Lecture 7: Entry and Growth Strategies

A Brief Review
The opening of China has taken a gradual process. In the beginning, most foreign companies entered China as joint ventures (EJVs and CJVs), holding a minority interest, as required by Chinese government, especially in state-controlled sectors including the retail sectorsin the form of investment amount and technology transfer. Gradually, after the mid 1990s, wholly-owned subsidiaries became more common.
P&G had special causes for shifting into WOS from three party EJVs.

Recently, mergers and acquisitions (M&As) have become a popular approach to enter China. Other modes of entry include, licensing, contract management, build-operate-transfer (BOT) Gradually, almost all industries are open to foreign companies.

Figure 2. Milestones of Chinas Economic Reform and Foreign Investment Policy (1977-2000)
1977 Deng came to power and began reform, first in the countryside.
1977 1979 China re-established its formal diplomatic relationship with the U.S. and passed its first law on Chinese-foreign joint enterprise 1981 Gang of Four sentenced. Reformers consolidated power. 1984 Fourteen open cities announced. 1987 Anti Bourgeois Liberalization. Hu Yaobang dismissed. 1989 Tiananmen Square bloodshed. Chinas MFN status has since become an annual debate. 1992 Deng visited Shenzhen and pushed reforms further and faster. China and US signed the IPR MOU. Retailing industry opened. 1995 Tariff reduction for 5000 items. Preferential tax treatment ended. 1997 Deng died in February. Hong Kong handover to China. Hang Seng index reached record high. Asian Financial Crisis 1999 Fiftith Anniversary of PRC. Reform began in housing, healthcare, social welfare, etc.. 2001 PNTR passed in U.S. Congress. 2003 WTO

1980 Special Economic Zones (SEZ) established in Shenzhen, Zhuhai, Shantou, and Xiamen 1983 Anti Bourgeois Spiritual Pollution. 1986 China passed law on foreign capital enterprise. 1988 Austerity program began after 10 years of heated growth. 1990 Pudong New Zone opened in Shanghai. Martial law lifted. 1993 Jiang Zemin became president and continued the reform. First copyright law passed. 1996 Service industry opened: banking, insurance, and trading companies. 1998 President Jiang visited the U.S. China began bid for WTO membership. 2000 WTO schedule in force. Macau reverted to China.

Open Door
1981 1982

Experimentation
1986 1987

Austerity
1 9 9 8 1991

Re-alignment
1997

Rationalization
2001

Restrictions of Foreign Investment in China by Sector

The Chinese Government classifies all investment into three categories by sector: Encouraged, 262(186) e.g.,
Light Industry Production of washing machines, refrigerators, freezers Production of synthetic emtrol, alcohol ether and alcohol ether sulfate Manufacture of compressors with a shaft power of 2 kw or less which are specially used for air-conditioners and refrigerators.

(Catalogue for the Guidance of Foreign Investment in Industry)

Permitted Restricted 75(112) Prohibited

Entry strategy considerations

Essentially it boils down to deciding where, when, and how to enter, and how much to investment, then implementing that plan Location selection is an important decision.
First-tier cities, second-tier cities Different regions/provinces Coastal vs. inland areas Special Economic Zones, Open Cities, Hi-tech parks, etc.. Retailing location: CEPA and Hong Kong firms

Location Selection (Where)

Where, that is the location within a country that depends upon a number of factors and policies. Among them are: Cost/Tax Factors (transportation, wage, availability of land and its costs, construction cost, materials cost, financing costs, tax rates, investment incentives, profit repatriation costs) Resource factors: supplies, raw materials, labor, transportation and logistics
Peugeot in Guangzhou

Demand Factors (market size and growth, customer base) Competition (local and foreign firms): multi-market competition Other success factors: traffic and market catchment for retailers,

Foreign vs. Local Firms

Foreign firms have decided to focus on the developed markets in the first-tier cities. Consumers in the coastal areas have higher brand awareness. Global brands have adopted intensive advertising to project an quality image. Many local firms, however, have avoided head-on competition with global brands. Instead, they have positioned themselves as a provider of good values lower price with good features. Local firms have focused on aggressive promotions and PoP activities and services. Now many local firms have closed the quality gaps and begun to meet the foreign firms head-on in the first tier markets and have gained a strong position in many cases.

