Modes of Entry for International Markets
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Critically discuss the various modes of entry for which an organisation can internationalise their operations. Is there one mode that is preferred above others?
Introduction to Foreign Market Entry Modes
An organisation has a number of different entry modes to choose from when it internationalizes its operations. This essay will focus on the different types of foreign entry modes organisations have to choose from. As well as what organisational circumstances, goals, and objectives are best suited to the types of different entry modes. Examples will also be given of organisations which have used these different entry modes when going international. There is no one entry mode that is superior to another, instead the organisations circumstances, goals, and objectives will be best suited to a certain entry mode. An organisation's internal resources and capabilities, and the environment of the country of entry are other important considerations when choosing the foreign entry mode.
Changes Leading to Internationalization
Changes in the internal and external environment have meant that more and more firms are expanding their operations across country borders. External factors such as: the removal of trade barriers, free trade agreements between countries, and an emerging middle class has made the idea of going global more attractive to organisations across the world. Internal factors such as: increasing profits, increasing market share and becoming a global brand are more drivers for organisations to globalise. Whilst there are a lot of drivers of internationalisation, and hence potential advantages to internationalise, there is no one best entry mode.
All organisations will have different reasons for going global, which will have an influence on which entry mode is best suited to them. An organisation will need to determine their desired level of commitment, flexibility, control, presence and risk when going global, in order to choose the entry mode which best suits their situation. A number of foreign entry modes exist, including: exporting, licensing, franchising, joint venture and wholly owned subsidiary. The following section will analyse these foreign entry modes in greater detail.
Types of Foreign Entry Modes
Exporting is a cross border sale of domestically grown or produced goods Cavusgil, 2004). There are three types of exporting: indirect exporting, direct exporting and cooperative exporting. Indirect exporting is the most low risk entry mode as there is effectively no exposure to the foreign market and its associated risks (Kotler & Armstrong, 2012). The organisation is merely selling their product to an agent in the foreign market who then sells the product on to an intermediary. Exporting is a common method used by organisations when they first enter a new market. Organisations choose this options as it's low risk, it requires less commitment, and gets their brand exposure to the new market. A number of organisations choose indirect export as an entry mode to see if the foreign market is receptive of their brand. In situations where the foreign market is receptive, an organisation may choose to further ingrain their presence in the foreign market with higher commitment, higher presence, and higher risk foreign entry mode strategies (Cavusgil, 2004). Exporting has become more prevalent across the globe due to the removal of trade barriers, and transport becoming cheaper and more efficient (Shaver, 2011).
A direct export is the same as an indirect export except that it doesn't involve an agent who sells the good to the intermediary. Direct exporting is a very common entry mode used by organisations who want exposure to a foreign market, but want to limit the risks associated with other types of entry modes. The Austrian energy drink Red Bull entered Australia using direct export as its entry mode. Red Bull is the leading energy drink brand in the Australian market, holding a 36% market share (Speedy, 2011). This case of Red Bull supports that exporting can be a very successful foreign entry mode strategy.
Cooperative exporting is another exporting option that organisations can use as a foreign market entry strategy. Organisations use this entry mode by entering an agreement with another foreign or local organisation to use its distribution network (Kotler & Armstrong 2012). This entry mode allows organisations reach to the foreign market without the associated risks that come with other entry modes. Cooperative exporting is generally mutually beneficial, provided the goods being exported don't impede the sale of other products being sold (Kotler & Armstrong, 2012). For cooperative exporting to be successful the exported product should complement, as oppose to compete against other products being sold. US chewing gum company Wrigley successfully entered the Indian market using cooperative export as their foreign entry mode. Wrigley entered a cooperative export agreement with Parrys, a local confectionery company, by doing so Wrigley gained access to 250,000 retail outlets (Kotler & Armstrong, 2012).
International licensing is a cross border agreement that permits organisations in the target country the rights to use the property of the licensor (Kotler & Armstrong, 2012). This property is generally intangible and includes: trademarks, patents, and production techniques. The licensee is required to pay a fee in exchange for the rights specified in the contract between the parties. Licensing is commonly chosen because it's low risk, has low exposure to economic and political conditions, has high return on investment and is preferred by local governments (Agrawal & Ramaswami, 1992). Microsoft Corp and Walt Disney Co are two examples of large multinationals that have had success in foreign markets using licensing as their entry mode. Whilst licensing in these examples have been very successful and undoubtedly the right foreign market entry mode, licensing does have its limitations. Licensing can reduce the potential profit of outright ownership, affect the image of the brand due to lack of control over licensee, and nurture a potential future competitor (Brouthers, 2013).
