I.

Starting International Operations

Fundamentals of legal entries/ entrance to global trade

agreements
Businesses operating in very competitive or almost saturated domestic markets are compelled
to consider international expansion. However, deciding to expand internationally should not
be taken lightly. Managers should consider whether the expansion would actually benefit
shareholders. If a company is unfamiliar with the new regions and the business methods
prevalent there, it is easy for them to underestimate the expenses of entering the new markets.
There are three basic decisions that firms make before expanding in foreign market:
1. Which market to enter,
2. When to enter the market and on what scale and,
3. How to Enter the Market

 Which Market to Enter?

The world’s 7.7 million people are located in 195 countries, 61 dependent areas like
Hong Kong, Puerto Rico, and 6 disputed teritories like Hong Kong and Puerto Rico.
But, these people dot hold the same profit potential for a form contemplating
foreign expansion.
There are four Key Factors in selecting global markets are:
1. Market’s size and growth rate.

-Market growth comparisons are a primary barometer of the progress of a

business. The market growth rate is a key factor to be considered when
calculating the development of a specific product in a particular market.
- Countries with a large market size justify the modes of entry with long-term
commitment requiring higher level of investment, such as wholly owned
subsidiaries or equity participation.
-firms invest more resources in markets with high growth potential
-The size of the market (in terms of demography), the current wealth
(purchasing power) of consumers in that market, and the probable future
wealth of consumers, which depends on economic growth rates, are all
factors that affect the long-term economic benefits of conducting business in
a country. Even if some markets such as China, India, and Indonesia, have
very big customer populations, one must also consider economic growth and
living standards. Accordingly, although being relatively impoverished, China
and, to a lesser extent, India, are expanding so quickly that they are desirable
destinations for foreign investment. Instead, Indonesia's sluggish
 development suggests that this large country is a much less desirable
destination for foreign investment.
-Companies that use a “global segment” approach to market selection, such as
Coca-Cola, Sony, or Microsoft, to name a few, therefore must manage two
dimensions for their brands. They must strive for superiority on basics like
the brand’s price, performance, features, and imagery, and, at the same time,
they must learn to manage brands’ global characteristics, which often
separate winners from losers. A good example is provided by Samsung, the
South Korean electronics maker. In the late 1990s, Samsung launched a
global advertising campaign that showed the South Korean giant excelling,
time after time, in engineering, design, and aesthetics. By doing so, Samsung
convinced consumers that it successfully competes directly with technology
leaders across the world, such as Nokia and Sony. As a result, Samsung was
able to change the perception that it was a down-market brand, and it became
known as a global provider of leading-edge technologies. This brand strategy,
in turn, allowed Samsung to use a global segmentation approach to making
market selection and entry decisions.

2. a particular country or region’s institutional contexts,

Institutional context refers to the analysis of a country’s :
(a) political and social systems,
(b) openness,
(c) product markets,
(d) labor markets, and,
(e) capital markets.

 The political system of a nation has an impact on its capital, labor, and product
markets. Workers cannot establish independent trade unions in socialist countries
like China, for example, which has an impact on wage levels. The social climate
of a nation is equally significant. The development of the capital market has been
impacted in South Africa, for instance, by the government's assistance for the
transfer of assets to the historically disadvantaged native African people.

 The more open a country’s economy, the more likely it is that global
intermediaries can freely operate there, which helps multinationals function more
effectively. From a strategic perspective, however, openness can be a double-
edged sword: a government that allows local companies to access the global
capital market neutralizes one of the key advantages of foreign companies.

 Recruiting local managers and other skilled workers in developing countries can
be difficult. The quality of local credentials can be hard to verify, there are
relatively few search firms and recruiting agencies, and the high-quality firms that
 do exist focus on top-level searches, so companies scramble to identify middle-
level managers, engineers, or floor supervisors.

 Capital and financial markets in developing countries often lack sophistication.

Reliable intermediaries like credit-rating agencies, investment analysts, merchant
bankers, or venture capital firms may not exist, and multinationals cannot count
on raising debt or equity capital locally to finance their operations.

