet. Meeting the goal of the alliance—marketing music over the Web—requires the competencies of both partners.
Finally, companies turn to strategic alliances for many of the same reasons that they turn to joint ventures. Some businesses use strategic alliances to gain access to a partner’s channels of distribution in a target market. Other firms use them to reduce exposure to the same kinds of risks from which joint ventures provide protection.
Disadvantages of Strategic Alliances
Perhaps the most important disadvantage of a strategic alliance is that it can create a future local or even global competitor. For example, one partner might be using the alliance to test a market and prepare the launch of a wholly owned subsidiary. By declining to cooperate with others in the area of its core competency, a company can reduce the likelihood of creating a competitor that would threaten its main area of business. Likewise, a company can insist on contractual clauses that constrain partners from competing against it with certain products or in certain geographic regions. Companies are also careful to protect special research programs, production techniques, and marketing practices that are not committed to the alliance. Naturally, managers must weigh the potential for encouraging new competition against the benefits of international cooperation.
As in the case of joint ventures, conflict can arise and eventually undermine cooperation. Alliance contracts are drawn up to cover as many contingencies as possible, but communication and cultural differences can still arise. When serious problems crop up, dissolution of the alliance may be the only option.
Selecting Partners for Cooperation
Every company’s goals and strategies are influenced by both its competitive strengths and the challenges it faces in the marketplace. Because the goals and strategies of any two companies are never exactly alike, cooperation can be difficult. Moreover, ventures and alliances often last many years, perhaps even indefinitely. Therefore, partner selection is a crucial ingredient for success. The following discussion focuses on partner selection in joint ventures and strategic alliances. Yet many of the same points also apply to contractual entry modes such as licensing and franchising, for which choosing the right partner is also important.
Every partner must be firmly committed to the goals of the cooperative arrangement. Many companies engage in cooperative forms of business, but the reasons behind each party’s participation are never identical. Sometimes, a company stops contributing to a cooperative arrangement once it achieves its own objectives. Detailing the precise duties and contributions of each party to an international cooperative arrangement through prior negotiations can go a long way toward ensuring continued cooperation. For some key considerations in negotiating international agreements, see the Global Manager’s Briefcase titled, “Negotiating Market Entry.”
Although the importance of locating a trustworthy partner seems obvious, cooperation should be approached with caution. Companies can have hidden reasons for cooperating. Sometimes they try to acquire more from cooperation than their partners realize. If a hidden agenda is discovered during the course of cooperation, trust can break down—in which case the cooperative arrangement is virtually destroyed. Because trust is so important, firms naturally prefer partners with whom they have had a favorable working relationship in the past. However, such arrangements are much easier for large multinationals than for small and medium-sized companies with little international experience and few international contacts.
Each party’s managers must be comfortable working with people of other cultures and traveling to (even perhaps living in) other national cultures. As a result, cooperation will go more smoothly and the transition—both in work life and personal life—will be easier for managers who are sent to work for a joint venture. Each partner’s managers should also be comfortable working with, and within, one another’s corporate culture. For example, although some companies encourage the participation of subordinates in decision making, others do not. Such differences often reflect differences in national culture, and when managers possess cultural understanding, adjustment and cooperation are likely to run more smoothly.
GLOBAL MANAGER’S BRIEFCASE: Negotiating Market Entry
Global business managers must negotiate the terms of many deals. A cooperative atmosphere between potential partners depends on both parties viewing contract negotiations as a success. Managers should be aware of the negotiation process and influential factors. The process normally occurs in four stages.
■ Stage 1: Preparation. Negotiators must have a clear vision of what the company wants to achieve. Negotiation will vary depending on whether the proposed business arrangement is a one-time deal or just the first phase of a lengthy partnership.
■ Stage 2: Opening Positions. Discussions begin as each side states its opening position, which is each side’s most favorable terms. Positions might emerge gradually to leave negotiators room to maneuver.
