Risk And Uncertainty For Firms Entering Foreign Markets Finance Essay
Companies, in this day and Age, are on a quest to expand market share and profitability to achieve and maintain a position of competitive advantage. Globalization, as such, has been a strategy that many companies have adopted towards this end.
Globalization refers to the linkages between markets that exist across national borders. This implies that what happens in one country has an impact on occurrences in other countries (Henry, p.260).
However, the concepts of risk and uncertainty cannot be ignored even as we refer to globalization and companies’ urge to venture into it.
There are many unknowns in the world of business, more so for international business. Organizations in international business or those seeking to venture into such or any other business are prone to face risk and uncertainty. Thus when a firm is entering a foreign market or internationally expanding for the first time there are many potential risks.
This report tackles the question of the unknowns that firms are faced with when entering foreign markets, distinguishing between the concepts of “risk” and “uncertainty”.
MOTIVES FOR EXPANSION INTO FOREIGN MARKETS
A firm has various motives for expansion into foreign markets that would make it prone to risk. These motives may be Market-lead, Capability-lead or Economics-lead;
Some Market-Lead motives are as follows;
Globalization of markets and competition- this exerts pressure on the firm to adopt internationalizing strategies, and not just larger businesses.
Internationalization of the Value Network.
Exploiting differences between countries.
Some Capability-Lead motives are as follows;
Leveraging Capabilities- by doing this across its businesses in a number of countries, the firm is able to achieve competitive advantage.
Enhancing Capabilities- through international acquisitions and strategic alliances the firm may acquire new capabilities.
Enhancing Learning- entry into some markets, foreign inclusive, may enhance organizational learning.
Some Economics-Lead motives (reducing costs) are as follows;
Economies of Scale- the firm can derive economies by increasing the scale of its operations.
Economies of Scope- by spreading costs over a larger output per unit costs may be reduced.
Assuming a firm is trying to enter the American market for the first time, it is bound to face a lot of challenges and risk, especially since it is one of the world’s biggest and active markets.
Risk refers to the likelihood and consequences of an undesirable occurrence(s). A firm entering a foreign market like the American market for the first time will face risk. There are many potential risks that are posed on a firm on the verge/with the motive of venturing into a foreign market for the first time.
Types of Risk
POLITICAL RISK- there is potential threat to a company’s operations in America due to the ineffectiveness and inefficiencies of the different political systems. For example, a change in governments from the republicans to the democrats would lead to a significant change in policies.
Other laws and regulations that can affect a business in a foreign market are as follows;
Revenue and tax laws as concerns remissions and what percentage of revenue is required to be ploughed back into the local economy of the foreign state.
Laws on pollution limits.
Tariffs, trade embargos and sanctions will also affect whether a business operate in a foreign market or not.
Labor laws as concerns wages and pension.
Health and safety laws.
Laws as regards use of local material in production
This is the potential threat to the firm’s operations in a country due to the economic policies and conditions in that country. In America, for example, interest rates may prove to be too high for a business that is coming from sub-Saharan Africa.
Government economic policies such as; Monetary and Fiscal Policies will affect a business and can either be beneficial or a threat to them.
This is the potential threat to a firm’s operations in a country due to fluctuations in the local currency’s exchange rates. The United States dollar is a strong currency and fluctuations in it have, and may prove either disastrous or beneficial to businesses the world over.
This is the potential threat to a company’s operations in a country due to the problems that managers have making decisions in the context of foreign markets. Different countries have different cultures. Hosted identified four national cultures that would have an impact on management styles in different countries;
Power distance- defining the extent to which a culture accepts different distribution of power within society. For cultures/nations with high power distance like France, Spain and Brazil; management style is autocratic with a lot of centralization, close supervision and top-down command chains.
This must to be taken into account as venturing into such cultures without such knowledge would indeed prove risky or hazardous.
Cultures like that of the United States and United Kingdom have less power distance and as such employees are more involved.
Uncertainty avoidance- referring to the extent to which order, security and control are preferred to ambiguity, uncertainty and change.
For nations with a high uncertainty avoidance culture, employees value task culture, written rules and regulations, and standardization. Deviance and/or ignorance of these values pose a threat to a firm wanting to operate in that nation.
On the other hand, nations with a low uncertainty avoidance culture like the United States, the United Kingdom and Australia, value flexibility and creativity and greater variability. Deviance and/or ignorance of these values would place a firm operating within such a nation at a risky position.
Individualism/Collectivism- referring to the preference to hire and work in an individualistic way (focusing on the ‘I’ identity as opposed to the ‘We’ identity) as is the case in the United States and the United Kingdom. Collectivism refers to countries that value organizational family, corporate social responsibility (CSR) and relationship over task; Japan.
Deviance and/or ignorance of such values poses risk for a firm operating in such a nation.
Masculinity refers to the extent to which a society values attributes such as;
These are masculine traits prominent in countries like the United Kingdom, the United States and Australia.
Feminine traits are those that emphasize on sympathy and service quality of life as is the case in Scandinavia and the Netherlands.
Such values and traits need to be considered when venturing into a foreign market to avoid putting a firm at unnecessary risk.
MARKET RISK- potential threat that a company faces by it being a part of a certain market. This risk can further be divided into;
Misy’s risk description according to their Annual Report on principal risks and uncertainties (2010) under the heading ‘Business environment and market risks’ is as follows;
“As an international company, we operate across the globe and difficult or unexpected economic conditions in the markets we serve may affect the financial position of our customers and their willingness to commit expenditure. Other developments in the markets we serve may also impact the Group. The financial services sector is currently subject to regulatory review which could increase taxes on, or curtail certain of the activities of our customers leading them to reduce expenditure. Our Healthcare business is benefiting from the Healthcare Stimulus program in the United States, however, we must ensure that we comply with the requirements for ‘meaningful use’ as defined by the United States Department of Health and Human Services across our healthcare product portfolio. In addition, we operate in highly competitive markets that are characterized by changing technology, industry standards and customer needs and by commercial pressures from customers.”