FDI Policies: Tax Incentives

Income Tax -Tax rate: 33% -Preferential rate of 15%: for energy, communications and infrastructure; SEZs, Economic & Tech. Development Zones, etc. - Preferential rate of 24%: open coastal cities & inland provincial capitals

FDI Policies: Tax Incentives

Income Tax Deductions -2 year tax holiday, 3 year half payment -Another 3 year of 15% tax rate for Mid/West areas -Another 3 year of half payment for hi-tech -Half payment for 70% export

Entry Approval Procedure

Project Proposal Feasibility Study Report Contract & Articles of Association Registration for Business License Approval Certificate

Timing (When)
Early Mover (Pioneer) Advantages include factors like market power, more preemptive opportunities, and strategic advantages over late movers. Early Mover, however, face environmental and operational risk that can come from host governments lack of experience, underdeveloped investment laws and regulations, protectionism, difficulty in early development stages, shortages of skilled workers, underdeveloped support services, lack of financing, uncertain foreign exchange, consulting cost burdens, poor infrastructure systems, and unstable market structures. Cui and Lui 2005

Timing (When)
Advantages and disadvantages of early movers (vs. followers and latecomers)

First-mover Advantages

Advantages in market share, profitability, and asset turnover Preemptive resources, etc.
Government policies, tax, land, labor, legal requirement, environmental restrictions, better business partners Ability to preempt rivals & capture demand by establishing strong brand name Build sales volume and ride down the experience curve with a cost advantage Create switching cost that tie customers into products & services

Market share reward over time:

brand awareness, stronger repeat purchase, scale economy, Time & effort in learning the rules Mistakes due to ignorance Liability of being a foreigner Costs of promoting & establishing a product educating customers (KFC in China -> benefit to McDonalds)

Greater uncertainty, consumer education, policy changes, low demand, less developed infrastructure

Followers (Dis)advantages
Survivor bias ? Some pioneers may not have survived, leaving only the strong pioneers, thus may bias our interpretation of pioneer advantages and maybe the disadvantages of followers. Disadvantages: declining incentives, more competition, windows of opportunity closed, higher barriers for entry Advantages: learning from others, lower risk, less uncertain, mature consumers, more advanced technologies Late entrants might overcome and leapfrog by strategies: electronics firms from South Korea and Taiwan, marketing intensity Entry during the growth stage by early followers

Cui, Geng and Hon-Kwon Lui (2005), Order of Entry and Performance of Multinationals in an Emerging Market: A Contingent Resource Perspective, Journal of International Marketing, Vol. 13, No. 4, 28-56.

Whereas some studies have found that first movers in foreign markets achieve superior performance than their later counterparts, others have revealed that the effect of first-mover advantages may be conditional on other factors, such as entry mode and resource commitment. Some researchers have explored the possibility that followers may overcome their late-moving disadvantages and eventually prevail. Drawing on the resource-based view, Cui and Lui examine the contingency effects of industry- and firm-level variables on the first-mover advantages and effective follower strategies for foreign investors in China.

Cui and Lui (2005) show that pioneers enjoy a small advantage in market share but not in profitability, indicating a trade-off between the two. Thus, early entry alone may not be sufficient to generate sustainable advantages. Early entry makes more sense for large firms in high-growth industries and firms that partner with local firms. In addition, pioneers tend to fare better in more open and competitive industries than in highly concentrated industries. Thus, the first-mover advantage must be integrated with other complementary resources to generate competitive advantages. Followers may augment performance by increasing resource commitment and marketing intensity. This enables them to make up the lost time and forgone advantages and potentially catch up with the early movers.
Volkswagon vs. GM Buick

 Given the results, Cui and Lui suggest that the claims about the benefits of pioneering in foreign markets need to be interpreted with caution. Such a decision must consider environmental and situational factors, such as industry growth, competitive scenario, and firm resources. Although emerging markets invariably offer attractive opportunities and sometimes handsome rewards for early movers, firms sometimes overlook the risks, challenges, and constraints of operating in volatile market conditions. Investors should consider the entry-order decision as a concerted effort to garner valuable resources on the basis of entry order and to deploy other firm resources and strategies that can help minimize risks, leverage their entry-order advantages, and sustain superior performance over time. It is critical that firms convert the opportunities that stem from entry order into competitive advantages and further develop their resources and capabilities to enhance their performance.

Implications
Early entry alone does not guarantee superior performance. The effect of the preconditions: industry, firm, and strategies Followers can augment performance by adopting certain strategies First movers: Volkswagon vs. Peugeot Late comers: Kodak and General Motors in China Important Note: 30 years after the opening of China, the timing NOW is a late entry? If so, what are the advantages/disadvantages for entering China at this time in 2010?
You are most likely a follower or a late mover!!!

