Modes of Entry In Foreign markets

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Introduction

Entry decisions will heavily influence the firms other functional decisions.

Decision Criteria for Mode of Entry

External Factors
Market Size and Growth Risk Government Regulations Competitive Environment Local Infrastructure

Internal factors
Company Objectives Need for Control Internal Resources, Assets and Capabilities Flexibility

physical factors

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Modes of Entry Decision Factors Ownership Advantages Location Advantages Internalization Advantages

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Modes of Entry

Exporting
Direct Exports Indirect Exports Intracorporate Transfers

Strategic Alliance Foreign Investment

Green Field Investments Joint Ventures Mergers & Acquisitions Portfolio Investment

Licensing Franchising Contract Manufacturing Management Contract Turnkey Projects

Counter-trade
Pure Barter Buy Back Counter Purchase

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The Firm & Its Competitive Advantage

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Entry Modes - Exporting

Advantages Avoids the often substantial cost of establishing manufacturing May help firm achieve experience curve & location economies Firm may manufacture in centralized location & export to other national markets to realize scale economies from global sales volume (Sony/TV, Matsushita/VCR, Samsung/Chips) Disadvantages Not appropriate in lower cost manufacturing locations High transport costs can make exporting uneconomical especially bulk products Tariff barriers can make exporting uneconomical If firm delegates marketing, sales & service to another company they may have divided loyalties because they carry competing products or are a large MNE Can set up wholly owned subsidiaries to handle local marketing & sales -> can exercise tight control while reaping cost advantage of manufacturing in a single location

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Licensing Under International Licensing, a firm in one country (the licensor) permits a firm in another country (the licensee) to use its intellectual property. These knowledge may be registered publicly, for example in the form of a patent or trademark, as a means of establishing ownership rights. Or, it may be retained within the firm: referred to as know-how, it is commonly based on operational experience.
IFB washing machine was manufactured in India under license from Bosch of Germany. Nike entered Indian Market in mid 1990s by licensing. Tommy Hilfiger corporation entered into licensing agreement with Arvind Mills for selling its product in India.
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Licensing
The licensee usually makes a lump sum payment. Additionally there is normally a royalty rate which tends to vary around a rule of thumb of 5%, depending on the type of industry and rate of technological change. A minimum performance clause is considered essential and some firms allow the licensee a period of grace' to get production and marketing started. There are also some companies that agree on a cross-licensing deal, whereby they just swap licenses instead of paying. There can also be a cross licensing agreement According to UNCTAD, flows of royalties and license fee receipts amounted to US$ 72 billion in 2001.

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Licensing
Licensing is often used where there is a barrier to trade or constraints on and risk in foreign investment. Licensing can serve as a Trojan Horse in the meaning that it opens the possibility for a company to enter a foreign market where it otherwise might have been forbidden. Problems with licensing is that it can create a potential competitor, and that it's often seen as a lastresort strategic alliance when other options are not available.

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Entry Mode - Licensing

Advantages

Disadvantages

Receive royalties for granting the rights to intangible property to licensee for specified period (patents, inventions, formulas, processes, designs, copyrights, trademarks) Licensee puts up most of the capital to get the operations going mitigates development cost & risk Allows firm to participate where there are barriers to investment (FujiXerox) Frequently used when firm possesses intangible property but does not want to develop the business application itself (Coco-Cola/clothing) Primarily used by manufacturing firms

Does not give firm tight control over manufacturing, marketing & strategy to realize experience curve & location economies Does not allow firm to coordinate strategic moves across countries by using profits earned in one country for competitive attacks in another Firms can lose control over the competitive advantage of their technological know-how.
Cross-licensing can mitigate risk by holding each other hostage for misuse Firms can reduce risk by forming a joint venture with each party taking equity stakes

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Franchising

A franchise agreement is an arrangement whereby a parent company (the franchisor) grants another independent (the franchisee) the right to do business in a prescribed manner. The right can take the form of selling the franchisors product. Using its name, production & marketing techniques, or general business approach.
Coca cola supplying the syrup to bottlers.

A franchise agreement will usually specify the given territory the franchisee can use as well as the extent to which the franchisee will be supported by the franchisor (e.g. training and marketing campaigns). Most franchisee agreements, however, do not provide the franchisee with exclusive control over the given territory. Cross or reverse franchise agreements
ITC Hotels & ITT Sheraton

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Franchising: Advantages

As practiced in retailing, franchising offers franchisees the advantage of starting up a new business quickly based on a proven trademark and formula of doing business, as opposed to having to build a new business and brand from scratch (often in the face of aggressive competition from franchise operators). As long as their brand and formula are carefully designed and properly executed, franchisors are able to expand their brand very rapidly across countries and continents, and can reap enormous profits in the process, while the franchisees do all the hard work of dealing with customers face-to-face. Additionally, the franchisor is able to build a captive distribution network, with no or very little financial commitment.
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Franchising: Disadvantages
For franchisees, the main disadvantage of franchising is a loss of control. While they gain the use of a system, trademarks, assistance, training, and marketing, the franchisee is required to follow the system and get approval of changes with the franchisor. Another problem is that the franchisor/franchisee relationship can easily give rise to litigation if either side is incompetent (or just not acting in good faith). For example, an incompetent franchisee can easily damage the public's goodwill towards the franchisor's brand by providing inferior goods and services, and an incompetent franchisor can destroy its franchisees by failing to promote the brand properly or by squeezing them too aggressively for profits.

