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Market Foreign Management
The different types of entry modes, to penetrate a foreign market, arise due to globalisation. The latter has drastically changed the way business conduct at international level. Owing to advances in transportation, technology and communications, nowadays practically every business of any size can supply or distribute goods, services, or intellectual property. However, when companies deal with international markets, it is complicated as the companies must be prepared to surmount differences in currency issues, language problems, cultural norms, and legal and regulatory regimes. Only the largest companies have the capital and knowledge to overcome these complications on their own. Many other businesses simply do not have the means to efficiently and affordably deal with all those variables in foreign jurisdictions, without a partner in the host country.
Foreign market entry mode has been defined by Root (1987) as “an institutional arrangement that makes possible the entry of a company’s products, technology, human skills, management, or other resources into a foreign country”. There are a broad variety of different entry modes that can generally be categorised into export entry modes, contractual entry modes and investment entry modes. A distinction is also made between equity based and non-equity based foreign market entry modes. Entry modes vary considerably in terms of not only cost incurred by firms but also benefits and disadvantages provided to firms.
In chapter 1, the study will be introduced and where definition of Modes of Entry will be given. In chapter 2 the Literature Review, the factors affecting the choice of entry will be explained. Furthermore there will be the description to each type of foreign entry mode and its theoretical advantages and disadvantages. Then in chapter 3 will proceed with the analytical and findings in each entry modes will be illustrated through a real case study. The recent case of firm going abroad will not be taken in the analysis with the purpose of getting enough information to evaluate each entry modes undertake in the case study namely Mc Donald’s Franchising entry mode, Toyota joint venture in United State, Nokia Greenfield investment in Hungary, and Nike Export entry mode. In Chapter 4, there will conclusion and recommendation of this study.
2.0 LITERATURE REVIEW
2.1 Choice of entry mode
Firms all over the world are internationalizing in highly increasing speed, and thus the selection of a proper entry mode in a foreign market may have significant and far reaching consequences on a firm’s success and survival.
In the selections of a suitable entry method, firms are significantly influenced by situational factors and key dimensions. The influencing factors include various factors such as country risk, socio-cultural distance, firm specific factors, government regulations, and international experience. The key dimensions differentiating market entry modes are the varying levels of management control, barriers to entry, commercial and political risks, equity investment, rapidity, level of resources commitment to the foreign market, and flexibility that each mode posses and also the evaluation of competitors’ entry methods.
Driscoll analyzed the characteristics of export, contractual and investment entry modes through the five aspects namely control; dissemination risk; resource commitment; flexibility and ownership. Driscoll explained each of the characteristics as follows : Control refers to that extent of a firm in governs the production process, co-ordinate activities, logistical and marketing and so on. Dissemination risk refers to the extent to which a firm’s know-how will be expropriated by a contractual partner. Resource commitment refers to the financial, physical and human resources that firms commit to a host market. Flexibility assesses that whether a firm can change the entry modes quickly and with low cost in the face of evolving circumstances. Ownership refers to the extent of a firm’s equity participation in an entry mode.
In Erramilli & Rao (1993), it is suggested that to conceptualize a firm’s desired level of different mode characteristics without considering its actual entry mode used, the efficacy of mode choice models would be improved. Based on this advice, Driscoll (1995) introduced a dynamic mode choice framework as shown in table 2 above. He believes that “a diverse range of situational influences that could bear on a firm’s desire for certain characteristic of mode choice”. Some factors would influence a firm to choose a desired entry mode. He also considers the gap between desired model and actual one and takes alternative mode characteristics into account when a firm chooses foreign market entry mode. Driscoll’s study emphasises that there is no optimal foreign market entry modes under all conditions. Therefore, a firm cannot just consider an institutionalizing mode; it needs to consider the characteristics of modes, the firm factors, environmental factors and other factors when it chooses entry mode.
2.2 Descriptions of the different modes of Foreign market entry
2.2.1. Export Entry Modes
Export mode is the most common strategy to use when entering international markets. Exporting is the shipment of products, manufactured in the domestic market or a third country, across national borders to fulfill foreign orders. Shipments may go directly to the end user, to a distributor or to a wholesaler. Exporting is mainly used in initial entry and gradually evolves towards foreign-based operations. Export entry modes are different from contractual entry modes and investment entry modes in a way that they are directly related to manufacturing. Export can be divided into direct and indirect export depending on the number and type of intermediaries.