Legal Framework
-3 basic laws on FDI
Law on Equity Joint Venture Law on Contractual Joint Venture Law on Wholly Foreign-owned Enterprises

-Implementation regulations
Specific requirements may vary by industry
$30 million investment in retailing (Amway) $10billion in assets in banking

Firms in some industries have to wait in line to get a license: insurance, banking, etc..

Market Entry Strategies - how

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Market Entry Strategies

Exporting:
Indirect: working through independent international marketing intermediaries.
Im/export countries in China or home country Agents, brokers, and distributors In the beginning, it is a good low-cost low risk strategy

Direct: company handles its own exports.

Building your own export and sales team Overtime, as your sales grow, it may be necessary as the cost of an indirect approach could be higher and yet one do not have control over indirect exporters.

Market Entry Strategies

Wholly owned subsidiaries Joint Venturing:

Again, more control and risky than exporting Joining with foreign companies to produce or market products or services. Partner-selection

Other Approaches:
Licensing Contract manufacturing Management contracting

Strategic Alliances Diebold with IBM

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Entry Modes - Exporting

Advantages avoids the often substantial cost of establishing manufacturing May help firm achieve experience curve & location economies Firm may manufacture in centralized location & export to other national markets to realize scale economies from global sales volume (Sony/TV, Matsushita/VCR, Samsung/Chips) Disadvantages Not appropriate if lower cost manufacturing locations High transport costs can make exporting uneconomical especially bulk products Tariff barriers can make exporting uneconomical If firm delegates marketing, sales & service to another company they may have divided loyalties because they carry competing products or are a large MNE (Diebold) Can set up wholly owned subsidiaries to handle local marketing & sales -> can exercise tight control while reaping cost advantage of manufacturing in a single location

Entry Modes Turnkey Project

Advantages Means of exporting process technology (chemical, pharmaceutical, petroleum, mining) Know-how to assemble & run technologically complex process is valuable asset earn economic benefit from asset Strategy useful where governments restrict FDI less risky than conventional FDI Disadvantages Firm has no long term interest in the country can take minority equity interest in company Firm may inadvertently create a competitor (middle east oil refineries) If firms process technology is a source of competitive advantage, then selling technology is also selling competitive advantage to potential competitors

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Entry Mode - Licensing

Advantages
Receive royalties for granting the rights to intangible property to licensee for specified period (patents, inventions, formulas, processes, designs, copyrights, trademarks) Licensee puts up most of the capital to get the operations going mitigates development cost & risk Allows firm to participate where there are barriers to investment (Fuji-Xerox) Frequently used when firm possesses intangible property but does not want to develop the business application itself (CocoCola/clothing) Primarily used by manufacturing firms

Disadvantages
Does not give firm tight control over manufacturing, marketing & strategy to realize experience curve & location economies Does not allow firm to coordinate strategic moves across countries by using profits earned in one country for competitive attacks in another Firms can lose control over the competitive advantage of their technological know-how.
Cross-licensing can mitigate risk by holding each other hostage for misuse Firms can reduce risk by forming a joint venture with each party taking equity stakes

Entry Mode - Franchising

Advantages Involves longer term commitment than licensing. Primarily used by service firms (McDonalds) Franchiser sells intangible property (trademark) & insists franchisee agrees to abide by strict business rules (location, methods, design, staffing, supply chain) Royalty payments that are some percentage of franchisees revenues Firm relieved of many costs & risks of opening new market. Disadvantages No manufacturing so no location economies & experience curve May inhibit the ability to take profits out of one country to support competitive attacks in another Risk of worldwide reputation if no quality control
Firm can set up master franchise in each country subsidiary which is JV (McDonalds & local firm)

Franchisers may do really well:

Ajisen Noodles:

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Entry Mode Joint Ventures

Advantages Typically 50/50 with contributed team of managers to share operating control Firm benefits from local partners knowledge of competitive conditions, culture, language, political system & business system Sharing market development costs & risks with local partner In some countries, political considerations make JVs the only feasible entry mode Disadvantages
Risk of giving away your technology to a partner Hold majority ownership for more control in venture Wall-off technology that is central to your core competency Does not give firm control over subsidiaries that it might need to realize experience curve or location economies Global strategic coordination firm use JV for checking competitor market share and limiting cash available for invading other markets (TI & Japan) Shared ownership can lead to conflicts & battles for control if goals/objectives change or they take different views on strategy

Entry Mode Wholly Owned Subsidiary

Advantages When there is technological competence wholly-owned subsidiary reduces risk over losing control Give firm tight control over operations in country -> engage in strategic coordination with profits Can realize location & experience curve economies centrally determined decisions Disadvantages Most costly method of market entry Risk associated with learning to do business in a new culture