Franchising is a foreign market entry strategy where a semi-independent business owner (the franchisee) pays fees and royalties to the franchiser to use a company's trademark and sell its products and/or services (Kotler & Armstrong, 2012). The terms and conditions of a franchise package vary depending on the contract, however it generally includes: equipment, operations and management manual, staff training, and location approval (Alon, 2014). Franchising is commonly used and a largely successful method of cross border market entry, however organisations pursuing this entry mode need to consider both the positive and negative aspects of franchising.
The most common advantages of franchising are that it capitalises on an already successful strategy, the franchisee generally has local knowledge, it's less risky than equity based foreign entry modes, and the franchisor isn't exposed to risks associated with the foreign market (Alon, 2014). Subway, 7-Eleven, Pizza Hut, and McDonalds are just a few examples of organisations that have been successful using franchising as their foreign market entry mode. Subway was founded in 1965 in the United States; using franchising as a foreign market entry strategy it has grown to have over 42,000 stores in 107 countries. Subway is now the world's largest franchise and highlights how successful franchising can be (Subway, 2014). Just like in the case of Subway, franchising allows for rapid expansion that would be unlikely using other foreign entry modes.
Whilst in general, franchising is a popular and successful mode for foreign market entry, there are a few potential shortcomings. These shortcomings include: decreased brand quality due to not having full control over franchises, not maximising profit as franchisor only receives a royalty fee and not the full profit made, and the possibility of nurturing a future competitor. Whilst these potential shortcomings could be detrimental to an organisation, franchising is continually chosen as a foreign market entry mode as franchisors believe that the rewards outweigh the risks.
An organisation may choose a joint venture as their foreign market entry mode for a number of different reasons, for example: to divide the risk with other parties, to leverage of each other's strengths etc. However if a joint venture is to be successful the two or more organisations that form the joint venture must/should have common objectives in regards to: the market of entry, acceptable levels of risk/reward of the market entered, the sharing of technology, joint product development and the following of local government laws (Kotler & Armstrong, 2012). Joint ventures often thrive if the following conditions are present between the partners: converging goals, small market share compared to the market leader, and are able to learn from one another without surrendering their competitive advantage or intellectual property (Chang, Chung & Moon, 2012).
Under the right circumstances, a joint venture can allow an organisation to gain access to a new market which it previously wouldn't have been able to do so by itself. The main restriction in this situation is generally the local government. A local government may choose to impose restrictions on wholly owned foreign investment for a number of reasons, such as: threat to local players, threat to the environment, threat to the long term prosperity of the industry etc. A real life example of this is Singapore Airlines entering the Indian market. The Indian government imposes restrictions on foreign airlines entering the local airline industry as a wholly owned subsidiary (The Indian Express, 2014). However Singapore Airlines entered a joint venture with the Tata group, and owns a 49% stake in the SIA/Tata alliance (The Indian Express, 2014). Whilst SIA wanted to enter the Indian domestic airline market with maximum presence, entering as a wholly owned subsidiary was not possible. Entering as a joint venture in this situation was the best entry mode for SIA as it allowed maximum exposure, maximum commitment, maximum flexibility and maximum potential rewards.
Wholly Owned Subsidiary
A wholly owned subsidiaries is the process where by an organisation enters a foreign market with 100% ownership of the foreign entity (Yiu & Makino, 2002). The two ways that wholly owned subsidiaries come about is through either acquisition or greenfield operations. Acquisition is the purchase of a foreign organisation as a way to enter a new market. A greenfield operation is the creation of a new organisation and legal entity in the foreign market. A number of organisations that want to limit their risk, while maximising their exposure to the foreign market will choose acquisition as their entry mode. This is because an acquisition uses an already established brand name and customer base. However neither acquisition or greenfield are seen as superior to one another, the entry mode which is more beneficial is dependent upon the organisations circumstances, goals and objectives.
Wholly owned subsidiaries incur more risks than all the entry modes previously mentioned, however if implemented correctly and in the right circumstances, it generally results in high rewards (profits). An organisation that enters a market as a wholly owned subsidiary has: high control, high commitment, high presence and high risk/reward. A wholly owned subsidiary allows an organisation to reach diverse geographic regions, markets and different industries. Through entering the correct markets and with good management a wholly owned subsidiary is a good hedge against market changes, such as political changes, legal changes and declines in different sectors (Yiu & Makino, 2002).
No one entry mode is considered to be superior to one another. When an organisation is choosing to internationalise their operations, they will first need to decide what its optimal levels of: commitment, flexibility, control, presence and risk are in order to select the most appropriate entry mode. An organisation's internal resources and capabilities are another important consideration when choosing the foreign entry mode. The market of entry is also another important consideration for the organisation planning to internationalize their operations. A PESTLE analysis of the foreign market will help the firm to gain a better understanding of the market environment. The process for an organisation to internationalize their operations is often quite difficult, and so is the process of choosing the foreign market entry mode. It's for this reason that there is no superior foreign market entry mode. From the examples given it's clear that each entry mode can be successful if implemented in the right circumstances.
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