126.96.36.199 Direct exporting (sell to buyers)
Direct exporting means that the firm has its own department of export which sells the products via an intermediary in the foreign economy namely direct agent and direct distributor. This way of exporting provides more control over the international operations than indirect exporting. Hence, this alternative often increases the sales potential and also the profit. There is as well a higher risk involved and more financial and human investments are needed.
There are differences between distributors and agents. The basis of an agent’s selling is commissions, while the distributors’ income is a margin between the prices the distributor buys the product for and the final price to the wholesalers or retailers. In contrast to agents the distributors usually maintain the product range. The agents also do not position the products, and do not hold payments while the distributors do both and as well as provide customers with after sales services. Using agents or distributors to introduce the products to a foreign market will have the advantages that they have knowledge about the market, customs, and have established business contacts.
Advantages of Direct Export:
- Access to the local market experience and contacts to potential customers.
- Shorter distribution chain( compared to indirect exporting)
- More control over marketing mix ( especially with agents)
- Local selling support and services available
Disadvantages of Direct Export:
- Little control over market price because of tariffs and lack of distribution control ( especially with distributors)
- Some investment in sales organisation required (contact from home base with distributor or agents)
- Cultural difference, providing communications problems and information filtering ( transaction cost occur)
- Possible trade restrictions
188.8.131.52. Indirect exporting (sell to intermediaries)
Indirect exporting is when the exporting manufactures are using independent organisations that are located in the foreign country. The sale in indirect exporting is like a domestic sale, and the company is not really involved in the global marketing, since the foreign company itself takes the products abroad.
Indirect export is often the fastest way for a company to get its products into a foreign market since customer relationships and marketing systems are already established. Through indirect export, it is the third party who will handle the whole transactions. This approach for exporting is useful for companies with limited international expansion objectives and if the sales are primarily viewed as a way of disposing remaining production, or as marginal. The types of indirect export are as follows:
- Export management companies
- Export trading companies
- Export broker agents
Advantages of Indirect export:
- Limited resources and investment required
- High degree of market diversification is possible as the company utilize the internationalization of an experienced exporter.
- Minimal risk ( market and political)
- NO export experience required
Disadvantages of Indirect export:
- No control over marketing mix elements other than product
- An additional domestic member in the distribution chain may add costs, leaving smaller profit to producer
- Lack of contact with market ( no market knowledge acquired)
- Limited product experience( based on commercial selling)
2.2.2 Contractual Entry Modes
Contractual entry modes are long term non-equity alliance between the company that wants to internalise and the company in target country for entry mode. There are many types of contractual entry mode namely technical agreements, Service contracts, managements, contract manufacture, Co-production agreements and others. The most use contractual entry modes are Licensing, Franchising and Turnkey projects which is going to be explained below.
Licensing concerns a product rights or the method of production marketing the product rights. These rights are usually protected by a patent or some other intellectual right. Licensing is when the exporter, the licensor, sells the right to manufacture or sell its products or services, on a certain market area, to the foreign party (the licensee). Based on the agreement, the exporter receives a onetime fee, a royalty or both. The royalty can vary, often between 0.125 and 15 per cent of the sales revenue. In other words in a licensing agreement, the licensor offers propriety assets to the licensee. The latter is in the foreign market and has to pay royalty fees or made a lump sum payment to the licensor for assets like e.g. trademark, technology, patents and know-how. Licensing agreement’s content is usually quite complex, wide and periodic.
Other than the intellectual property rights, the licensing contract might also include turning-in unprotected know-how. In this licensing contract, the licensor is committed to give all the information to the licensee about the operation. There are many types of licensing arrangements. In a licensing arrangement, the core is patents and know-how, which can be completed by trademarks, models, copyrights and marketing and management’s know-how.
Licensing contract is divided into three main types of licensing:
- Product licensing, the idea of licensing is to agree on usage, manufacturing or marketing right of the whole product, a partial product, a component or a product improvement,
- Method licensing, the method licensing agreement turns in the right to use a certain manufacturing method or a part of it and also possibly the right to use model protection.
- Representation licensing agreement is usually done within two companies that are concentrated on project deliveries, in this case the contract will relate to for example projecting systems, sharing manufacturing and marketing procedures.
Advantages of licensing:
- The ability to enter several foreign markets simultaneously by using several licensees or one licensee with access to a regional market, for example the European Union.