 Future economic growth rates appear to be a function of a free market system and
a country’s capacity for growth (which may be greater in less developed nations).
the costs and risks associated with doing business in a foreign country are
typically lower in economically advanced and politically stable democratic
nations, and they are greater in less developed and politically unstable nationso.
Other things being equal, the benefit–cost–risk trade-off is likely to be most
favorable in politically stable developed and developing nations that have free
market systems, where there is no dramatic upsurge in either inflation rates or
private-sector debt. The trade-off is likely to be least favorable in politically
unstable developing nations that operate with a mixed or command economy or in
developing nations where speculative financial bubbles have led to excess
borrowing.

3. a region’s competitive environment

-Presence of competitors and their level of involvement in an overseas market

is another crucial factor in deciding on an entry mode so as to effectively
respond to competitive market forces. This is one of the major reasons behind
auto companies setting up their operations in India and other emerging
markets so as to effectively respond to global competition.
- The value that an international business can add to a foreign market is
another crucial consideration. This is dependent on the market fit of its
product offering and the type of local competitors. The value of the product to
consumers is likely to be significantly higher if the international business can
provide a product that has not previously been widely available in that market
and that fills an unmet need than if it merely offers the same kind of product
that domestic rivals and other foreign entrants are already providing. Greater
value enables the opportunity to set higher prices and/or accelerate the growth
of sales volume.
-A company can rate nations according to their attractiveness and potential for
long-term profit by taking these variables into account. Then, it gives
preference to accessing highly ranked markets. For instance, Tesco, a major
British supermarket chain, has been actively growing its international
operations recently, particularly by concentrating on developing areas with
weak domestic competitors.
 4. a market’s cultural, administrative, geographic, and economic distance from other
markets the company serves.

-The level of development of physical infrastructure such as roads, railways,

telecommunications, financial institutions, and marketing channels is a pre-
condition for a company to commit more resources to an overseas market.

 Timing and Scale

Once attractive markets have been identified, it is important to consider the timing of
entry. Just as many companies have overestimated market potential abroad and
underestimated the time and effort needed to create a real market presence, so have
they justified their overseas’ expansion on the grounds of an urgent need to participate
in the market early.
Arguing that there existed a limited window of opportunity in which to act, which
would reward only those players bold enough to move early, many companies made
sizable commitments to foreign markets even though their own financial projections
showed they would not be profitable for years to come. This dogmatic belief in the
concept of a first-mover advantage (sometimes referred to as “pioneer advantage”)
became one of the most widely established theories of business. We say that entry is
early when an international business enters a foreign market before other foreign
firms and late when it enters after other international businesses have already
established themselves.

Advantages Disadvantages
First Mover -Capture Market Shares Pioneering cost
-Experience Curve - cost of business failure
-Create switching costs - cost of promoting and
that tie customers to their establishing a product
products offering
Later Mover -Opportunity to free ride -Customer Loyalty
on first mover -Entry Barrier
investment
-Reduce probability of
failure

First Mover Advantages

-ability to preempt rivals and capture demand by establishing a strong brand
name.
 -ability to build sales volume in that country and ride down the experience curve
ahead of rivals, which enable the early entrant to cut prices below that of later
entrants, thereby driving them out of the market.
-ability to create switching costs that tie customers into their products or services.
Such switching costs make it difficult for later entrants to win business.

First Mover Disadvantage

pioneering costs
-arises when the business system in a foreign country is so different from that
in a firm’s home market that the enterprise has to devote considerable effort,
time, and expense to learning the rules of the game.
-include the costs of business failure, costs of promoting and establishing a
product offering, including the costs of educating customers
-An early entrant may be put at a severe disadvantage, relative to a later
entrant, if regulations change in a way that diminishes the value of an early
entrant’s investments. This is a serious risk in many developing nations where
the rules that govern business practices are still evolving. Early entrants can
find themselves at a disadvantage if a subsequent change in regulations
invalidates prior assumptions about the best business model for operating in
that country

Late Mover Advantage

-avoiding pioneering cost by riding on an early entrant’s investments in learning
and customer education by watching how the early entrant proceeded in the
market, entrant’s costly mistakes, and exploiting the market potential created by
the early entrant’s investments in customer education.
-Example, KFC introduced the Chinese to American-style fast food, but a later
entrant, McDonald’s, has capitalized on the market in China

Late Mover Disadvantage

-It's tough to compete with a subjective standard since first movers in an industry
set the benchmark for certain goods or services.
 -If the technology or products developed by first mover are protected through
patents and difficult to replicate, late-movers may find it difficult to catch up and
compete.

