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    The Strategy of International Business LEARNING OBJECTIVES After reading this chapter, you will be able to: Lo LO13-2 1013-3 13. Explain the concept of strategy. Recognize how firms Understand how pressures for cost red pressures for local responsivenes choice. 1013 and their pros and cons. Ford's Global Strategy Opening Case When Ford CEO Alan Mulally arrived at the company in 2006 after a long career at Boeing, he was shocked to learn that the company produced one Ford Focus for Europe and a totally different one for the United States. *Can you imagine having one Bosing 737 for Europe and, one 737 for the United States?” he said at the time, Due to this product strategy, Ford was unable to buy common parts for the vehicles, could not share development costs, and couldn't use its European Focus plants to make cars for the United States, or vice versa. In a business where economies of scale are Important, the re- suit was high costs. Nor were these problems limited to 16 Ford Focus. The strategy of designing and building different cars for different regions wes the standard approach at Ford, Ford's long-standing strategy of regional models was based on the assumption that consumers in diferent re- gions had different tastes and preferences, which required Considerable local customization. Americans, it was ar ued, loved their trucks and SUVS, while Europeans pre- ferred smaller, fuel-efficient cars. Notwithstanding such differences, Mulally stil could not understand why small car models like the Focus, or the Escape SUV, which were soid in different regions, were not built on the same plat- form and did not share common parts. In truth, the strat- egy probably had more to do with the autonomy of cifferent, regions within Ford's organization, a fact that was deeply rofit by expanding globally ions and influence strategic Identity the different strategies for competing globally embedded in Ford's history as one of the oldest mutina- tional corporations. When the global financial crisis rocked the world's automobile industry in 2008-2009, and precipitated the steapest drop in sales since the Great Depression, Mulaly decided that Ford had to change Its long standing practices in order to get its costs under control. Moreover, he felt that there was no way that Ford would be able to compete effectively in the large developing markets of CChina and india unless Ford leveraged its global scale to ‘produce low cost cars, The result wes Mulsly’s One Ford strategy, which aims to create @ handful of car platforms that Ford can use everywhere in the world Under this strategy new models, such as the 2013 Fiesta, Focus, and Escape, share a common design, aro bul on a common platform, use the same perts, and are but in identical factories around the world, Utimataly, Fe hopes 1o have only five platforms to deliver sales of more than 6 milion vehicles by 2016. In 2006 Ford had 16 plat forms that accounted for sales of 6.6 milion vehicles. By pursuing this strategy, Ford can share the costs of design and tooling, and it can attain much greater scale econo- mies in the production of component parts. Ford has stated that it wil take about one-third out of the $1 billion cost of develoning a new car model and should sigriicantly reduce ts $50 bilon annual budget for component parts Moreover, since the different factories producing thes cars ae identical inal respects, useful knowiedge acquired 379 through experience in one factory can quickly be trans- fetred to other factories, resulting in systemwide cost, savings. What Ford hopes is that this strategy will bring down costs sufficiently to enable Ford to make greater profit, "margins in developed markets and to make good margins, at lower price points in hypercompatitive developing na- tions, such as China, now the world’s largest car market, where Ford currently trails its global rivals such as General Motors and Volkswagen. Indeed, the strategy is central to Mulally’s goal for increasing Ford's sales from 5.5 milion in, 2010 to & milion by mid-cecade.* 380 LO13-1 Introduction ‘The primary focus thus far in this book has been on aspects of the larger environment in which international businesses compete. As described in the preceding chapters, this en- vironment has included the different political, economic, and cultural institutions found in nations, the intemational trade and investment framework, and the international mon- etary system. Now our focus shifts from the environment tothe firm itself and, in particu- lar, to the actions managers can take to compete more effectively as an international business. This chapter looks at how firms can increase their profitability by expanding, their operations in foreign markets. We discuss the different strategies that firms pursue when competing internationally, consider the pros and cons of these strategies, and study the various factors that affect a fitm’s choice of strategy. Ford Motor Company's One Ford strategy, profiled in the opening case, gives a pre- view of some issues explored in this chapter. Historically Ford pursued a localization, selling cars in the different regions that were designed and produced locally (j.e., one design for Europe, another for North America). While this strategy did have the virtue of ‘ensuring that the offering was tailored the tastes and preferences of consumers in differ- ent regions, it also