Term Paper on Foreign Market Entry Modes

Introduction

Foreign market entry modes differ in degree of risk they present, the control and commitment of resources they require and the return on investment they promise.

There are two major types of entry modes: equity and non-equity modes. The non-equity modes category includes export and contractual agreements. The equity modes category includes: joint venture and wholly owned subsidiaries.

Exporting

Exporting is the process of selling of goods and services produced in one country to other countries.

There are two types of exporting: direct and indirect.

Direct exports

Direct exports represent the most basic mode of exporting, capitalizing on economies of scale in production concentrated in the home country and affording better control over distribution. Direct export works the best if the volumes are small. Large volumes of export may trigger protectionism.

Type of Direct Exporting.

Sales representatives represent foreign suppliers/manufacturers in their local markets for an established commission on sales. Provide support services to a manufacturer regarding local advertising, local sales presentations, customs clearance formalities, legal requirements. Manufacturers of highly technical services or products such as production machinery, benefit the most form sales representation.

Importing distributors purchase product in their own right and resell it in their local markets to wholesalers, retailers, or both. Importing distributors are a good market entry strategy for products that are carried in inventory, such as toys, appliances, prepared food.

Advantages of direct exporting:

Control over selection of foreign markets and choice of foreign representative companies
Good information feedback from target market
Better protection of trademarks, patents, goodwill, and other intangible property
Potentially greater sales than with indirect exporting.

Disadvantages of direct exporting:

Higher start-up costs and higher risks as opposed to indirect exporting
Greater information requirements
Longer time-to-market as opposed to indirect exporting.

Indirect exports

Indirect exports are the process of exporting through domestically based export intermediaries. The exporter has no control over its products in the foreign market.

Types of indirect exporting:

Export trading companies (ETCs) provide support services of the entire export process for one or more suppliers. Attractive to suppliers that are not familiar with exporting as ETCs usually perform all the necessary work: locate overseas trading partners, present the product, quote on specific enquiries, etc.

Export management companies (EMCs) are similar to ETCs in the way that they usually export for producers. Unlike ETCs, they rarely take on export credit risks and carry one type of product, not representing competing ones. Usually, EMCs trade on behalf of their suppliers as their export departments.

Export merchants are wholesale companies that buy unpackaged products from suppliers/manufacturers for resale overseas under their own brand names. The advantage of export merchants is promotion. One of the disadvantages for using export merchants result in presence of identical products under different brand names and pricing on the market, meaning that export merchant’s activities may hinder manufacturer’s exporting efforts.

Confirming houses are intermediate sellers that work for foreign buyers. They receive the product requirements from their clients, negotiate purchases, make delivery, and pay the suppliers/manufacturers. An opportunity here arises in the fact that if the client likes the product it may become a trade representative. A potential disadvantage includes supplier’s unawareness and lack of control over what a confirming house does with their product.

Nonconforming purchasing agents are similar to confirming houses with the exception that they do not pay the suppliers directly – payments take place between a supplier/manufacturer and a foreign buyer.

Advantages of indirect exporting:

Fast market access
Concentration of resources for production
Little or no financial commitment. The export partner usually covers most expenses associated with international sales
Low risk exists for those companies who consider their domestic market to be more important and for those companies that are still developing their R&D, marketing, and sales strategies.
The management team is not distracted
No direct handle of export processes.

Disadvantages of indirect exporting:

Higher risk than with direct exporting
Little or no control over distribution, sales, marketing, etc. as opposed to direct exporting
Inability to learn how to operate overseas
Wrong choice of market and distributor may lead to inadequate market feedback affecting the international success of the company
Potentially lower sales as compared to direct exporting, due to wrong choice of market and distributors by export partners.

Those companies that seriously consider international markets as a crucial part of their success would likely consider direct exporting as the market entry tool. Indirect exporting is preferred by companies who would want to avoid financial risk as a threat to their other goals.

Licensing

An international licensing agreement allows foreign firms, either exclusively or non-exclusively to manufacture a proprietor’s product for a fixed term in a specific market.

Summarizing, in this foreign market entry mode, a licensor in the home country makes limited rights or resources available to the licensee in the host country. The rights or resources may include patents,

trademarks, managerial skills, technology, and others that can make it possible for the licensee to manufacture and sell in the host country a similar product to the one the licensor has already been producing and selling in the home country without requiring the licensor to open a new operation overseas. The licensor earnings usually take forms of one time payments, technical fees and royalty payments usually calculated as a percentage of sales.

As in this mode of entry the transference of knowledge between the parental company and the licensee is strongly present, the decision of making an international license agreement depend on the respect the host government show for intellectual property and on the ability of the licensor to choose the right partners and avoid them to compete in each other market. Licensing is a relatively flexible work agreement that can be customized to fit the needs and interests of both, licensor and licensee.