■ Stage 3: Hard Bargaining. The relative power of each party is key in the outcome of negotiations. Direct conflict is likely at this stage, and culture plays a role. For example, Chinese negotiators will likely try to avoid conflict and may call off talks if conflict erupts.
■ Stage 4: Agreement and Follow-up. Negotiations reaching this stage are a success. Whereas Western negotiators view signing contracts as the end of negotiations, most Asian negotiators see contracts as the start of a flexible relationship.
Two key elements influence international business negotiations:
■ Cultural Elements. Negotiating styles differ from culture to culture. Successful negotiations in Asian cultures mean protecting the other party from losing face (being embarrassed or shamed) and meeting the other party halfway. Yet negotiators in Western cultures typically hope to gain many concessions with little concern for embarrassing the other party.
■ Political and Legal Elements. Negotiators may have political motives. A rigid public position might be taken to show the company or government officials back home that they are working in the company’s or nation’s interest. Also, consumer groups and labor unions might lobby government officials to ensure that a proposed agreement benefits them.
Above all, a suitable partner must have something valuable to offer. Firms should avoid cooperation simply because they are approached by another company. Rather, managers must be certain that they are getting a fair return on their cooperative efforts. And they should evaluate the benefits of a potential international cooperative arrangement just as they would any other investment opportunity.
Strategic Factors in Selecting an Entry Mode
The choice of entry mode has many important strategic implications for a company’s future operations.7 Because enormous investments in time and money can go into determining an entry mode, the choice must be made carefully. Several key factors that influence a company’s international entry mode selection are the cultural environment, political and legal environments, market size, production and shipping costs, and international experience. Let’s now explore each of these factors.
As we saw in Chapter 2, the dimensions of culture—values, beliefs, customs, languages, religions—can differ greatly from one nation to another. In such cases, managers can be less confident in their ability to manage operations in the host country. They can be concerned about the potential not only for communication problems but also for interpersonal difficulties. As a result, managers may avoid investment entry modes in favor of exporting or a contractual mode. On the other hand, cultural similarity encourages confidence and thus the likelihood of investment. Likewise, the importance of cultural differences diminishes when managers are knowledgeable about the culture of the target market.
Political and Legal Environments
As mentioned earlier in this chapter, political instability in a target market increases the risk exposure of investments. Significant political differences and levels of instability cause companies to avoid large investments and to favor entry modes that shelter assets.
A target market’s legal system also influences the choice of entry mode. Certain import regulations, such as high tariffs or low quota limits, can encourage investment. A company that produces locally avoids tariffs that increase product cost; it also doesn’t have to worry about making it into the market below the quota (if there is one). But low tariffs and high quota limits discourage investment. Also, governments may enact laws that ban certain types of investment outright. For many years, China had banned wholly owned subsidiaries by non-Chinese companies and required that joint ventures be formed with local partners. Finally, if a market is lax in enforcing copyright and patent laws, a company may prefer to use investment entry to maintain control over its assets and marketing.
The size of a potential market also influences the choice of entry mode. For example, rising incomes in a market encourage investment entry modes because investment allows a firm to prepare for expanding market demand and to increase its understanding of the target market. High domestic demand in China is attracting investment in joint ventures, strategic alliances, and wholly owned subsidiaries. On the other hand, if investors believe that a market is likely to remain relatively small, better options might include exporting or contractual entry.
Production and Shipping Costs
By helping to control total costs, low-cost production and shipping can give a company an advantage. Accordingly, setting up production in a market is desirable when the total cost of production there is lower than in the home market. Low-cost local production might also encourage contractual entry through licensing or franchising. If production costs are sufficiently low, the international production site might even begin supplying other markets, including the home country. An additional potential benefit of local production might be that managers could observe buyer behavior and modify products to better suit the needs of the local market. Lower production costs at home make it more appealing to export to international markets.