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Greenfield or Acquisition???
Greenfield
better ability to build organization you want Easier to establish own culture & operating routine Do not have revenue & profit history Slower to establish need to understand how to do business in that country

Acquisition
50%-80% of FDI is acquisition Quick to execute rapidly build presence Acquisitions can preempt competition Buying known revenue & profit stream: NPC of future cash flows!!! Asset valuation, negotiation, government permission ( by Coca Cola failed, premium price Payment methods: cash or stock swaps Need to marry divergent corporate cultures

Overview of inward M&A activity

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Overview of inward M&A activity

Number of Announced M&A PRC deals

How much to invest: Scale of Entry

Large scale entry Requires commitment of significant resources & implies rapid entry (Dutch ING spend billions to acquire US operations) Strategic commitment Decision that has long term impact & is difficult to reverse (entering market on large scale) Change the competitive playing field & unleash number of changes e.g. how competitors might react Can limit strategic flexibility Small scale entry Allows firm to learn about a foreign market while limiting the firms exposure -> limits risks May be more difficulty to build market share & capture early mover advantages Discussion based on developing country considerations Can use MNEs to learn & bench mark against Can focus on niches the MNE ignores or cant serve Can piggyback with MNEs

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Entry Strategies
1. Preparation

Key Concerns & Objectives market research, assessment of demand, political risk, and financial feasibility establish beachhead operation, transfer of capital and management, ensure smooth transition sales growth, market share, new product development, and distribution customer loyalty, competition, coordination and rationalization

Mode & Scale

Operations Management market research, feasibility study, and transaction cost analysis

Marketing Strategies

Human Resources

middlemen service, offshore office, representative office with a small staff single local market, representative office, and the first joint venture

advertising and promotion to create consumer need awareness and to stimulate demand focus on brand recognition and consumer preference, establish distribution channels,

middlemen, expatriates training, relocation, support and performance

2. Entry

transfer of capital, equipment, technology, and personnel, business plan implementation and evaluation

expatriates & bicultural/bilinguals, transfer of technical and managerial know-how

3. Expansion

expand to other regional markets, establish national headquarters, increase local partnerships expand to marginal markets, wholly owned subsidiary, and even mergers /acquisitions

localize supplies and production, management initiative and motivation, and meeting competition, coordination among branches, achieve cost effectiveness, and improve post-sale service

encourage brand preference, expand distribution network, and manage channel relations sales force development, focus on consumer promotion and post-sale service

combination of local and expatriate management, team building, and increased training needs for locals localization of human resources, motivation and creativity, and longterm HR development

4. Experienced

Table 1. Stages of Global Market Expansion and Business Strategy Implications

Supplementary information: China Strategies of MNCs in Retailing

Strategy 1: Speedy Entry instead of a gradual approach The retail sector has allowed greater penetration by MNCs than promised. It was caused by some local government unauthorized approval to show their achievements in attracting FDI. Foreign retailers have entered almost all provincial cities and municipalities Carrefour used unconventional methods in entering and expanding in China market by allowing individual supermarkets to purchase their products independently. Before 2002, all Carrefour supermarkets were wholly owned. However, it was forced to have joint ventures with Chinese firms by Chinese government policies that foreign supermarkets cannot have an equity control over 65%. If you remember, Carrefour withdrew from HK in 2004. Others MNCs retails have also entered China market in large scale and quickened their speed of entry. Wal-Mart (1996) entered Shenzhen, DongGuan and now march into Beijing.

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 Strategy 2: Use Eastern China as a Base and Extend into the Western China
A gradual approach -- testing the market first before expansion With the policy change, MNCs are also changing their strategies In the past few years, they had been developing their businesses mainly in the Eastern region. That is a preparation stage. Since 2002, they have adopted clearly a strategy of using Eastern China as a base and extend into the Western China. Wal-mart has now also entered Northeastern region and XiAn. Others have also entered XinJiang, Sichuan, YunNan

Strategy 3: Multiple Operational Methods

Before 2002, they mainly used shopping plaza method. After 2002, they have started using discount shops, club membership shops, community shops, etc. For example, Wal-mart, at the end of 2002, had 19 shopping plazas, 4 Sam membership stores, 2 community stores, etc. Park & Shop, Watson's, Fortress, Giordano, Moiselle, Jean West, etc., have also entered China market.

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 Strategy 4: Localization
Local sourcing

McDonalds, Carrefour Training and rotation

Localization of human resources

Localization of operational methods

Coca-Cola WalMart Superstore method is a preferred method For example, all 36 Carrefour stores are superstores. Membership club store method has entered some embarrassment.