 Scale
The amount of resources committed to entering a foreign market.
When thinking about entering a market, a global corporation must also take the scale
of entry into account. Large-scale market entry necessitates the investment of
enormous resources and calls for quick entry.
Consider the entry of the Dutch insurance company ING into the U.S. insurance
market in 1999. ING had to spend several billion dollars to acquire its U.S.
operations. Not all firms have the resources necessary to enter on a large scale, and
even some large firms prefer to enter foreign markets on a small scale and then build
slowly as they become more familiar with the market.

Large Scale Entry

Positives
•Demonstrate commitment to markets and customers
- Significant assets and resources are needed for a large-scale foreign market entry,
which commits a firm to the market. The large scale of resources signals the firms
commitments to the market and customers.
•Brand Building
- make it easier for the company to attract customers and distributors The scale of
entry gives both customers and distributors reasons for believing that company will
remain in the market for the long run.
•Deters potential entrants
- The scale of entry may also give other foreign institutions considering entry into
the market a pause. Now they will have to compete not only against indigenous
institutions in the market, but also against an aggressive and successful foreign
company.

Negatives
•Limits strategic flexibility elsewhere
 - by committing itself heavily to the market, the company may have fewer
resources available to support expansion in other desirable market. The
commitment limits the company’s strategic flexibility
•Significant capital at risk
- Large scale means significant number of resources to invest which comes with a
great risk

Small Scale Entry

Positives
•Less costly
- by giving the firm time to collect information, small-scale entry reduces the risks
associated with a subsequent largescale entry. The risk-averse firm that enters a
foreign market on a small scale may limit its potential losses.
•Focus on organization learning
- Small-scale entry allows a firm to learn about a foreign market while limiting the
firm’s exposure to that market. Small-scale entry is a way to gather information
about a foreign market before deciding whether to enter on a significant scale and
how best to enter.

Negatives
•Lack of commitment
•Difficulties building market share
- The lack of commitment associated with small amount of investment may make it
more difficult for the small-scale entrant to build market share and to capture first-
mover or early-mover advantages.

 Modes of Entry

Once a firm decides to enter a foreign market, the question arises as to the best mode
of entry.

1. Exporting
 - refers to the sale of products and services in foreign countries that are sourced
from the home country.

- typically, the easiest way to enter an international market, and therefore most
firms begin their international expansion using this model of entry.

2 modes of exporting
 Direct Exporting
- is selling the products to a country directly through its distribution
arrangement or through a host country's company.
-occurs when a company actively seeks and conducts exporting.
-may still use agents and brokers from outside of the organization but the
manager

 Indirect Exporting
- is selling the products to a country directly through an intermediary that is
not part of the company
-sometimes called the casual or accidental exporting
-make us of agents and brokers who bring together sellers and buyers of
products in different countries

Advantages
1. Low Cost
-exporting avoids the often substantial costs of establishing manufacturing
operations in the host country.
2. Experience Curve and Location Economies
-Location Economies is the cost advantages from performing a value creation
activity at the optimal location for that activity.
 -Experience Curve is an economic term which means that the more a firm produces
of a particular good or service, the more it gains in efficiency. Thus, the cost of
production decreases in proportion to the volume of products produced.
-By manufacturing the product in a centralized location and exporting it to other
national markets, the firm may realize substantial scale economies from its global
sales volume

Disadvantage
1. Expensive
-exporting from the firm’s home base may not be appropriate if lower-cost locations
for manufacturing the product can be found, particularly for firms pursuing global or
transnational strategies, it may be preferable to manufacture where the mix of factor
conditions is most favorable from a value creation perspective and to export to the rest
of the world from that location

2. High Transport Cost

- high transport costs can make exporting uneconomical, particularly for bulk
products. One way of getting around this is to manufacture bulk products
regionally

3. Import Barrier
-Threat of tariff barriers by the host-country government can make it very risky for
exporting

4. Customer Loyalty
-when a firm delegates its marketing, sales, and service in each country where it does
business to another company. Local agents often carry the products of competing
firms and so have divided loyalties. In such cases, the local agent may not do as
good a job as the firm would if it managed its marketing itself. Similar problems can
occur when another multinational takes on distribution.