- Enter market with high trade barriers.
- It is a non-equity mode, therefore licensor make profit quickly without big investments. The firm does not have to bear the development costs and risks associated with opening a foreign market.
- Licensing also saves marketing and distribution costs, which are left for the licensee.
- Licensing also enables the licensor to get insight of licensee’s market knowledge, business relations and cost advantages.
- The licensor decreases the exposure to economic and political instabilities in the foreign country.
- Can be used by inexperienced companies in international business
- Avoid the cost to customer of shipping large bulky products to foreign markets
Disadvantages of licensing:
- There is a risk that the licensee may become a competitor once the term of the agreement concludes, by using the licensor’s technology and taking their customers.
- Not every company can use this entry model unless in possess certain type of intellectual property right or the name of the company is of enough interest to the other party.
- The licensor’s income from royalties is not as much as would be gained when manufacturing and marketing the product themselves.
- There is another risk that the licensee will underreport sales in order to lower the royalty payment
Franchising is a form of licensing, which is most often used as market entry modes for services such as fast foods, business to-consumer services and business-to-business services. Franchising is somewhat like licensing where the franchiser gives the franchisee right to use trademarks, know-how and trade name for royalty. Franchising does not only cover products (like licensing) but it usually contains the entire business operation including products, suppliers, technological know-how, and even the look of the business The normal time for a franchisee agreement is 10 years and the arrangement may or may not include operation manuals, marketing plan and training and quality monitoring.
The idea of the franchising chain is that all parties use a uniform model in order to make the customer of a franchising chain may feel that he is dealing with franchisor’s company itself. In fact, regarding to the law, the customer is dealing with independents companies that have even have different owners. Franchising agreement usually includes training and offers management services, as the operations are done in accordance with the franchisor’s directions. Franchising has especially spread to areas, where certain selling style, name and the quality of service are crucial.
Franchisee has different customs on the payments to the franchisor. Normally when a company joins the franchising chain it pays a one-time joining fee. As the operation goes on, the franchisee pays continues service fess that usually are based on the sales volumes of the franchisee company. (Koch 2001).
Advantages of franchising:
- Same as licensing above
- Like with licensing, the franchisor gain local knowledge of the market place and in this case the domestic franchisee is highly motivated
- The fast expansion to a foreign market with low capital expenditures, standardised marketing, motivated franchisees and taking of low political risk.
Disadvantages of franchising:
- Same as in licensing above,
- Since franchising requires more capital initially, it is more suitable to large and well-established companies with good brand images. So small firm get often problem to use this entry modes
- Home country franchisor does not have daily operational control of foreign store. There is a risk that franchisees may not perform at desired quality level.
- more responsibilities ,more complicated and greater commitment to foreign firm than licensing or exports
184.108.40.206 Turnkey project
In turnkey projects, the contractor agrees to handle every detail of the project for a foreign client, including the training of operating personnel. At completion of the contract, the foreign client is handed the “key” to a plant that is ready for full operation. Hence we get the term turnkey. The company, who make the turnkey project, works overseas to build a facility for a local private company or agency of a state, province or municipality. This is actually a means of exporting process technology to another country. Typically these projects are large public sector project such as urban transit stations, commercial airport and telecommunications infrastructure.
Sometimes a turnkey project such as an urban transit system takes the form of a built-operate-transfer or a built-own-operate-transfer project. A sophisticated type of counter trade, in which the builder operates and may also own a public sector project for a specified period of years before turning it over to the government.
Advantages of Turnkey Projects:
- They are a way of earning great economic returns from the know-how required to assemble and run a technologically complex process, for example contractor must train and prepare owner to operate facility
- Turnkey projects may also make sense in a country where the political and economic environment is such that a longer-term investment might expose the firm to unacceptable political and/or economic risk.
- Less risky than conventional FDI
- The firm that enters into a turnkey deal will have no long-term interest in the foreign country.
- The firm that enters into a turnkey project may create a competitor. 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 and/or actual competitors.
2.2.3 Investment Entry Modes
Investment entry modes are about acquiring ownership in a company that is located in the foreign market. In other word, the activities within this category involve ownership of production units or other facilities in the overseas market, based on some sort of equity investment. Several companies want to have ownership in some or all of their international ventures. This can be achieved by joint ventures (equity based), acquisitions, green-field investment.
