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Chapter 11 Entering Foreign Markets

NON-EQUITY MODES
EXPORTING Involves sending goods or services to another country for sale Often only available choice for SMEs or new firms wanting to go international Many advantages based on multiplier effect (increase in spending causes increase in income and consumption greater than the initial injection of funds) Unfamiliar target markets complexities and mechanics of exporting to countries with different business practices, language, culture, legal systems and currency discourage many SMEs. Paperwork, complex formalities and potential delays and errors also discourage export Two types of exporting: Direct: company engages a customer/agent located overseas Indirect: company uses an agent located within their home country to engage with customers overseas Advantages Achieve economies of scale Minimal risk & access to larger overseas markets Avoids substantial costs associated with establishing manufacturing operations in host country Better control over distribution (direct exports) Concentration of resources on production (indirect exports) No need to directly handle export processes (avoid substantial paperwork) Disadvantages Firms home base may not be appropriate if lower-cost locations for manufacturing can be found abroad Potentially high transportation costs Trade barriers (tariffs) Less control over distribution Less control over marketing Distance from customers Inability to learn how to operate overseas

CONTRACTUAL AGREEMENTS Turnkey projects A project where a firm agrees to handle every detail of the project for a foreign client and hand over the key to the plant when it is ready for full operation. e.g. Firm builds and operates an airport and hands ownership over to client after agreed amount of time. Advantages Less risky than traditional FDI and can offer access to countries that ordinarily restrict FDI Also more advantageous than FDI in countries where unstable political and economic environment threatens longterm investments Disadvantages No long-term investment in the foreign country (especially if the country turns out to be a major market for the output of the process that has been exported. Minor equity interest can be used to get around this) May create competitors client will learn and tech/knowledge might spillover into target country

If the firms technology and know-how is there competitive advantage then they would essentially be selling it to competitors

Licensing An agreement that allows a party to use an industrial or intellectual property right in exchange for payment Companies that spend a relatively large share of their revenues on R&D are likely to be licensors and vice versa Advantages Firm doesnt have to bear development costs and risks associated with opening a foreign market. Useful for volatile/unstable foreign markets Can allow a firm to enter a market that restricts FDI Allows firms that produce intangible property to earn a return without developing the business applications it enables themselves Disadvantages Licensor doesnt have tight control over manufacturing, marketing and strategy Cant fully realise experience curve and location economies Limits the licensors ability to coordinate strategic moves across countries to resist global competitors Can lose competitive advantage (in form of know-how and tech) to competitors. Cross licensing agreements is where the two firms trade intellectual property thereby reducing risk of the other firm violating its licensing contract

Franchising A specialised form of licensing in which a franchisor allows a franchisee to operate an enterprise using its intellectual property for a fee. Franchisee usually required to abide by strict rules on how to conduct its business. With minor adjustments for the local market, it can result in a highly profitable international business Advantages Firm relieved of many costs and risks associated with entering a foreign market on its own (these are assumed by the franchisee) Allows global presence to be established at relatively low cost and risk Disadvantages As with licensing, it limits the firms ability to coordinate strategic moves across countries Quality control can be difficult which may negatively affect brand name

Dangers of partnerships under licensing/franchising Any partnership is risky because of the fact that there are partners Partners from different companies; different people; different corporate cultures; different ideas about how to deal with problems could give rise to disagreement. Current partners likely to become competitors in the future

EQUITY MODES

JOINT VENTURES An agreement where two partners from different countries share a business (including risks, input costs and profits) Typically 50/50 but stakes vary Advantages Benefits from local partners knowledge of host countrys competitive conditions, culture, language and political and business systems. Distribute costs and risks Political factors sometimes make JVs the only feasible mode of entry Research suggests that JVs lower the risk of the firms assets being nationalised by the local government Disadvantages Risk giving control of technology to partner Doesnt give firm tight control over subsidiaries Shared ownership could lead to conflicts over control if goals and objectives change or if there are differing views on how to proceed. Changes in bargaining power also may lead to conflict.