generated considerable duplication and high costs. By the late 2000s, Alan Mulally, Ford's CEO, decided that the company could no longer afford the high costs associated with this approach, and he pushed the company to adopt his One Ford strategy, Under this global standardization strategy Ford aims to design and sel the same models worldwide. The idea is to reap substantial cost reduction from sharing design costs, building on common platforms, sharing component parts across models, and build- ing cars in identical factories around the world to share tooling costs. To the extent that Ford can do ths, the company should be able to lower prices and still make good profits, Which should help it not only hold onto its share in developed markets but also gain share in rapidly growing emerging markets such as India and China. While there is a risk that, the lack of local customization will lead to some loss of sales at the margin, Mulally clearly feels that the benefits in terms of lower costs and more competitive pricing clearly outweigh those risks. Only time will tell if he is correct. (Strategy and the Firm ‘Before we discuss the strategies that managers in the multinational enterprise can pur- sue, we need to review some basic principles of strategy. A firm's strategy can be de- fined as the actions that managers take, to attain the goals of the firm, For most firms, the preeminent goal is to maximize the value of the firm for its owners and its share- holders (subject to the very important constraint that this is done in a legal, ethical, and socially responsible manner—see Chapter 5 for details). To maximize the value of a firm, managers must pursue strategies that increase the profitability of the enterprise and its rate of profit growth over time (see Figure 13.1). Profitability can be measured in a number of ways, but for consistency, we define it as the rate of return that the firm makes on its invested capital (ROIC), which is calculated by dividing the net profits of the firm by total invested capital. Profit-growth is measured by the percentage ‘The Strategy of Intemational Business Chapter 13 Profitability ‘Add Value and LL "| “Raise Prices Enterprise a Valuation _ | J SointreinEnisting | Markets: LL Profit Growth Enter New Markets increase in net profits over time. In general, higher profitability and a higher rate of profit growth will increase the value of an enterprise and thus the returns garnered by its owners, the shareholders.> "Managers can increase the profitability of the firm by pursuing strategies that lower costs or by pursuing strategies that add value to the firm's products, which enables the Jinn to raise prices. Managers can increase the rate at which the firm’s profits grow over time by pursuing strategies to sell more products in existing markets or by pursuing strat- egies to enter new markets, As we shall se, expanding internationally can help managers boost the firm's profitability and increase the rate of profit growth over time. VALUE CREATION ‘The way to increase the profitability of a firm is to.create more value. The amount of value a firm creates is measured by the difference bétween its costs.of production and the value that consumers perceive inits products. In general, the more value customers place on a firm's products, the higher the price the firm can charge for those products. However, the price a firm charges for a good or service is typically less than the value placed on that good or service by the customer. This is because the customer captures some of that value in the form of what economists call a consumer surplus," The cus- tomer is able to do this because the firm is competing with other firms for the custom- er’ business, so the firm must charge a lower price than it could were it a monopoly supplier, Also, it is normally impossible to segment the market to such a degree that the firm can charge each customer a price that reflects that individual's assessment of the value of a product, which economists refer to as a customer's reservation price. For these reasons, the price that gets charged tends to be less than the Value placed on the product by many customers. Figure 13.2 illustrates these concepts. The value of a product to an average consumer is V; the average price that the firm can charge a consumer for that product given competitive pressures and its ability to segment the market is P; and the average unit cost of producing that product is C (C comprises all relevant costs, including the firm's cost of capital). The firm’s profit per unit sold (p) is equal to P ~ C, while the consumer surplus per unitis equal to V~ P (another way of thinking of the consumer surplus is as “value for the money"; the greater the consumer surplus, the greater the value for the money the consumer gets). The firm makes a profit so long as P is greater than C, and 3a1 FIGURE 13.1 Determinants of Enterprise Value FIGURE 13.2 Value Creation —— __V=value of produit to an average consume: V-C P= price per unit VP C= cost of production per unit 7 V- P= consumer surplus per unit G P— C= profit per unit sold ~ V- C= value created per unit its profit will be greater the lower C is relative to P. The difference between V and P is in part determined by the intensity of competitive pressure in the marketplace; the lower the intensity of competitive pressure, the higher the price charged relative to V. In general, the higher the firm's