Companies that produce goods with high shipping costs naturally prefer local production. Contractual and investment entry modes are viable options in this case. Alternatively, exporting is feasible when products have relatively lower shipping costs. Finally, because they are subject to less price competition, products for which there are fewer substitutes or those that are discretionary items can more easily absorb higher shipping and production costs. In this case exporting is a likely selection.
By way of summary, Figure 13.6 illustrates the control, risk, and experience relationships of each entry mode. Most companies enter the international marketplace through exporting. As companies gain international experience, they tend to select entry modes that require deeper involvement. But this means businesses must accept greater risk in return for greater control over operations and strategy. Eventually, they may explore the advantages of licensing, franchising, management contracts, and turnkey projects. After businesses become comfortable in a particular market, joint ventures, strategic alliances, and wholly owned subsidiaries become viable options.
Bear in mind that this evolutionary path of accepting greater risk and control with experience does not hold for every company. Whereas some firms remain fixed at one point, others skip several entry modes altogether. Advances in technology and transportation are allowing more and more small companies to leapfrog several stages at once. These relationships also vary for each company depending on its product and characteristics of the home and target markets.
1. What is a wholly owned subsidiary? Identify its advantages and disadvantages.
2. What is meant by the term joint venture? Identify four joint venture configurations.
3. How does a strategic alliance differ from a joint venture? Explain the pluses and minuses of such alliances.
4. Discuss the strategic factors to consider when selecting an entry mode.
FIGURE 13.6 Evolution of the Entry Mode Decision
Source: Franklin R. Root, Entry Strategies for International Markets (Lexington, MA: Lexington Books, 1987), pp. 8–21.
A Final Word
This chapter explained important factors in selecting entry modes and key aspects in their management. We studied the circumstances under which each entry mode is most appropriate and the advantages and disadvantages that each provides. The choice of which entry mode(s) to use in entering international markets matches a company’s international strategy. Some companies will want entry modes that give them tight control over international activities because they are pursuing a global strategy. Meanwhile, other companies might not require an entry mode with central control because they are pursuing a multinational strategy. The entry mode must also be chosen to align well with an organization’s structure.
1. Explain how companies use exporting, importing, and countertrade.
■ Exporting helps a company to expand sales, diversify sales, or gain experience and represents a low-cost, low-risk way of getting started in international business.
■ A successful export strategy involves: (1) identifying a potential market, (2) matching needs to abilities, (3) initiating meetings, and (4) committing resources.
■ Direct exporting occurs when a company sells its products directly to buyers in a target market through local sales representatives or distributors.
■ Indirect exporting occurs when a company sells its products to intermediaries (agents, export management companies, and export trading companies) who then resell to buyers in a target market.
■ Countertrade is selling goods or services that are paid for with other goods or services; it can take the form of: (1) barter, (2) counterpurchase,(3) offset, (4) switch trading, and (5) buyback.
2. Explain the various means of financing export and import activities.
■ With advance payment an importer pays an exporter for merchandise before it is shipped.
■ Documentary collection calls for a bank to act as an intermediary without accepting financial risk.
■ Under a letter of credit, the importer’s bank issues a document stating that the bank will pay the exporter when the exporter fulfills the terms of the document.
■ Several types of letters of credit are an irrevocable letter of credit, a revocable letter of credit, and a confirmed letter of credit.
■ Under open account, an exporter ships merchandise and later bills the importer for its value.
3. Describe the different contractual entry modes that are available to companies.
■ Licensing is a contractual entry mode in which a company that owns intangible property (the licensor) grants another firm (the licensee) the right to use that property for a specified period of time.
■ Franchising is a contractual entry mode in which one company (the franchiser) supplies another (the franchisee) with intangible property and other assistance over an extended period.
■ A management contract is where one company supplies another with managerial expertise for a specific period of time and is used to transfer two types of knowledge—the specialized knowledge of technical managers and the business-management skills of general managers.
■ A turnkey (build–operate–transfer) project is where one company designs, constructs, and tests a production facility for a client.
