UNIT 5

Unit Structure 3.0 Overview 3.1 3.2 3.3 3.4 3.5 3.6 3.7 Learning Objectives

MODES OF ENTRY

Motivations for International Expansion Factors Affecting the Modes of Entry Types of Modes of Entry Exercises Summary Suggested Readings

3.0

OVERVIEW

One of the most important decisions faced by MNE in its decision to penetrate a foreign market is the choice of the correct mode of entry. If well chosen, the vehicle for international production may reap significant benefits whilst on the other hand, the wrong choice of the mode of entry may entail significant losses for the multinational.

3.1

LEARNING OBJECTIVES
By the end of this Unit, you should be able to understand and grasp the following: 1. the motivations for international production; 2. the factors affecting the choice of modes of entry;

3. Understand the benefits and limitations of the various vehicles for international production.

3.2

Motivations for International Production

Decisions a firm has to take while going foreign: o Which markets to enter? o When to enter those markets? o On what scale? And o HOW? This decision relates to which vehicle of entry to penetrate a foreign market.

3.2.1 Types of Strategies to be used:

PROACTIVE (pulled by good foreign markets) o Firm specific advantage o Resource availability o Economies of scale o Economic and political factors

REACTIVE (pushed by bad domestic markets) o Domestic competition o Poor domestic market o Follow customers

3.3

Factors Affecting the Modes of Entry

In order to decide which mode of entry the MNE will choose, it will depend upon the need of the firm and after the analysis of variables like cultural differences, political or economic factors, the legal structure, the OLI configuration as well as the cost, benefits or risks associated to each of the mode. In addition, the following factors are important: Need for control there is a desire to reduce uncertainty and maintain full control over the foreign operation. Resource availability - lack of access to financial capital may mean that entry by full ownership is impossible so that non-equity or partial equity modes are preferable; this is most likely to arise for small firms. Global strategy - global integration vs. national responsiveness; in the case of the former, the firm is more likely to use ownership routes since EOS and scope & synergies are better achieved through internal market/hierarchy.

3.4

Types of Modes of Entry

FOREIGN MARKET ENTRY

MANUFACTURING AT HOME

MANUFACTURING ABROAD
CONTRACTUAL

INVESTMENT ENTRY

EXPORTING

OVERSEAS ASSEMBLY/ MIXING

DIRECT

INDIRECT LICENSING/ FRANCHISING

CONTRACT MANUF.

ACQUISITION/ SELF -BUILT OTHER DIRECT ENTRY

PIGGY BACKING TURNKEY PROJECTS MGT CONTRACTS JOINT VENTURES

1. Exporting
Advantages of Exporting as Mode of Entry: o low financial cost (but have startup costs); o risk limited only to value of exports; o can enter foreign market gradually (ease of startup, less chance of mistakes, gain experience); o gain information about and expertise in foreign market; o export success breeds more export success; . Disadvantages of Exporting: o difficulty in identifying customer needs; o potential problems with local distributors; o selecting the local distributor; o how to split the profits with the local firm, differences in motivation, and time horizon; o logistical considerations; o costs of warehousing, transport, distribution, longer supply lines, difficulties in communication.

Other Factors affecting Export Decisions o government policies ; o export promotion, financing, foreign tariffs and NTBs; o marketing considerations; 4

o brand image, responsiveness to customer, service, need for feedback from customers, need to tailor product to market.

2.

International Licensing

From licensor to licensee for royalty: One firm (the licensor) sells or leases the right to use its intellectual property (technology, patents, copyrights, trademarks, etc.) to another firm (the licensee), for a fee (royalty payment). It is also sometimes referred to sale of know-how. The contract spells out: boundaries of the agreement: What is included? What is excluded? compensation: Who gets what? rights, privileges and constraints of two parties. dispute resolution: how to settle fights? duration of the contract: affects incentives and performance.

Advantages

low financial cost and risks therefore low risk of loss; can learn about foreign market potential; Fast access to market and low political risks; access to foreign markets with high TBs and NTBs.

Disadvantages
foreign market access is constrained by contract;

licensee may not perform up to expectations; quality control from a distance- not easy; may be creating a future competitor; know-how already available to the firm when license expires.

3. International Franchising
A firm (the franchisor) allows another firm (the franchisee) to operate a business under the name of the first firm, in return for a fee (normally a fixed payment and royalty). The franchisor provides capital, market knowledge, personal involvement, trademarks, operating systems, product reputation & support services (advertising, training, quality assurance). E.g. Mc Donald.

The contract spells out: same items as licensing - boundaries of the agreement, compensation, rights, privileges & constraints of two parties, dispute resolution, duration of the contract. more control than licensing: franchisee agrees to adhere to franchisors requirements for appearance, financial reporting and operating procedures. more support than licensing: franchisor helps establish the business, provides expertise, advertising & corporate image, helps with suppliers (may be supplier). Advantages of Franchising: expand into foreign markets with low risk and low cost; more control than under licensing or exporting with distributor; 6

obtain key information about the foreign market more easily than under licensing/exports; lessons learned can be applied at home.

Disadvantages of Franchising: must share profits with franchisee; probable greater financial commitment than under licensing or exports; more complicated; more responsibilities, greater commitment to foreign firm than licensing or exports; do not have tight control over foreign partner.

