8 Modes of Entering in International Business
Kajal Gandhi
1. Learning Outcome:
After completing this module the students will be clear about:
• Factors to be considered while going global
• Different modes of entry
• Pros and cons of different methods
• Comparative study of different methods
2. Introduction
Entering a new market is always a risky business, with a big potential of failure. To research the options of entry strategy can help in determine which strategy to use. The major question that the company face in today’s cosmic economy is what is the most suitable and appropriate way for a company to go global, go beyond its border and enter unpracticed territories on foreign sand. The companies are very skeptical regarding the profitability and safety of the decision. When a company is going global, these are the various areas that needs to be addressed. These are also the issues that every company has to tackle when it puts its strategy to enter a new market.
In this chapter, we will go through entry methods that are most often used.
Each strategy has its own gain and shortcomings. Entry methods or strategies can be broadly classified into two categories:
1) Strategic alliances
2) Standalone entries
There are cases where a companies are forced to form strategic alliances while entering new market. This is because of inadequacy of resources, that is required to successfully service the markets and derive profits from it.
Entry modes can be broadly classified into three groups. The first group is entering new markets through export modes and that include indirect and direct exporting, direct agent/distribution, and direct branch subsidiary and other. The second group is contractual entry modes; licensing, franchising, technical agreements, service contracts, management contracts, construction/turnkey contracts, co-production contracts and other. For the last one that is called investment entry mode includes sole venture or acquisition and joint venture.
FACTORS TO BE CONSIDERED BEFORE ENTERING
The choice of entry must be based on an assessment of a nation’s long run profit potential.This potential is a function of the following factors:
1) Timing of Entry: Once attractive markets have been identified,it is important to consider the timing of entry..Entry is early when an international business enters a foreign market before other firms and late when it enters after other international businesses have already established themselves.The advantages associated with entering early is known as First Mover Advantages.
Advantages of First Mover:
a) Ability to preempt rivals and capture demand by establishing a strong brand name.
b) Ability to build sales volume
c) Increase in experience in that country which results into decrease in cost.
d) Ability to create switching cost that tie customers into their products and services
Disadvantages of First Mover:
a) Rise of pioneering costs (costs of promoting and establishing a product offering)
b) Change in regulation in the host country
2) Scale of Entry: Another issue that an international business needs to consider when contemplating market entry is the scale of entry.Entering the market on a large scale involves the commitment of significant resources.Entering the market on a large scale implies rapid entry. Whereas on the other hand small scale entry is a way to gather information about foreign market.But the lack of commitment associated by small scale entry may make it more difficult for the small scale entrant to build market share or to capture first mover advantages.Small scale entrant are more risk averse than the large scale entrant.
EXPORT MODES
Exporting is commonly used when someone talks about export mode in general. One of the most common options are export modes. Export modes consist of indirect entry and direct agent/distribution.
Direct and Indirect Exporting
Many manufacturing firms begin their global expansion as exporters.Exporting is one of the methods that organizations can use to enter foreign markets. In this entry method, goods and services produced in one country are offered to sale in another country through marketing and distribution channels. Thus, this method requires a significant investment in marketing strategies. In reality, exporting is the most traditional and well-established form of operating in foreign markets.
Export can either be done as Direct Export that is using an agent, distributor, or overseas subsidiary, or acts via a Government agency. It can also be done as an Indirect Export that is products are exported through trading companies, export management companies, piggybacking and counter-trade.
Another option for exporters is to sell products direct to foreign end-users. This option does not incur intermediary costs and exporters have higher control over price and profits. However, it is more practical for markets where potential buyers are limited in number or easily identified and reached. Mail order sales and web-based B2C and B2B sales are the most common forms of selling direct to end-users.
There is a difference between passive and active exporters. passive exporters wait for foreign orders that is it does not invest extra to generate sales. Whereas active exporters incur higher cost such as marketing cost to boost up the sales.
As an entry method, exporting has several advantages. Comparing to other methods, exporting is fairly simple and with low costs or investments and risks. Other advantages of exporting are increased utilization of the domestic plant, thus using idle capacity and reducing unit costs through economies of scale. Exporting also helps in diversifying markets, which reduces the company’s exposure to domestic demand instability.
On the other hand, the disadvantages of exporting include high transport costs, trade barriers, tariffs, and problems with local agents. In addition, exporters have lower control of distribution and local agents, face the risk of exchange rate fluctuations, and are subject to custom duties and taxes in the importing counties. Although exporting costs are relatively low compared with the other entry methods, to enter and develop these markets exporters usually incur costs to gain exposure, set up sales and distribution networks, and attract customers. Furthermore, products might need to be modified or redesigned, including packaging, in order to meet local requirements or customer preferences. Similarly, linguistic, demographic and environmental differences demand special attention to ensure exporting success.