Following are the main advantages and reasons to use an international licensing for expanding internationally:

Obtain extra income for technical know-how and services
Reach new markets not accessible by export from existing facilities
Quickly expand without much risk and large capital investment
Pave the way for future investments in the market
Retain established markets closed by trade restrictions
Political risk is minimized as the licensee is usually 100% locally owned
Is highly attractive for companies that are new in international business.

On the other hand, international licensing is a foreign market entry mode that presents some disadvantages and reasons why companies should not use it as:

Lower income than in other entry modes
Loss of control of the licensee manufacture and marketing operations and practices dealing to loss of quality
Risk of having the trademark and reputation ruined by a incompetent partner
The foreign partner can also become a competitor by selling its production in places where the parental company is already in.

Franchising

The Franchising system can be defined as: “A system in which semi-independent business owners (franchisees) pay fees and royalties to a parent company (franchiser) in return for the right to become identified with its trademark, to sell its products or services, and often to use its business format and system.”

Compared to licensing, franchising agreements tends to be longer and the franchisor offers a broader package of rights and resources which usually includes: equipments, managerial systems, operation manual, initial trainings, site approval and all the support necessary for the franchisee to run its business in the same way it is done by the franchisor. In addition to that, while a licensing agreement involves things such as intellectual property, trade secrets and others while in franchising it is limited to trademarks and operating know-how of the business.

Advantages of the international franchising mode:

Low political risk
Low cost
Allows simultaneous expansion into different regions of the world
Well selected partners bring financial investment as well as managerial capabilities to the operation.

Disadvantages of the international franchising mode:

Franchisees may turn into future competitors
Demand of franchisees may be scarce when starting to franchise a company, which can lead to making agreements with the wrong candidates
A wrong franchisee may ruin the company’s name and reputation in the market
Comparing to other modes such as exporting and even licensing, international franchising requires a greater financial investment to attract prospects and support and manage franchisees.

Turnkey projects

A turnkey project refers to a project in which clients pay contractors to design and construct new facilities and train personnel. A turnkey project is way for a foreign company to export its process and technology to other countries by building a plant in that country. Industrial companies that specialize in complex production technologies normally use turnkey projects as an entry strategy.

One of the major advantages of turnkey projects is the possibility for a company to establish a plant and earn profits in a foreign country especially in which foreign direct investment opportunities are limited and lack of expertise in a specific area exists.

Potential disadvantages of a turnkey project for a company include risk of revealing companies secrets to rivals, and takeover of their plant by the host country. By entering a market with a turnkey project proves that a company has no long-term interest in the country which can become a disadvantage if the country proves to be the main market for the output of the exported process.

Wholly owned subsidiaries (WOS)

A wholly owned subsidiary includes two types of strategies: Greenfield investment and Acquisitions. Greenfield investment and acquisition include both advantages and disadvantages. To decide which entry modes to use is depending on situations.

Greenfield investment is the establishment of a new wholly owned subsidiary. It is often complex and potentially costly, but it is able to full control to the firm and has the most potential to provide above average return. “Wholly owned subsidiaries and expatriate staff are preferred in service industries where close contact with end customers and high levels of professional skills, specialized know how, and customization is required.” Greenfield investment is more likely preferred where physical capital intensive plants are planned. This strategy is attractive if there are no competitors to buy or the transfer competitive advantages that consists of embedded competencies, skills, routines, and culture.

Greenfield investment is high risk due to the costs of establishing a new business in a new country. A firm may need to acquire knowledge and expertise of the existing market by third parties, such consultant, competitors, or business partners. This entry strategy takes much time due to the need of establishing new operations, distribution networks, and the necessity to learn and implement appropriate marketing strategies to compete with rivals in a new market.

Acquisition has become a popular mode of entering foreign markets mainly due to its quick access. Acquisition strategy offers the fastest, and the largest, initial international expansion of any of the alternative.

Acquisition has been increasing because it is a way to achieve greater market power. The market share usually is affected by market power. Therefore, many multinational corporations apply acquisitions to achieve their greater market power require buying a competitor, a supplier, a distributor, or a business in highly related industry to allow exercise of a core competency and capture competitive advantage in the market.

Acquisition is lower risk than Greenfield investment because of the outcomes of an acquisition can be estimated more easily and accurately. In overall, acquisition is attractive if there are well established firms already in operations or competitors want to enter the region.

On the other hand, there are many disadvantages and problems in achieving acquisition success.

