Week 11:

Entry Modes ->

Management from an
Economics Perspective

BSP 2005 Asian Business

Environments
Instructor: Peter Zeitz

Advantages and Drawbacks of

Entry Modes
The so-called advantages and drawbacks of
entry modes are generalizations.
Decentralized modes such as turnkey plants,
licensing, franchising tend to facilitate rapid
expansion, but can involve a loss of control
over technology, brand perceptions, pricing,
etc.
These are tendencies and not universal laws.

There are counterexamples.

Rapid expansion itself can be a means of securing
greater control.

Licensing
Meta-exporting with need for IPR instead of exporting a
good, export the intangible right to make a good
Advantages
Overcomes transport cost obstacle
Maximizes return to core knowledge asset

Drawbacks
Requires sophisticated IPR protections in target market.
Limited control over how technologies are used.
Limited ability to coordinate use of knowledge assets to pursue
global and market-specific strategies
May not create a durable strategic advantage in a specific market.

Mitigation Strategies
Cross-licensing is a relationship-based substitute for IPR enforcement.
Complex use restrictions can be applied where they are enforceable.

Back to VCR example

Sony employs market-leading Betamax technology and is
reluctant to license manufacturing rights to other firms.
Concerned about loss of technological advantage.

JVC is crafty upstart (but with backing from Matsushita) and

inferior VHS technology
Aggressively licenses VHS tech to other consumer electronics firms and
accepts lower margins.
Can expand manufacturing of VHS machines much more rapidly through
this strategy.

Competition between licensees drives down VHS prices and VHS

market share grows as VCRs become widely adopted
Superior Betamax tech is driven out of the world market due to network
externality.
Japan is the only exception.

Here, licensing and rapid expansion become a means for JVC to control the
set of technologies and product features available on the market.

Franchising
Meta-exporting with need for IPR and monitoring
instead of exporting a good, export the intangible right
to make a good and monitor how this right is used.
Advantages
Overcomes transport cost obstacle
Increases return to core knowledge asset (typically a brand
reputation here)
Some ability to coordinate use of knowledge assets to pursue
global and market-specific strategies

Drawbacks
Requires moderate IPR protections in target market.
Increased monitoring/management costs relative to licensing

Joint-Venture
Multinational manages and owns assets jointly with local partner.
Advantages
Sometimes used as a legal way to purchase an entry right from a host
country government
Can acquire knowledge necessary to localize product or production
process to target market
Some ability to coordinate use of knowledge assets to pursue global and
market-specific strategies
Less complex IPR requirements

Drawbacks
Increased monitoring/management costs.
Risk of expropriation of physical assets.
Potential leakage of knowledge to host country partner.
Can come into conflict with local partner which may have different
strategic objectives.

Wholly-owned
Multinational owns and controls foreign subsidiary.
Advantages
Strongest ability to coordinate use of knowledge assets to
pursue global and market-specific strategies
Ability to use trade secrets to reduce IPR requirements but
these remain greater than turnkey projects or exporting

Drawbacks
Increased monitoring/management costs.
Can lack knowledge necessary to localize product or
production process to target market.
Risk of expropriation of physical assets.
Heightened political risk relative to joint-venture.

How can we relate management to the

economic theories we have discussed?
Earlier in the course, we discussed the aggregate
production function and the concepts of human capital,
physical capital, and total factor productivity.
How can we incorporate management in this framework?

Total factor productivity captures everything that is not

explained by other factors.
So effects of management may enter TFP
But TFP reflects a mix of factors, how could we measure
management effects more specifically?

Management and human capital are clearly related.

So effects of management may enter through human capital as
well.
How could we distinguish the contributions of management and
human capital?

General Human Capital vs.

Firm-specific Human Capital
General Human Capital Employee skills valued by multiple
potential employers
Employee can shop around for best salary and has strong bargaining
power
Wages fully reflect the value of employees general skills

Firm-specific human capital Specialized employee skills valued

by single employer
Only exists in the context of a specific employer-employee relationship
Created by matching employers specialized needs with employees
specialized skills
Created by training employees to develop specialized skills
Creates a matching rent divided between employer and employee
These matching rents contribute to the value of the firm and are a
component of effective management.
Acqui-hiring in Silicon Valley

Resource Prices and

Economic Contributions
The economic contributions of resources are
reflected in their market prices.
General Human Capital -> employee wage
Physical Capital -> market value of physical asset
Intellectual Property -> market value of patent portfolio
and licensing rights, imputed value of R&D expenditure
Management and Firm-specific human capital -> firm
valuation not accounted for by ownership of physical
capital and intellectual property
Total Factor Productivity associated with location ->
affects prices of immobile factors (land component of
physical capital, wage, location economies component of
firm valuation)

Organizational Capital
Organizational Capital Value firms create
by combining specialized resources and
developing management systems.
Used to quantify management contribution
indirectly
A measure of firms competitive advantage

Firms Market Value = Value of Physical

Assets + Value of Intellectual Property +
Organizational Capital

Organizational Capital Among US

Firms
Physical Capital
IP
Organizational Capital

Physical Capital
IP
Organizational Capital

Direct Approaches to
Measuring Management
Assigned reading employs a direct approach to
quantifying the contribution of management.
Initial Steps
Design survey and interview procedure to assess
implementation of managerial best practices
Administer survey in over 9000 firms around the
world to generate managerial performance scores

Validate Construct
Demonstrate relationship of management scores to
general firm performance measures
Total Factor Productivity, Return on Assets

Theoretical Issues in this

approach
Universal definition of good and bad management
Divided into three distinct components:
monitoring, targets, incentives

Based on lead authors experience at McKinsey

Different approach from strategy/contingent

management view.
Contingent Management: Every organization is optimally
adopting its practices to the situation it finds itself in
Here, the authors are focused on universal best practices.

Their survey approach would not capture value

creation associated with adaptation of management
to a specific context.

Survey of Management Practice

Monitoring

Survey of Management Practice

Targets

Survey of Management Practice

Incentives

Some Stylized Facts

Some Stylized Facts

Some Stylized Facts

Some Stylized Facts

Some Stylized Facts

Some Stylized Facts

Some Stylized Facts

Construct Validation