4. Explain the various types of investment entry modes.
■ Investment entry modes entail the direct investment in plant and equipment in a country coupled with ongoing involvement in the local operation.
■ A wholly owned subsidiary is a facility entirely owned and controlled by a single parent company.
■ A separate company created and jointly owned by two or more independent entities to achieve a common business objective is called a joint venture.
■ Joint ventures can involve forward integration (investing in downstream activities), backward integration (investing in upstream activities), a buyback joint venture (input is provided by and output is absorbed by each partner), and multistage joint venture (downstream integration by one partner and upstream integration by another).
■ A strategic alliance is a relationship in which two or more entities cooperate (but do not form a separate company).
5. Discuss the important strategic factors in selecting an entry mode.
■ Managers are typically less confident in their ability to manage operations in unfamiliar cultures and may avoid investment entry modes in favor of exporting or a contractual mode.
■ Large political differences and high levels of instability cause companies to avoid large investments and favor entry modes that shelter assets.
■ Rising incomes encourage investment entry because investment allows a firm to prepare for expanding market demand and to increase its understanding of the target market.
■ Producing locally is desirable when the total cost of production in a market is lower than in the home market and when shipping costs are high.
■ Companies tend to make their initial foray into international markets using exporting and select entry modes that require deeper involvement as they gain international experience.
Talk It Over
1. Not all companies “go international” by first exporting, then using contracts, and then investing in other markets. How does a company’s product influence the process of going international? How (if at all) does technology, such as the Internet, affect the process of going international?
2. “Companies should use investment entry modes whenever possible because they offer the greatest control over business operations.” Do you agree or disagree with this statement? Are there times when other types of market entry offer greater control? When is investment entry a poor option?
3. In earlier chapters, we learned how governments get involved in the international flow of trade and foreign direct investment. We also learned how regional economic integration is influencing international business. Identify two market entry modes and describe how each might be affected by the actions of governments and by increasing regional integration.
1. Research/Interview Project. As a team of three or four students, interview a manager of a company involved in international business. What method did the company use initially to go international? Does the company export? If so, is it a direct or an indirect exporter? How does the company receive payment for its goods? Does the company use different entry modes in different markets? What factors influenced its choice of entry mode in each case? How do managers deal with cultural differences when negotiating across cultures? Provide any other information on the company your team believes is relevant to the discussion of market entry.
2. Negotiation Project. This project is designed to introduce you to the complexity of negotiations and to help develop your negotiating skills.
Background: A western European automobile manufacturer is considering entering markets in Southeast Asia. The company wants to construct an assembly plant outside Bangkok, Thailand, to assemble its lower-priced cars. Major components would come from manufacturing plants in Brazil, Poland, and China. The cars would then be sold in emerging markets throughout Southeast Asia and the Indian subcontinent. Managers are hoping to strike a $100 million joint venture deal with the Thai government. The company would supply technology and management for the venture, and the government would contribute a minority share of financing to the venture. The company considers the government’s main contributions to be providing tax breaks (and other financial incentives) and a stable business environment in which to operate.
Financial capital is flowing into Thailand at a fair pace. The currency is strong, and inflation remains low. As with other nations in the region, investors are generally wary of the nation’s stability. The new auto assembly plant would boost the local economy, reduce unemployment, and increase local wages. But some local politicians fear the company might be interested only in exploiting the country’s relatively low-cost labor.
Activity: Break into an equal number of negotiating teams of three or four persons. Half the teams are to represent the company and the other half the government. As a group, meet for 15 minutes to develop the team’s opening position and negotiating strategy. Meet with a team from the other side and undertake 20 minutes of negotiations. After the negotiating session, spend 15 minutes comparing the progress of your negotiations with that of the other pairs of teams.