profit per unit sold, the greater its profitability, all else being equal ‘The firm's value creation is measured by the difference between Vand C (VC) ‘company creates value by converting inputs that cost C into a product on which consumers place a value of V. A company can create more value (VC) either by lowering production costs, C, or by making the product more attractive through superior design, styling, functionality, features, reliability, after-sales service, and the like, so that consumers place a greater value on it (V increases) and, consequently, are willing to pay | ahigher price (P increases). This discussion suggests that a firm has high profits when it creates more value for its customers and does so at a lower cost. We refer to a strategy that focuses primarily on lowering production costs as a low-cost strategy. We refer to strategy that focuses primarily on increasing the attractiveness of a product as a, differentiation strategy® 4 Michael Porter has argued that low cost and differentiation are two basic strategies for creating value and attaining a competitive advantage in an industry.” According to Porter, superior profitability goes to those firms that can create superior value, and the way to create superior value is to drive down the cost structure of the business and/or differentiate the product in some way so that consumers value it more and are prepared to pay a premium price. Superior value creation relative to rivals does not necessarily requite a firm to have the lowest-cost structure in an industry, or to create the most valuable product in the eyes of consumers. However, it does require that the gap be- tween value (V) and cost of production (C) be greater than the gap attained by competitors. STRATEGIC POSITIONING Porter notes that it is important for a firm to be explicit about its choice. of stratezic is with regard to value creation (differentiation) and low cost, and to configure its ‘The convex curve in Figure 13.3 is what economists refer to as an efficiency. frontien, The efficiency frontier shows all of the different positions that a firm can adopt with regard to adding value to the product (V) and low cost (C) assuming that its internal op- erations are configured eificiently to support a particular position (note thatthe horizontal axis in Figure 13.3 is reverse scaled—moving along the axis to the right implies lower costs). The efficiency frontier has a convex shape because of diminishing returns Diminishing returns imply that when a firm already has significant value built into its product offering, increasing value by a relatively small amount requires significant The Strategy of Intern Cr _ Etfcioney Frontior Strategie Choices in This Area Not Vibe in international |. Hotel industry reased Value(itferentition (V) High Cost Low Cost) | Additional costs. The converse also holds, when a firm already has a low-cost structure, _ thas to give up a lot of value in its product offering to get additional cost reductions. Figure 13.3 plots three hotel firms with a global presence that cater to international | travelers, Four Seasons, Marriott International, and Starwood (Starwood owns the Sheraton and Westin chains). Four Seasons positions itself as a luxury chain and emphasizes the value of its product offering, which drives up its costs of operations. Marriott and Starwood are positioned more in the middle of the market, Both emphasize sullicient value to attract international business travelers, but are not Iuxury chains Tike Four Seasons. In Figure 13.3, Four Seasons and Marriott are shown to be on the efficiency frontier, indicating that their intemal operations are well configured to their strategy and nun efficiently. Starwood is inside the frontier, indicating that its operations are not_ running as efficieritly as they might be and that its.costs are too high. This implies that Starwood is less profitable than Four Seasons and Marriott and that its managers must take steps to improve the company’s performance. Porter emphasizes that itis very important for management to decile where the com- pany wants to be positioned with regard to value (V) and cost (C), to configure operations accordingly, and to manage them efficiently to make sure the firm is operating on the ef- ficiency frontier. However, not all positions on the efficiency frontier are viable. In the international hotel industry, for example, there might not be enough demand to support a chain that emphasizes very low, cost and strips all the value out of its product offering (see Figure 13,3), International travelers are relatively affluent and expect a degree of comfort (value) when they travel away from home. A centtal tenet of the basic strategy paradigm is that to maximize its profitability, a firm must do three things: (a) pick a position on the efficiency frontier that is viable in the sense that there is enough demand to support that choice; (b) configure its internal operations, such as manufacturing, marketing, logistics, information systems, human re- sources, and so on, so that they support that position; and (¢) make sure thatthe firm has the right organization structure in place to execute its strategy. The strategy, operations, and organization of the firm must all be consistent with each other if it és to attain a competitive advantage and garner superior profitability. By operations we mean the

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