4. Turnkey Projects
One firm (or firms) agrees to fully design, construct and equip a facility and then turn the key over to the purchaser when the plant is ready for operation. May be a fixed price or a cost plus contract. Often done with large construction projects in developing countries. The contractor agrees to handle every detail of the project for the foreign client. The client is handed the key to a plant that is ready for full operation.

Advantages:
can earn a return on knowledge asset; less risky than conventional FDI;

Disadvantages
no long-term interest in the foreign country; may create a competitor.

5. Joint Ventures & Strategic Alliances

A strategic alliance (SA): Two or more firms join forces in pursuit of common goals without losing their strategic autonomy and without abandoning their own specific interests (Child & Faulkner, 1998).

C o mpany A
G oals and Interest Specific to A

Co mpany B Alliance
L imited C ommon G oals

G oals and Interest Specific to B

A joint venture is a Special type of SA where two or more firms join together to create a new business entity; which is legally separate and distinct from its parent firms; and where the percent of ownership of each parent is negotiated between the two firms.

Advantages ease of market entry; reduce costs of entry with foreign partners; financial costs, TBs & NTBs, lack of knowledge about local market; time to market may also be reduced; shared risk; reduces total financial investment; reduce the risk of competition (by joining the other); shared risks of new product development; shared knowledge and expertise; access to complementary technology; EOS and scope gains; synergy and competitive advantage; distribution network or other specialized assets necessary to be successful in foreign market. Disadvantages incompatible partners- incompatibilities in management philosophies and practices; access to information- difficulties in getting access to information from partner. Fear of opportunistic behaviour by partner; distribution of earnings- have to split profits from SA; problems with accounting procedures; transfer pricing issues; what to do when SA runs at a loss; potential loss of autonomypartner firms share risks and profits, but also share control. Also, SA may be first step to takeover by one partner; changing circumstances threaten SA viabilityloss of commitment to the SA.

6. Majority-Owned Subsidiaries
A multinational is a firm that owns value-adding activities in more than one country.

Advantages:
no risk of losing technical competence to a competitor; tight control of operations; location economies.

Disadvantages
bear full costs and risks; cultural differences; different political systems; different languages.

3.5

EXERCISES
1. The internalization theory posits that firms would have a strong incentive to avoid joint venture agreements since they are viewed as second best alternatives in allowing the firms to expropriate the returns on it ownership specific advantages (Caves, 1982; Killing, 1983; Harrigan, 1985). Nevertheless, it may be argued that if a firm possesses a rent-yielding asset which enables it to compete in a foreign market and if joint venture agreements are superior to other modes for appropriating rents from the use of such asset in the foreign market, it may be possible to justify the use of joint ventures within the internalization framework. 2. Most companies, if given the choice, would prefer to penetrate a foreign market as fully owned subsidiaries. Discuss.

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3.6

SUMMARY
One of the most important decisions faced by MNE in its decision to penetrate a foreign market is the choice of the correct mode of entry. If well chosen, the vehicle for international production may reap significant benefits whilst on the other hand, the wrong choice of the mode of entry may entail significant losses for the multinational. In order to decide which mode of entry the MNE will choose, it will depend upon the need of the firm and after the analysis of variables like cultural differences, political or economic factors, the legal structure, the OLI configuration as well as the cost, benefits or risks associated to each of the mode. o The advantages of exporting are amongst others low financial costs and limited risks while the main limitations are the difficulty in identifying customer needs and potential problems with local distributors. The main benefits of international licensing are the low financial cost and risks and fast access to market and low political risks while the main limitations are that the foreign market access may be constrained by the contract and the licensee may not perform up to expectations. The main advantages of franchising are the ability for the firm to expand into foreign markets with low risk and low cost and there is greater control than under licensing or exporting with distributor while the main disadvantages are that the franchisor must share profits with franchisee and there is a possibility of greater financial commitment than under licensing or exports. The main advantage of turnkey projects is that it is less risky that conventional FDI whilst the main disadvantage is that it may create a competitor. The main advantages of a joint venture are that it permits firms to get first hand experience in a foreign country with limited initial capital exposure and it also

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permits to alleviate cultural differences whilst the main limitations may arise because of differences in company strategy and due to communication differences. The main benefit of opening a fully owned subsidiary in a foreign market is that it allows for greater control over the foreign operation by the parent company whilst the grater costs is linked to cultural differences that may arise from operating in an alien country.

3.7

SUGGESTED READINGS
Dunning, J.H. (1993). Multinational Enterprise and the Global Economy, AddisonWesley, Wokingham. Anderson, E.M. and Gatignon, H. (1986). Modes of Foreign Entry: A Transaction Costs Analysis and Propositions, Journal of International Business Studies, 17, pp. 1-26. Barkema, H. and Vermulen, F. (1997). What Differences in the Cultural backgrounds of Partners Are Detrimental for International Joint Ventures? Journal of International Business Studies, Vol. 28, No.4, pp. 845-64. Beamish, P.W. (1984). Joint Venture Performance in Developing Countries, Unpublished Doctoral Dissertation, The University of Western Ontario. Beamish, P.W. and Banks, J.C. (1987). Equity Joint Ventures and the Theory of the Multinational Enterprise, Journal of International Business Studies, 18, pp. 1-15.

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