advance payment (p. 358)
agents (p. 355)
barter (p. 357)
bill of lading (p. 358)
buyback (p. 357)
counterpurchase (p. 357)
countertrade (p. 357)
cross licensing (p. 362)
direct exporting (p. 354)
documentary collection (p. 358)
draft (bill of exchange) (p. 358)
entry mode (p. 352)
export management company (EMC) (p. 355)
export trading company (ETC) (p. 355)
franchising (p. 363)
freight forwarder (p. 356)
indirect exporting (p. 354)
joint venture (p. 368)
letter of credit (p. 359)
licensing (p. 361)
management contract (p. 365)
offset (p. 357)
open account (p. 360)
strategic alliance (p. 370)
switch trading (p. 357)
turnkey (build–operate–transfer) project (p. 366)
wholly owned subsidiary (p. 367)
Take It to the Web
1. Video Report. Visit this book’s channel on YouTube (YouTube.com/MyIBvideos). Click on “Playlists” near the top of the page and click on the set of videos labeled “Ch 13: Selecting and Managing Entry Modes.” Watch one video from the list and summarize it in a half-page report. Reflecting on the contents of this chapter, which aspects of selecting and managing entry modes can you identify in the video? How might a company engaged in international business act on the information contained in the video?
2. Web Site Report. This chapter’s opening company profile discussed Marvel’s 50/50 joint venture with Sony that oversees all licensing and merchandising for Spider-Man, as well as Sony’s animated TV series titled Spider-Man. Not mentioned in the opener is that Marvel and Sony became embroiled in a series of lawsuits and counterlawsuits. Perform an Internet search for the name of the joint venture, “Spider-Man Merchandising L. P.,” and locate stories that discuss the lawsuits and their settlement.
What reasons did Marvel give for its initial lawsuit against Sony over its activities? Do you think Marvel was justified in filing suit against Sony? Was it a ruse for Marvel to exact something out of Sony, as some believe? Do you think Sony was right to countersue as it did? What do you think was the main motivation to form the venture from the perspective of each partner?
Do you think the 50/50 split had anything to do with the joint venture’s difficulties? Why or why not? Do you think differences in organizational culture (perhaps rooted in national culture) played any role in the conflict? Do you think anything could have been done during the formation of the joint venture that would have reduced the chances of this dispute arising? Explain.
1. You are the director of international operations for a leading clothing designer based in New York. Your firm recently formed a 50/50 joint venture with a top Latin American manufacturer. On a recent trip to the joint venture’s factory in Latin America, you uncovered discrepancies between the financial results sent to the U.S. parent company and those sent to the local parent firm. Further investigation has convinced you that the local venture’s top management is keeping two sets of accounting records to facilitate the diversion of funds to personal bank accounts. This scenario is not surprising to you, however, because it is rather common in the local country. What do you do? Do you confront your local joint venture partner directly or find another solution? Might you devise a policy that encourages the local partner to be honest in its financial reporting? If so, how do you go about doing this?
2. You own a small manufacturing firm in California and are considering entering either Australia or Hong Kong. You are unsure which country you should target and you are unclear about which entry mode is most appropriate. A recent study investigated the differences between ethical perceptions of business managers from Australia and Hong Kong. The researchers determined two factors impact the perception of ethical problems: (a) culture and (b) the particular mode of market entry (e.g., exporting, contractual, investment in subsidiaries, or joint ventures). What ethical issues do you think might arise in conjunction with the various market entry modes discussed in this chapter? How might these issues influence your entry-mode selection?
3. You are chief operating officer of a Germany-based telecommunications firm considering a joint venture inside China with a Chinese firm. The consultant you’ve hired to help you through the negotiations has just informed you that ethical concerns can arise when international companies consider a cooperative form of market entry (such as a joint venture) with a local partner. This is especially true when each partner contributes personnel to the venture because cultural perspectives cause people to see ethical decisions differently. This is of special concern to you because the venture plans to employ people from both China and Germany—which have very different cultural backgrounds. Is there anything that your two companies can do to establish ethical principles in such a situation—either before or after formation of the cooperative arrangement? Can you think of a company that succeeded in the face of such difficulties?