Integrating two organizations can be quite difficult due to different organization cultures, control system, and relationships. Integration is a complex issue, but it is one of the most important things for organizations.
By applying acquisitions, some companies significantly increased their levels of debt which can have negative effects on the firms because high debt may cause bankruptcy.
Too much diversification may cause problems. Even when a firm is not too over diversified, a high level of diversification can have a negative effect on the firm in the long term performance due to a lack of management of diversification.

Joint venture

There are five common objectives in a joint venture: market entry, risk/reward sharing, technology sharing and joint product development, and conforming to government regulations. Other benefits include political connections and distribution channel access that may depend on relationships. Such alliances often are favorable when:

The partners’ strategic goals converge while their competitive goals diverge
The partners’ size, market power, and resources are small compared to the Industry leaders
Partners are able to learn from one another while limiting access to their own proprietary skills

The key issues to consider in a joint venture are ownership, control, length of agreement, pricing, technology transfer, local firm capabilities and resources, and government intentions. Potential problems include:

Conflict over asymmetric new investments
Mistrust over proprietary knowledge
Performance ambiguity – how to split the pie
Lack of parent firm support
Cultural clashes
If, how, and when to terminate the relationship

Joint ventures have conflicting pressures to cooperate and compete:

Strategic imperative: the partners want to maximize the advantage gained for the joint venture, but they also want to maximize their own competitive position.
The joint venture attempts to develop shared resources, but each firm wants to develop and protect its own proprietary resources.
The joint venture is controlled through negotiations and coordination processes, while each firm would like to have hierarchical control.

Strategic alliance

A strategic alliance is a term used to describe a variety of cooperative agreements between different firms, such as shared research, formal joint ventures, or minority equity participation. The modern form of strategic alliances is becoming increasingly popular and has three distinguishing characteristics:

1. They are frequently between firms in industrialized nations

2. The focus is often on creating new products and/or technologies rather than distributing existing ones

3. They are often only created for short term durations

Advantages of a strategic alliance

Technology Exchange

This is a major objective for many strategic alliances. The reason for this is that many breakthroughs and major technological innovations are based on interdisciplinary and/or inter-industrial advances. Because of this, it is increasingly difficult for a single firm to possess the necessary resources or capabilities to conduct their own effective R&D efforts. This is also perpetuated by shorter product life cycles and the need for many companies to stay competitive through innovation. Some industries that have become centers for extensive cooperative agreements are:

Telecommunications
Electronics
Pharmaceuticals
Information technology
Specialty chemicals

Global competition

There is a growing perception that global battles between corporations be fought between teams of players aligned in strategic partnerships. Strategic alliances will become key tools for companies if they want to remain competitive in this globalized environment, particularly in industries that have dominant leaders, such as cell phone manufactures, where smaller companies need to ally in order to remain competitive.

Industry convergence

As industries converge and the traditional lines between different industrial sectors blur, strategic alliances are sometimes the only way to develop the complex skills necessary in the time frame required. Alliances become a way of shaping competition by decreasing competitive intensity, excluding potential entrants, and isolating players, and building complex value chains that can act as barriers.

Economies of scale and reduction of risk

Pooling resources can contribute greatly to economies of scale, and smaller companies especially can benefit greatly from strategic alliances in terms of cost reduction because of increased economies of scale.

In terms on risk reduction, in strategic alliances no one firm bears the full risk, and cost of, a joint activity. This is extremely advantageous to businesses involved in high risk / cost activities such as R&D. This is also advantageous to smaller organizations that are more affected by risky activities.

Alliance as an alternative to merger

Some industry sectors have constraints to cross-border mergers and acquisitions, strategic alliances prove to be an excellent alternative to bypass these constraints. Alliances often lead to full-scale integration if restrictions are lifted by one or both countries.

Disadvantages of strategic alliances

The risks of competitive collaboration

Some strategic alliances involve firms that are in fierce competition outside the specific scope of the alliance. This creates the risk that one or both partners will try to use the alliance to create an advantage over the other. The benefits of this alliance may cause unbalance between the parties, there are several factors that may cause this asymmetry:

The partnership may be forged to exchange resources and capabilities such as technology. This may cause one partner to obtain the desired technology and abandon the other partner, effectively appropriating all the benefits of the alliance.

Using investment initiative to erode the other partners competitive position. This is a situation where one partner makes and keeps control of critical resources. This creates the threat that the stronger partner may strip the other of the necessary infrastructure.

Strengths gained by learning from one company can be used against the other. As companies learn from the other, usually by task sharing, their capabilities become strengthened, sometimes this strength exceeds the scope of the venture and a company can use it to gain a competitive advantage against the company they may be working with.

Firms may use alliances to acquire its partner. One firm may target a firm and ally with them to use the knowledge gained and trust built in the alliance to take over the other.