Strategy 5: Take Over (M&As)

China Resources Corporation (Hong Kong) acquired in Guangzhou Use 30 million Yuan to take over ZhongShan There are rumors about the listing of Carrefour taking over

Strategy 6: Market exchange for market

WalMart, Carrefour and other MNCS relocated
their global purchase centre to China Purchase lots of cheap and good quality products for supplying their global retail network. At one time, WalMart made an offer to acquire Carrefours stores in China.

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 Strategy 7: Retail Dumping

Wal-mark and Metro make losses in China market but earn profits in US and European markets According Merrill Lynch, almost all MNCs retailers in China are losing money except Carrefour which had a profit of $1.2 billion in 2002.

A Comparison of Entry Strategies

Partner
Carrefour Wal-mart
Alliance with listed companies
Joint venture with non retail companies. Intend to take over

Structure
Spring up everywhere

Profit Source
Profit from suppliers

Three region strategy

logistics

Metro Auchan Pricesmart

Joint venture with non retail companies Cross share holding and combined to expand

Focus on Eastern China

Limited customer base

Three point strategy (Beijing, Shanghai and ChenDu Occupy second and third tier markets

Depot

Membership + discount

exclusive right

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Supplement: Remaking of Local Retailers

Strategy 1: Speedy Expansion and Territorial Control LianHua based in Jiangsu and Zhejiang regions and rapidly expanded into Southern China, Northern China and Northeastern China. In the form of shopping plaza, convenient stores and supermarkets HuaLian is just as speedy as LianHua in terms of expansion Gome has even entered Hong Kong Suning have expanded from cities to less populated areas, such as the second tier cities.

Strategy 2: Expand in multiple methods

WuShang has shopping centers, convenient stores, home appliances city. ZhongShang Group has shopping centres, warehouse plaza, chain stores. Shenzhen Causeway Bay operates in the format of Mall +Department + Convenient Store. Diversification

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 Strategy 3: Niche Market Competition

To avoid direct competition with MNCs in major cities, local retailers have entered country and village levels in form of community store. Local street market reformed into supermarket is more competitive in the countryside because of their fresh and cheap supplies.

Strategy 4: Alliance, Merger and Takeover

Beijing ZhongDa, Shanghai YongLe, Guangzhou DongZhe, etc. 9 regional home appliances retailers formed Chinas first purchase alliance-Shanghai ZhongYongTongTai Marketing Company Limited. MingRen in Guangdong acquired Zhuhais New Seven Star, DaoNenJia in Guangzhu, etc.

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 Strategy 5: Enhance Information Systems and Technologies

24 hour satellite and DNN data network connects the headquarters with branches and depots to support nationwide centralized purchase and deliveries. IS development moved from system construction to efficiency and value enhancement and to enhance management of enterprises Realization that the bottleneck of IS is not investment nor technology. It is management.

Other issues
Exit Strategies Cut loss and withdrawal: -- not so quick or easy! Profit repatriation (expatriation) Government restrictions on entering and leaving the market! Real Estate Capital/currency controls taking profit and proceeds out of country, currency conversion, exchange control Trade sale esp. for foreign direct investment and M&A Capitalization: Initial public offering (IPO) domestic and/or international
Choice of overseas listing market (e.g., NYSE, NASDAQ, LSE, HKSE) often for deeper markets and richer valuations Local regulatory issues (e.g., political acceptability) Carl E. Walter & Fraser J.T. Howie in Privatizing China (2003) outline five methods of corporate restructuring for international listings of Chinese enterprises:

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1.

Basic indirect overseas listing structure

Issues Shares

Holding company incorporated in tax-efficient jurisdiction 100% Offshore China investment company >50% Chinese joint venture partner <50% Onshore Sino-foreign joint venture company

Cash

Public investors of foreign listed shares

Source: Walter & Howie, Privatizing China (2003)

2. Back door listing with share offer

Step 1 Step 2 Issues shares Publicly listed company Publicly listed company

Public investors

Acquires listed company

Cash

Sells assets

Unlisted company
Source: Walter & Howie, Privatizing China (2003)

Parent company

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3. Typical listed infrastructure company

Public investors Cash Issues Shares Listed company Provincial Communications Bureau

Highway Segment # 1 Tariff structure

Source: Walter & Howie, Privatizing China (2003)

Highway Segment # 2

Highway Segment # 3

4. Red chip listed company

Chinese municipal government Cash

onshore offshore Listed company Hong Kong registered company Issues Shares Cash Public investors

Source: Walter & Howie, Privatizing China (2003)

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