PRACTICING INTERNATIONAL MANAGEMENT CASE Telecom Ventures Unite the World
The world of telecommunications is changing. The era of global e-commerce is here, driven by new technologies such as broadband and wireless Internet access that make possible video telephone connections and high-speed data transmission. Annual worldwide revenues for telecommunications services total $600 billion, with international companies accounting for 20 percent of the business.
Market opportunities are opening around the world as post, telephone, and telegraph (PTT) monopolies are undergoing privatization. Since 1998 telecom deregulation has been taking place in earnest in Europe. Meanwhile, governments in developing countries are boosting investments in infrastructure improvements to increase the number of available telephone lines. The demand for telephone service is growing at a sharp pace; international telephone call volume more than doubled over a recent six-year period. The net result of these changes is the globalization of the telecommunications industry. As William Donovan, a vice president at Sea-Land Service, said recently, “I don’t want to have to talk to a bunch of different PTTs around the world. I don’t want to have to go to one carrier in one country and a second in another just because it doesn’t have a presence there.”
Several alliances and joint venture partnerships formed between companies hoping to capitalize on the changed market and business environment. France Telecom, Deutsche Telekom, and Sprint created Global One to bring international telecommunications services to multinational companies. As part of the deal, Sprint sold 10 percent of its stock to each of its French and German partners. One hurdle for the company was how to integrate the three partners’ communication networks into a unified whole. Yet start-up costs were high, and the need to communicate in three different languages created some friction among personnel. Early on, lengthy negotiations were required to reach agreement about the value each partner brought to the venture. A former Global One executive noted, “There is no trust among the partners.” Other problems included equipment and billing incompatibilities resulting from distribution agreements with telephone monopolies in individual countries. And then there were the financial losses that prompted Sprint chairman William T. Esrey to install Sprint executive Gary Forsee as CEO and president of Global One.
AT&T also depends on various partnership strategies as entry modes. WorldPartners began as an alliance of AT&T, Kokusai Denshin Denwa (KDD) of Japan, and Telecom of Singapore. The goal was to provide improved telecommunications services for companies conducting business globally. Today WorldPartners is composed of 10 companies, including Telecom New Zealand, Telestra (Australia), Hong Kong Telecom, and Unisource.
Unisource is itself a joint venture that originally included Sweden’s Telia AB, Swiss Telecom PTT, and PTT Telecom Netherlands. Later, Telefonica de España became an equal equity partner in Unisource. Unisource and AT&T then agreed to form a 60–40 joint venture known as AT&T–Unisource Communications to offer voice, data, and messaging services to businesses with European operations. AT&T would have preferred to form a joint venture with the French or German telephone companies. Yet European regulators, concerned about AT&T’s strong brand name and enormous size, refused to approve such a deal.
There was strong logic for the deal. As AT&T–Unisource CEO James Cosgrove explained from headquarters near Amsterdam in Hoofddorp, “You have to be European to play in Europe and yet you have to offer global solutions.” Despite the fact that there are five corporate parents, a sense of equality and congeniality has developed. CEO Cosgrove explains, “Working practices of two years have ironed out remarkably well. We have learned that you have to see this thing as a common operation. Otherwise too many bad compromises can be made.” The presence of Telefonica de España in the alliance was especially significant for AT&T because of the Spanish company’s strong influence in Latin America. Unfortunately, the alliance was weakened when Telefonica decided to ally itself with Concert Communications. To fill the void, AT&T and Italy’s Stet announced a new alliance that would expand communication services to Latin America as well as Europe.
The third major telecommunications alliance, Concert Communications, was formed when British Telecommunications PLC bought a 20 percent stake in MCI Communications. Again, the goal of the alliance was to offer global voice and data network services to global corporations.
1. What strengths did AT&T bring to its joint venture with Unisource?
2. Can you think of any potential complications that could arise in the AT&T–Unisource joint venture?
3. Assess the formation of Global One, Unisource, and other partnerships discussed in this case in terms of the strategic factors for selecting entry modes identified in the chapter.