Four further classifications of risk as classified by Misy in their Annual Report (2010) are:
Strategic Risk- which further embodies;
Business environment and market risks
Business strategy risks
Operational Risk- which further embodies;
Product development risks
Contract implementation and service level risks
Business continuity risks
Intellectual property risks
Financial Risk- which embodies;
Foreign exchange and interest rate risks
Compliance Risk- which embodies;
Legal and regulatory risks
Strategy and Risk
There are a number of strategies that can be employed in relation to risk, that is, the various types of risks. In response to positional risk this report considers the following strategies;
The Strategy Clock
The Strategy Clock (et al, p. 225) is a vital tool in determining the positioning of a firm. A firm entering a foreign market for the first time can assess which of the eight strategies/positions on the strategy clock to pursue, with full understanding of the risk that the various positions pose.
Likely to be segment specific.
Risk of price war & low margins; need to be cost leader.
Low cost base & reinvestment in low price & differentiation.
a) Differentiation; without price premium
Perceived added value by user, yielding market share benefits.
b) Differentiation; with price premium
Perceived added value sufficient to bear price premium.
Perceived added value to a particular segment, warranting price premium
Increased price/standard value
Higher margins if competitors do not follow; risk of losing market share.
Increased price/low value
Only feasible in monopoly situation.
Low value/standard price
Loss of market share.
Porter’s Competitive Forces
Porter’s 5 forces (1980) is another tool for positioning in relation to risk. The ideal situation (especially for a firm entering a foreign market for the first time) is one of low risk where;
Bargaining power of buyers is low
Bargaining power of suppliers is low
Threat from potential entrants is low
Threat from substitutes is low
Competitive rivalry is low
Why Companies Expand/Venture into Foreign Markets
To spread business risk across a wider market base. It will not depend entirely depend on operations in domestic markets.
To achieve/maintain core competences.
To lower costs and enhance firms’ competitiveness.
To gain access to new customers- expanding into foreign markets offers potential for increased revenue, profit and long-term relationships and growth, and becomes an especially attractive option when a company’s home market is mature
It is important that risk is identified in advance, recorded and managed. A firm entering the United States market for the first time can do this using one of the following four strategies;
Avoidance- where the factors that give rise to the risk are removed or the profit is undertaken.
Reduction/Mitigation- these measures tend to reduce the likelihood and the consequence of the risk/risky event.
Transference- where the risk is passed on to or stored in another party.
Absorption- where potential risk is accepted in the hope that the consequences can be coped with if necessary.
Uncertainty refers to indecision or doubt over options. Uncertainty is inherent in a company’s strategy, because nobody can be sure about the future or the stability of an economy. There is therefore even more uncertainty for firms in international business or those planning to enter foreign markets.
Uncertainty Avoidance refers to the extent to which people can tolerate risk and uncertainty in their lives. People in societies with high uncertainty avoidance create institutions that minimize risk and ensure financial security. Companies emphasize stable careers and produce many rules to regulate actions and minimize ambiguity.
Uncertainty Avoidance determines whether or not risk will be an issue for a company. Higher profits do come with greater risks and vice versa. Therefore for a firm entering the United States market for the first time will have to undertake risk management in order to identify risks and gauge whether or not they are able to tolerate whatever risks are discovered.
FOREIGN DIRECT INVESTMENT (FDI)
Another option that companies wanting to enter a foreign market like that of the United States can consider is FDI. FDI is an internalization strategy in which the firm establishes a physical presence abroad by acquiring productive assets such as capital, technology, labor, plant and equipment.
FDI is the most advanced expensive, complex and riskiest entry strategy that a firm could use. It is undertaken by and targeted at firms from both advanced economies and emerging markets.
Some considerations relevant to choice of foreign market entry strategy are;
Degree of control that the firm wants to maintain over decisions, operations, and strategic assets involved in a venture;
Degree of risk that the firm is willing to tolerate, and the timeframe in which it expects returns;
Organizational and financial resources (for example, capital, managers, technology) that the firm will commit to the venture;
Availability and capabilities of partners in the market;
Value-adding activities that the firm wants to perform itself in the market, and what activities it will leave to partners;
Long-term strategic importance of the market
CONCLUSION AND RECOMMENDATION
From the above analogy it can be derived that the question at hand has been adequately addressed.
This report has affirmed that a firm will face unknowns in the world of business, more so in foreign/international markets.
This report has also affirmed that risk is indeed a factor of concern for firms seeking to venture into such markets. It has significantly defined risk and highlighted a considerable range of types of risk.
This report went further in even suggesting risk-related strategies and outlining the risk management framework.
Uncertainty has also been addressed.
It has also addressed the issue of FDI, its associated risks and how it is an option for venturing into foreign markets.
The concept of uncertainty does not seem to ’hold as much water’ as that of risk. It would seem uncertainty is a by-product of risk as doubt or indecision over a promising/profitable venture would be sparked by the risk that comes with it.
In conclusion, Risk cannot be avoided in business whether it is local or international. Risk is always present and can either be high, medium or low, but never absent. What differs is how tolerable different firms are to risk and how they individually manage their risk.
I would recommend that firms engage in wide-scope risk management as even the smallest of risks can prove to be huge blows to competitive advantage. The business environment is turbulent, more so now than in the past years. It would be unwise to invest in business and not be able to make any profit whatsoever due to falling prey to ‘unforeseen’ risks and subsequent consequences.
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