A joint venture is a contractual arrangement whereby a separate entity is created to carry on trade or business on its own, separate from the core business of the participants. A joint venture occurs when new organizations are created, jointly owned by both partners. At least one of these partners must be from another country than the rest and the location of the company must be outside of at least one party’s home country.
Typically, a company forming a joint venture will often partner with one of its customers, vendors, distributors, or even one of its competitors. These businesses agree to exchange resources, share risks, and divide rewards from a joint enterprise, which is usually physically located in one of the partners’ jurisdictions. The contributions of joint venture partners often differ. The local joint venture partner will frequently supply physical space, channels of distribution, sources of supply, and on-the ground knowledge and information. The other partner usually provides cash, key marketing personnel, certain operating personnel, and intellectual property rights.
Joint venture is an equity entry mode. Ownership of the venture may be 50% for each party, or may be other proportions with one party holding the majority share. In order to make a joint venture remain successful on a long-term-basis, there must be willingness and careful advance planning from both parties to renegotiate the venture terms as soon as possible. When multiple partners participate in the joint venture, the venture maybe called a consortium.
Advantages of a Joint venture:
- Joint venture makes faster access to foreign markets. The local partner to the joint venture may have already established itself in the marketplace and often will have already obtained, or have access to, government contacts, lines of credit, regulatory approvals, scarce supplies and utilities, qualified employees, and cultural knowledge. Upon formation of the Joint venture, the non-resident partner has access to the local partner’s pre-established ties to the local market.
- When the development costs and/or risks of opening a foreign market are high, a firm might gain by sharing these costs and/or risks with a local partner. In many countries, political considerations make joint ventures the only feasible entry mode.
- The reputation of the resident partner gives the joint venturecredibility in the local marketplace, especially with existing key suppliers and customers.
Disadvantages of Joint venture:
- Shared ownership can lead to conflicts and battles for control if goals and objectives differ or change over time.
- Joint venture can foreclose other opportunities for entry into a foreign marketplace.
- It can be difficult for a joint venture to independently obtain financing, particularly debt financing. That is, in part, because Joint venture are usually finite in their duration and lack permanence. Thus, the parents of a joint venture should expect either to adequately capitalise the entity up front or to guarantee loans made to the joint venture.
- Another potential disadvantage of joint venture a firm that enters into a joint venture risks giving control of its technology to its partner and there is the possibility you might wind up turning your own joint venture partner into a competitor. However, this danger can be ameliorated by non-competition, non-solicitation, and confidentiality provisions in the joint venture agreement.
Strategic alliance is when the mutual coordination of strategic planning and management that enable two or more organisations to align their long term goals to the benefit of each organisation and generally the organisations remain independent. Strategic alliances are cooperative relationships on different levels in the organisation. Licensing, joint ventures, research and development partnerships are just few of the alliances possible when exploring new markets. In other words, strategic alliances can be described as a partnership between businesses with the purpose of achieving common goals while minimising risk, maximising leverage and benefiting from those facets of their operations that complement each other’s. A strategic alliance might be entered into for a one-off activity, or it might focus on just one part of a business, or its objective might be new products jointly developed for a particular market.
Generally, each company involved in the strategic alliance will benefit by working together. The arrangement they enter into may not be as formal as a joint venture agreement. Alliances are usually accomplished with a written contract, often with agreed termination points, and do not result in the creation of an independent business organisation. The objective of a strategic alliance is to gain a competitive advantage to a company’s strategic position. Strategic alliances have increased a great deal since globalisation became an opportunity for companies.
There are different types of strategic alliances:
1) Marketing alliances where the companies jointly market products that are complementary produced by one or both of the firms.
2) A promotional alliance refers to the collaboration where one firm agrees to join in promotion for the other firm’s products.
3) Logistics alliance is one more type of cooperation where one company offers, to another company, distribution services for their products.
4) Collaborations between businesses arise when the firms do not for example have the capacity or the financial means to develop new technologies.
Advantages of Strategic alliance:
- Increased leverage
Strategic alliances allow you to gain greater results from your company’s core strengths
- Risk sharing
A strategic alliance with an international company will help to offset your market exposure and allow you to jointly exploit new opportunities.
- Opportunities for growth
Strategic alliances can create the means by which small companies can grow. By “marrying” your company’s product to somebody else’s distribution, or your R&D to a partner’s production skills, you may be able to expand your business overseas more quickly and more cheaply than by other means.