2. Licensing
-the granting of permission by the licenser to the licensee to use intellectual
property rights, such as trademarks, patents, brand names, or technology, under
defined conditions.
-The possibility of licensing makes for a flatter world because it creates a legal
vehicle for taking a product or service delivered in one country and providing a
nearly identical version of that product or service in another country.
-Under a licensing agreement, the multinational firm grants rights on its intangible
property to a foreign company for a specified period. The licenser is normally paid
 a royalty on each unit produced and sold. Although the multinational firm usually
has no ownership interests, it often provides ongoing support and advice.

Advantages
1. Income without overhead
- In the typical international licensing deal, the licensee puts up most of the
capital necessary to get the overseas operation going. Thus, a primary
advantage of licensing is that the firm does not have to bear the
development costs and risks associated with opening a foreign market
2. Fast entry
-licensing is also often used when a firm wishes to participate in a foreign
market but is prohibited from doing so by barriers to investment. This was
one of the original reasons for the formation of the Fuji–Xerox joint
venture in 1962. Xerox wanted to participate in the Japanese market but
was prohibited from setting up a wholly owned subsidiary by the Japanese
government. So Xerox set up the joint venture with Fuji and then licensed
its know-how to the joint venture.
3. Low Risk
-licensing is frequently used when a firm possesses some intangible
property that might have business applications, but it does not want to
develop those applications itself. For example, Bell Laboratories at AT&T
originally invented the transistor circuit in the 1950s, but AT&T decided it
did not want to produce transistors, so it licensed the technology to a
number of other companies, such as Texas Instruments. Similarly, Coca-
Cola has licensed its famous trademark to clothing manufacturers, which
have incorporated the design into clothing.

Disadvantages
1. Risk of IP theft
2. Revenue not guaranteed
3. Risk of diminished reputation
Most firms wish to maintain control over how their know-how is used, and a firm
can quickly lose control over its technology by licensing it. Many firms have
made the mistake of thinking they could maintain control over their know-how
within the framework of a licensing agreement. RCA Corporation, for example,
once licensed its color TV technology to Japanese firms including Matsushita and
 Sony. The Japanese firms quickly assimilated the technology, improved on it, and
used it to enter the U.S. market, taking substantial market share away from RCA

3. Franchising
- firm grants rights on its intangible property, like technology or a brand name, to
a foreign company for a specified period of time and receives a royalty in return.

Advantages
1. Low Risk
- The franchisor is relieved of many of the costs and risks of opening a
foreign market on its own. Instead, the franchisee typically assumes those
costs and risks.
2. Fast expansion
-a firm can build a global presence quickly and at a relatively low cost
and risk by using franchising as a mode of entry

Disadvantages
1. Quality Control
- The foundation of franchising arrangements is that the firm’s brand
name conveys a message to consumers about the quality of the firm’s
product. Thus, a business traveler checking in at a hotel in Hong Kong
can reasonably expect the same quality of room, food, and service that
she would receive in the same hotel located at New York. The Hotel
name/brand is supposed to guarantee consistent product quality.
4. Joint Venture
A joint venture is a contractual, strategic partnership between two or more
separate business entities to pursue a business opportunity together. The partners
in a joint venture each contribute capital and resources in exchange for an equity
stake and share in any resulting profits

Advantages
1. Knowledge and support from a local partner
-a firm benefit from a local partner’s knowledge of the host country’s
competitive conditions, culture, language, political systems, and
business systems
2. Shared Risk and Cost
- 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 countries, political considerations make joint ventures
the only feasible entry mode. Research suggests joint ventures with
local partners face a low risk of being subject to nationalization or
other forms of adverse government interference. This appears to be
because local equity partners, who may have some influence on host-
government policy, have a vested interest in speaking out against
nationalization or government interference.