Wholly Owned Subsidiary
Many organizations prefer to establish their presence in foreign markets with 100% ownership through wholly owned subsidiaries. Under this method, organizations obtain greater control over operations and higher profits since there is no ownership split agreement. However, such entry method requires large investments and faces higher risks, especially in the political, legal and economical arenas. There are two approaches for the wholly owned subsidiaries entry method; one is through acquisition and the other through greenfield investments.Greenfield investment means using funds to build an entirely new facility.Though such approach entails full control and no risk of cultural conflicts, its costs are extremely high, and returns on investment are obtained in the long-run due to the extent of time required to build the facility, start operations, and attain economies of scale and the experience-curve. In contrast, acquisition allows organizations to get to the foreign market faster. Organizations taking the acquisition approach use its funds to buy existing facilities and operations. This is done by acquiring the equity of the firm that previously owned the facility. There are several advantages of wholly owned subsidiaries.Firstly,when a firm’s competitive advantage is based on technological competence,a wholly owned subsidiary will often be a preferred mode of entry because it reduces the risk of losing control over that competence.Many technologically sound firms prefer this mode for entering foreign market.secondly,the wholly owned subsidiary give a firm tight control of operations in different countries.lastly.a wholly owned subsidiary may be required if a firm is trying to realise location and experience curve economies.
This is considered to be the most costly method of serving a foreign market.Firms choosing this mode of entry has t incur total capital costs and undertake the risks of setting up overseas operations.The risks are a bit lower if host country enterprise is acquired.But acquisitions has different set of problems.but the decision to go for acquisition or greenfield ventures is very crucial.
CONTRACTUAL ENTRY MODES
These types of entry modes consist of several similar, but get different contractual arrangements between the firms form the domestic market and the company that licenses the intangible assets in the foreign market. This includes licensing, franchising, technical agreements, service contracts, management contracts, construction/turnkey contracts, co- production contracts and other. The goal is to enhance the long-run competitiveness for the partners in the alliance and it is built on the belief that each party has something unique to contribute to the partnership.
Turnkey Projects
In a turnkey project the contractor agrees to handle every detail of the project for a foreign client including the training of operational personnel. At the completion of the contract, the foreign client is handed the key to a plant that is ready for full operation. It is very common in the chemical, pharmaceutical and petroleum refining industries. That is mainly used in industries which is compl and uses expensive production technologies.
The advantages of this mode of entry is earning great returns from the asset.The strategy is particularly useful where FDI is limited by host-government regulations.A turnkey project is less risky than FDI.
Three main limitations are attached to this course of entry.Firstly,the firm enters into turnkey deals with no long term interest in the foreign country.This could be a limitation if the firm subsequently proves to be a success.Secondly,a firm entering in this way heedlessly creates competitors.And lastly,if the firm’s process technology is a source of competitive advantage,then selling this technology through a turnkey project is also selling competitive advantage to potential or actual competitors.
Licensing
A licensing agreement is an agreement whereby a licensor grants the rights to intangible property to another entity for a specified period,and intern the licensor receives a royalty fee from the licensee. Intangible property includes patents, inventions, formulas, processes, design, copyrights and trademarks. Licensing is a common method of international market entry for companies with an distinctive and legally protected asset, which is a key differentiating element in their marketing offer. Because little investment on the part of the licensor is required, licensing has the potential to provide a very large ROI. However, because the licensee produces and markets the product, potential returns from manufacturing and marketing activities may be lost. Licensing to a foreign company requires a carefully crafted licensing agreement. A great care must be taken to protect trademarks and intellectual property.
Licensing offers businesses many advantages, such as rapid entry into foreign markets and virtually no capital requirements to establish manufacturing operations abroad. Returns are usually realised more quickly than for manufacturing ventures. The other major advantage of licensing is that, despite the low level of local involvement required of the international licensor, the business is essentially local and is in the shape of the local business that holds the license. As a result, import barriers such as regulation or tariffs do not apply. On the other hand, the disadvantages of licensing are that control over use of assets may be lost over manufacturing and marketing. The licensee usually has to obtain approval from the international vendor for product design and specification. This is because the licensee is not a representative of the international vendor and, compared to a distributor or franchisee, is much more of an independent business that licenses only one specific and closely defined aspect of the marketing offer.
Franchising
Franchising is one of the entry modes that has been widely used as a rapid method of international expansion. This is similar to licensing,although franchising tends to involve long terms commitments than licensing.It is a more sophisticated form of licensing in which the franchiser not only sells intangible property to the franchisee but also insists that the franchisee agree to concede to rules and regulations of how it does business.While licensing is employed primarily by manufacturing firms,franchising is done by service firms.Similar to that of licensing,the franchiser typically receives a royalty payment,which amounts to some percentage of franchisee’s revenues.
Some of the common, but not essential, features of franchised businesses are as follows:
1) Group purchasing arrangements.
2) An exclusive territory for each franchisee.
3) Group advertising programs.
4) Initial and ongoing training and support from the franchisor.
5) Assistance from the franchisor with equipment specification, site selection and premises fit-out and signage.
The advantages of franchising as an entry method is low costs and low risks.This in return motivates the franchisee to build a profitable operation as quickly as possible.
The drawback is the problem of adapting the franchised asset or brand to local market tastes. Franchising carries this constraint is the fact that marketing budgets at local levels are usually restricted to short-term promotions rather than market development.
