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 in order
to meet demand itself nor can it contract with another licensee. A good product and lucrative
market, therefore, do not guarantee success for a producer entering a market through
licensing.

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 can operate in
any manner it chooses. Promoting a global image might later require considerable amounts of
time and money in order 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

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.

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 start-up capital, management
training, location advice, and advertising assistance to their franchisees.

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.

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 franchises.

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.

Management Contracts

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..

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 invested 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, 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, 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.

Turnkey projects

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.
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. For example,
Telecommunications Consultants India constructed telecom networks in both Madagascar
and Ghana—two turnkey projects worth a combined total of $28 million.

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 (www.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.

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.

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 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. 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.

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.

joint ventures

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. For
example, Suzuki Motor Corporation, of Japan, formed a joint venture with the government of
India to manufacture a small-engine car specifically for the Indian market.

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 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.

Strategic Alliances

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.

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
website, 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.

Strategic Factors in Selecting an Entry Mode

The choice of entry mode has many important strategic implications for a company’s future
operations. Because enormous investments in time and money can go into determining an
entry mode, the choice must be made carefully. Let’s now examine several key factors that
influence a company’s international entry mode selection.

 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 indefinitely. Therefore, partner selection is a crucial ingredient for
success.

Every partner must be firmly committed to the goals of the venture or agreement. 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 venture once
it achieves its own objectives.

Although the importance of locating a trustworthy partner seems obvious, partners should be
selected cautiously. Companies can have hidden agendas. Sometimes they try to acquire more
from cooperation than their partners realize. If a hidden agenda is discovered, trust can break
down and virtually destroy an agreement. Trust is so important that firms naturally prefer to
partner with firms that they have had a favorable experience with in the past. However, such
arrangements are much easier for large multinational corporations than for small and
medium-sized companies with little international experience and few international contacts.

In an international arrangement, each party’s managers must be comfortable working with

people of other cultures and with traveling to (even perhaps living in) other cultures. As a
result, cooperation will go more smoothly and the transition in work life and personal life will
be easier for managers. 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.

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 efforts. And they should evaluate the
benefits of a potential international arrangement just as they would any other investment
opportunity.

 Cultural Environment

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 does not have to worry
about making it into the market below the quota (if there is one). But low tariffs and high
quota limits discourage market entry by means of 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.

 Market Size

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.

 International Experience

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.
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 small companies to
leapfrog several stages at once. These relationships also vary for each company depending on
its product and the characteristics of home and target markets.