Disadvantage

1. Core Technology may be loss

-as with licensing, a firm that enters into a joint venture risks giving
control of its technology to its partner. The local partner may gain the
know-how to produce its own competitive product or service to rival the
multinational firm
2. Less Control
-A joint venture does not give a firm the tight control over subsidiaries that
it might need to realize experience learning curve or location economies.
Nor does it give a firm the tight control over a foreign subsidiary that it
might need for engaging in coordinated global attacks against its rivals.
3. Conflict
- shared ownership arrangement can lead to conflicts and battles for control
between the investing firms if their goals and objectives change or if they
take different views as to what the strategy should be
5. Wholly Owned Subsidiary
Firms may want to have a direct operating presence in the foreign country,
completely under their control. To achieve this, the company can establish a new,
wholly owned subsidiary from scratch, or it can purchase an existing company in
that country.

2 types of Wholly owned subsidiary

 Acquisitions
-An acquisition is a form of investment where a firm gains control of
another firm by purchasing its stock, exchanging the stock for its own, or,
in the case of a private firm, paying the owners a purchase price. In recent
years, cross border acquisitions have made up over 60 percent of all
acquisitions completed worldwide. Many studies have shown that between
40 percent and 60 percent of all acquisitions fail to increase the market
value of the acquired company by more than the amount invested

 Greenfield ventures
-a cross border investment where the parent company builds from
scratch and fully owns its subsidiary. It requires purchase of local
property, assets and hire of local man power.

The choice between acquisitions and greenfield ventures is clearly

not an easy one. Both modes have their advantages and
disadvantages. In general, the choice will depend on the
circumstances confronting the firm. If the firm is seeking to enter a
market where there are already well-established incumbent
enterprises, and where global competitors are also interested in
establishing a presence, it may pay the firm to enter via an
acquisition. In such circumstances, a greenfield venture may be too
slow to establish a sizable presence. However, if the firm is going
to make an acquisition, its management should consider the risks
associated with acquisitions that were discussed earlier when
determining which firms to purchase. It may be better to enter by
the slower route of a greenfield venture than to make a bad
acquisition. If the firm is considering entering a country where
there are no incumbent competitors to be acquired, then a
greenfield venture may be the only mode.

Advantages
1. Tight Control
 -when a firm’s competitive advantage is based on technological
competence, a wholly owned subsidiary will often be the preferred entry
mode because it reduces the risk of losing control over that competence. A
wholly owned subsidiary gives a firm tight control over operations in
different countries. This is necessary for engaging in global strategic
coordination
2. Economy of Scale
-A wholly owned subsidiary may be required if a firm is trying to realize
location and experience curve economies (as firms pursuing global and
transnational strategies try to do). When cost pressures are intense, it may
pay a firm to configure its value chain in such a way that the value added
at each stage is maximized. Thus, a national subsidiary may specialize in
manufacturing only part of the product line or certain components of the
end product, exchanging parts and products with other subsidiaries in the
firm’s global system. Establishing such a global production system
requires a high degree of control over the operations of each affiliate. The
various operations must be prepared to accept centrally determined
decisions as to how they will produce, how much they will produce, and
how their output will be priced for transfer to the next operation. Because
licensees or joint-venture partners are unlikely to accept such a
subservient role, establishing wholly owned subsidiaries may be
necessary. Finally, establishing a wholly owned subsidiary gives the firm
a 100 percent share in the profits generated in a foreign market.

Disadvantages
1. Huge Sunk Cost and High Risk
-Establishing a wholly owned subsidiary is generally the most costly
method of serving a foreign market from a capital investment standpoint.
Firms taking this approach must bear the full capital costs and risks of
setting up overseas operations. The risks associated with learning to do
business in a new culture are less if the firm acquires an established host-
country enterprise. However, acquisitions raise additional problems,
including those associated with trying to marry divergent corporate
cultures. These problems may more than offset any benefits derived by
acquiring an established operation.

SOURCES:
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marketplace/Charles W. L. Hill.—8th ed
https://www.yourarticlelibrary.com/international-marketing/2-factors-affecting-the-selection-
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modes-of-en.html
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%20strategies_20170710150750.pdf
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