Contract Manufacturing
This entry mode is a cross between licensing and investment entry. The company contracts a firm in the foreign market to assemble or manufacture the products but they still have the responsibility for marketing and distribution of the products.
This entry mode requires minimum investment of cash, time and executive talent; it also provides fast entry to a new market. On the other hand it also has potential as formidable drawbacks like: training of potential competitor that have access to know-how and high quality products more over the profit from the manufacturing is transferred to the contractor.
Management contracts
The international management contract gives the company the right to control the day-to- day operations in a firm located in a foreign market. Often this contract do not give them the right to take decisions on new capital investment, policy changes, assume long-term debt or alter ownership arrangement. When a manufacturer want to enter a management contract they seldom do so isolated from other arrangements.
INVESTMENT ENTRY MODES
An investment entry mode has many names like sole venture, Foreign Direct Investment (FDI), solely owned subsidiary and wholly owned subsidiary. Both in articles sole venture, FDI, solely owned subsidiary and wholly owned subsidiary is connected under the same headline, investment entry modes. A large investment in a new country can be done sole venture with new establishment or sole venture acquisition and also joint venture. The sole venture mode is a high investment that also brings high risks and possibility to high returns. In sole venture mode, a firm tries to develop a foreign market by directly investing in that market.
Foreign direct investment
The Organization for Economic Co-operation and Development (OECD) define foreign direct investment (FDI) as a category of investment that reflects the objective of establishing a lasting interest by a resident enterprise in one economy (direct investor) in an enterprise (direct investment enterprise) that is resident in an economy other than that of the direct investor. Foreign Direct Investment (FDI) is a strategy approach. This entry modes offers a high degree of control over the international business in the host country. This is high financial commitment mode, but also a transfer of technology, skills, management, manufacturing and marketing, production processes and other recourses. To have unique asset or competitive advantage is often important when a firm want to replicate their good business in on other country. According to there are several factors that influence foreign direct investment. Both mention size of the market as one crucial determinant to which market the company shall choose to precede with.
Acquisition
Acquisition is when a company buys an established business in a foreign market. This mode of entry has become very popular. The reason for acquiring a foreign company can be a mix of the following reasons these are geographical changes. The acquiring of specific asset like management, technology, product diversification, sourcing of raw material or other products of sale outside the host country or financial diversification etc. When you acquire a company the success depends on the selection process on which company to buy, therefore is the possible advantages not certain. The specific advantages can be a faster start in the new market due to establish firm, new product line and a short payback period due to immediate income for the investors. The disadvantages on the other hand are transfers of ownership and control and hard to evaluate the prospects, but several of the advantages can turn in to disadvantages if it is not handle right.
Joint Ventures
A joint venture means establishing a firm that is jointly owned by two or ore otherwise independent firms.This is a popular mode of entry. The term Joint Venture applies to those strategic alliances where there is equity participation from both the foreign entrant and the local collaborator. The equity participation can be of different ratios, ranging from a minority stake, equal stake to a controlling stake or a more predominant majority stake.
The advantages attached to this mode of entry are reduction in the capital risk because the costs are being shared, benefit of the firm from local partner’s knowledge of the host country’s competitive conditions, culture, language, political systems and business.In many countries political conditions dictate this entry to be the only feasible mode of entry.
Many companies avoid joint venture due to complexities involved in coordinating policies,decisions, and execution with a different company.Other drawbacks are distinct difference in culture,managerial styles and communication barrier.
Advantages and Disadvantages of Entry Modes
Summary
This chapter tried to explain the basic entry decisions which includes identifying which markets to enter,when to enter the markets, and on what scale. The most attractive foreign markets tend to be found in politically stable developed and developing nations that have free market systems and where there is not a dramatic upsurge in either inflation rates or private sector debt.Though there are several advantages associated with entering a national market early, before other international businesses have established themselves. These advantages have to weighed against the pioneering costs that early entrants often have to bear,including a greater risk of business failure. There are six modes of entering the foreign market exporting,creating turnkey projects, licensing, franchising,establishing joint venture and setting up wholly owned subsidiaries. All the entries have their respective advantages and disadvantages. According to the requirement and how much cost and risk the entrant firm is ready to bear the mode of entry is to be decided.
Suggested Reading Books:
1) International Business: The Challenges of Global Competition by by Donald Ball and Michael Geringer
2) International Business: Competing in the Global Marketplace by Charles W.L.Hill
ebooks:
- International Business: Opportunities and Challenges in a flattening world by Mason Carpenter, Sanjyot P. Dunung – Flat World Knowledge , 2011
- International trade Theory and Policy by by Steven M. Suranovic – internationalecon.com , 2007
Websites:
1) http://www.isu.edu.tw/upload/28/3/29520/paper/9502/P95020802.pdf
2) http://citeseerist.psu.edu/viewdoc/download?doi=10.1.1.470.65&rep=rep1&type=pdf
3) https://mpra.uuni- muenchen.de/32153/1/Foreign_markets_entry_mode_decision_for_SMEs.pdf