- Greater responsiveness
By allowing you to focus on developing your core strengths, strategic alliances provide the ability to respond more quickly to change and opportunity.
Disadvantages of strategic alliance:
- High commitment – time, money, people
- Difficulty of identifying a compatible partner
- Potential for conflict between the partners
- A small company risks being subsumed by a larger partner
- Strategic priorities change over time
- Political risk in the country where the strategic alliance is based
- If the relationship breaks down, the cost/ownership of market information, market intelligence and jointly developed products can be an issue.
220.127.116.11 Wholly owned subsidiaries
A company will use a wholly owned subsidiary when the company wants to have 100 percent ownership. This is a very expensive mode where the firm has to do everything itself with the company’s financial and human resources. Thus, more it is the large multi national corporations that could select this entry mode rather than small and medium sized enterprises. A wholly owned subsidiary could be divided in two separate ways Greenfield investment and Acquisitions.
Greenfield investment is a mode of entry where the firm starts from scratch in the new market and opens up own stores while using their expertise. It involves the transfer of assets, management talent, and proprietary technology and manufacturing know-how. It requires the skill to operate and manage in another culture with different business practices, labour forces and government regulations. The degree of risk varies according to the political and economic conditions in the host country. Despite these risks many companies prefer to use this mode of entry because of its total control over strategy, operation and profits.
Advantages of Greenfield investment:
- A wholly owned subsidiary gives a firm the tight control over operations in different countries that are necessary for engaging in global strategic coordination (i.e., using profits from one country to support competitive attacks in another).
- A wholly owned subsidiary maybe required if a firm is trying to realize location and experience curve economies.
- Local production lessens transport/import-related costs, taxes & fees.
- Availability of goods can be guaranteed, delays may be eliminated.
- More uniform quality of product or service.
- Local production says that the firm is willing to adapt products & services to the local customer requirements
Disadvantages of Greenfield investment:
- Higher risk exposure namely political risk and economic risk
- Heavier pre-decision information gathering & research evaluation
- “Country-of-origin” effects can be lost by manufacturing elsewhere.
- Establishing a wholly owned subsidiary is generally the most costly method of serving a foreign market.
Acquisition is a very expensive mode of entry where the company acquirers or buys an already existing company in the foreign market. Acquisition is one way of entering a market by buying an already existing brand instead of trying to compete and launch the company’s products on the market and thereby lowering the chance of a profitable product. Acquisition is a risky alternative though, because the culture of the corporation is hard to transfer to the acquired firm. Most important, it is a very expensive alternative and both great profit and great losses could be the end product of this entry mode.
Advantages of Acquisitions:
- They are quick to execute
- Acquisitions enable firms to preempt their competitors
- Managers may believe acquisitions are less risky than green-field ventures
Disadvantages of Acquisitions:
- The acquiring firms often overpay for the assets of the acquired firm
- There may be a clash between the cultures of the acquiring and acquired firm
- Attempts to realize synergies by integrating the operations of the acquired and acquiring entities often run into roadblocks and take much longer than forecast
- There is inadequate pre-acquisition screening
3.0ANALYSIS AND FINDINGS
Case study 1: McDonald’s used franchising as foreign entry mode
In 1940, the first restaurant was opened by the McDonald brothers, Dick and Macin San Bernardino and California. Then Ray Kroc, a Chicago based salesman with a flair for marketing, became involved that the business really started to grow. He realised that Mc Donald’s, could be successful by using franchising, and could be exploited throughout the United States and beyond. Its first franchising was in Canada in 1967. In 2001, McDonald’s served over 16 billion customers, equivalent to a lunch and dinner for every man, woman and child in the world. McDonald’s global sales were over $38bn, making it by far the largest food service company in the world. McDonald’s success on rapid growth and expansion is due to franchising that are based on selling quality products cheaply and quickly around the world. In 2002, around 70% of McDonald’s are franchises.
Mc Donald’s ownership advantage to go abroad is its brand name. The exceptional growth of Mc Donald’s is largely credited to the creation of its strong brand name identity. With the purpose of protecting its brand name, Mc Donald’s used radio and press advertisement to provide specific messages across the world emphasising on the quality of product ingredients. In addition to that Mc Donald’s carry out massive investment in sponsorship which is also a central part of the image building process, for example Football World cup and Olympic Games.
The franchise agreement is that McDonald’s, the franchisor, grants the right to sell McDonald’s branded goods to someone w
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