WHOLLY OWNED SUBSIDIARIES Firm owns 100% of shares in subsidiary established through Greenfield investment or a M&A Advantages Reduced risk of losing technological competence Tight control over operations in different countries which is necessary for engaging in global strategic co-ordinations May allow a firm to realise location economies (the place thatll cost them the least to manufacture their products) 100% share of profits generated in foreign market Disadvantages Highly costly in terms of capital investment Firm will bear the full costs and risks of setting up overseas operations Risks associated with M&As managing conflicting corporate culture. Also very risky 55% of international M&As fail.

GREENFIELD VS ACQUISITIONS Acquisitions Cross-border purchase or exchange of equity involving two or more companies Advantages Quicker to execute than Greenfield investments Allows firm to pre-empt their competitors. Firms acquire others so their competitors may not or because an Disadvantages Acquiring firm can overpay for assets (can occur if there is more than one buyer or if the hubris hypothesis occurs. This is when management is too optimistic about the value that can be

opportunity to expand prevents itself Perceived to be less risky than Greenfield investments. Firms gets all the knowledge, technology, distribution networks, customer service systems, brand name, employee local knowledge etc. which can reduce the risk of mistakes caused by ignorance of the national culture

created) Corporate culture clash Attempts to realise synergies run into roadblocks and take longer than expected. Could be too costly for firm Inadequate pre-acquisition screening can lead to the purchase of a troubled organisation

Greenfield investments Building a subsidiary from scratch Advantages Greater ability for firm to build exactly the kind of subsidiary it wants Easier to build organisation culture from scratch than to change an existing one Less potential for unpleasant surprises Disadvantages Slower to establish Global competitors may enter via acquisitions and build a big market presence thereby limiting market potential for Greenfield venture.

CORE COMPETENCIES AND ENTRY MODE


Firms often expand internationally to earn greater returns from their core competences. Optimal entry mode depends on some degree, to the nature of their core competencies. Distinction made between technological know-how and managerial know-how.

Technological know-how If competitive advantage based on tech know-how, licensing and JV arrangements should be avoided to minimise risk of losing control over technology. Firm should enter via WOS Licensing or JV arrangements can be structured to reduce the risk of losing technology to partners however If technological advantage is perceived to be only transitory and is expected to be rapidly imitated, firm might want to license its tech as rapidly as possible to gain global acceptance for its tech before imitation occurs This may also deter foreign firms from developing their own, potentially superior technology. May also help establish dominant design in industry Risks of losing control over technology often discourages licensing though Managerial know-how If competitive advantage based on management know-how, losing control to franchisees or partners is not that great. With these companies, their most valuable asset (brand name) is protected by international laws. Franchising and subsidiaries (wholly owned or JV) is preferred

COUNTERTRADING
Governments may implement policies that do not favour trade. For example, a government may restrict convertibility of its currency to service international debt or it may increase tariffs to protect local industries. Countertrading is a common solution. It denotes a range of barter-like agreements to trade goods and services for others when they cannot be traded for money Allows firm to finance an export deal when other means are not available Often involves two or more of the following

Barter Direct exchange of goods and services between two parties without a cash transaction. Problems with this... If goods are not transferred simultaneously, one party ends up financing the other for a while. Firms run the risk of having to accept goods they dont want, cant use or have difficulty reselling at a reasonable price Often used as a one-time-only deal with partners who are not creditworthy or trustworthy Counter-purchase When a firm agrees to purchase a certain amount of materials back from a country to which it has made a sale For example, China buys with AUD, products from an Australian firm and the firm agrees to use some of its proceeds to buy some textiles produced in China. Offset When a firm agrees to purchase a product from any firm within the country to which it has made a sale Firm agrees to use a percentage of the proceeds its made from a sale. Gives exporter greater flexibility to choose the goods that it wishes to purchase Switch-trading This involves using a third-party trading house in a countertrade agreement. When a firm enters a counter-purchase or offset agreement and doesnt want to purchase goods from the target country, it can sell its counter-purchase credits to a third-party trading house who sells it at a profit to a firm that does want it. Compensation or buy-backs When a firm builds a plant in a country and agrees to take a certain percentage of the planets output as partial payment for the contract