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Contract Manufacturing
Under

Contract Manufacturing, a company enters into contracts with foreign countries to manufacture or assemble the product while retaining the responsibility of marketing the product.
Hindustan Lever, Godrej soaps, produced Dettol for Reckitt & coleman; Johnson baby soaps for Johnson & Johnson; and Ponds Dreamflower, Cold Cream, and Sandalwood for Ponds.
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Contract Manufacturing Advantages

Company

does not have to commit resources for setting up production facilities. Freedom from risk of investing in foreign countries If idle production capacity is readily available, it enables the marketer to get started immediately. Cost of production is lower. Less risky way to start witheasy to drop if the business is not profitable.
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Contract Manufacturing

Disadvantages
In some cases, there might be loss in potential profit from manufacturing. Less control over manufacturing process. Risk of developing potential competitors. Not suitable in case of high-tech products and cases which involve technical secrets.

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Management Contracts

A management contract is an arrangement under which operational control of an enterprise is vested by contract in a separate enterprise which performs the necessary managerial functions in return for a fee.
Tata Tea

Management contracts involve not just selling a method of doing things (as with franchising or licensing) but involves actually doing them. A management contract can involve a wide range of functions, such as technical operation of a production facility, management of personnel, accounting, marketing services and training.
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Management Contracts
Many hotels, especially in Asia, operate under management contract arrangements, as they can more easily obtain economies of scale, a global reservation systems, brand recognition etc. It is not unusual for contracts to be signed for 25 years, and having a fee as high as 3.5% of total revenues and 6-10% of gross operating profit. Management contracts have been used to a wide extent in the airline industry, and when foreign government action restricts other entry methods. Management contracts are often formed where there is a lack of local skills to run a project. It is an alternative to foreign direct investment as it does not involve as high risk and can yield higher returns for the company.

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Turnkey Projects
An

agreement by the seller to supply a buyer with a facility fully equipped and ready to be operated by the buyer's personnel, who will be trained by the seller. Many Turnkey contracts involve Government/public sector as buyer.

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Entry Modes Turnkey Project

Advantages

Disadvantages

Means of exporting process technology (chemical, pharmaceutical, petroleum, mining) Know-how to assemble & run technologically complex process is valuable asset earn economic benefit from asset Strategy useful where governments restrict FDI - less risky than conventional FDI

Firm has no long term interest in the country can take minority equity interest in company Firm may inadvertently create a competitor (middle east oil refineries) If firms process technology is a source of competitive advantage, then selling technology is also selling competitive advantage to potential competitors

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Strategic Alliances
Strategic Alliances (SAs)
Typically a collaborative arrangement between firms, sometimes competitors, across borders
Based

on sharing of vital information, assets, and technology between the partners Have the effect of weakening the tie between potential ownership advantages and company control

Equity Strategic Alliances

Joint Ventures

Non-equity Strategic Alliances

Distribution Alliances Manufacturing Alliances Research and Development Alliances
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Foreign Investment
Foreign Investment

Foreign Direct Investment

Portfolio Investment

Wholly Owned Subsidiary

Joint Ventures

Mergers & Acquisitions

Investment by FIIs

Investment in GDRs, FDRs, FCCBs, etc

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Foreign Direct Investment

Defined as Investment made to acquire lasting interest in enterprises operating outside of the economy of the investor.
Consists of a parent enterprise & a foreign affiliate, which together for a Transnational corporation (TNC). Investment must afford the parent enterprise control over its foreign affiliate (10% or more of ordinary shares or voting power) Can be Inward Directed or Outward Directed; Also can be classified as Horizontal FDI & Vertical FDI (Backward vertical & Forward Vertical)
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Foreign Direct Investment

Foreign Direct Investment is now more important than trade as a vehicle of international transactions. Once a firm undertakes FDI it become a multinational enterprise Overseas production facilities comprise a large and increasingly vital part of international business Why is FDI growing at faster rates than trade?
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Motives for FDI

Market-seeking (market size, market growth, access to regional markets) Resource-seeking (raw materials, natural resources, low-cost skilled labour, knowledge, technology) Efficiency-seeking (cost of resources under above adjusted for productivity, transport /communication costs, membership of regional integration agreements/trading blocks)

These Categories are not mutually exclusive

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Greenfield or Acquisition

Greenfield
better ability to build organization you want Easier to establish own culture & operating routine Do not have revenue & profit history Slower to establish need to understand how to do business in that country

Acquisition
50%-80% of FDI is acquisition Quick to execute rapidly build presence Acquisitions can preempt competition Buying known revenue & profit stream Need to marry divergent corporate cultures
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Foreign Investment in India

India's direct investment abroad was initiated in 1992. Streamlining of the procedures and substantial liberalization has been done since 1995. As of now, Indian corporate/Registered partnership firms are allowed to invest abroad up to 100% of their net worth and are permitted to make overseas investments in business activity.

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WHAT GOLDMAN SACHS HAS TO SAY ABOUT INDIA

India has the potential to show the fastest growth over the next 30 and 50 years Growth could be higher than 5% over the next 30 years and close to 5% as late as 2050 India has the potential to raise its US dollar income per capita in 2050 to 35 times its current level Indias GDP will exceed Italys in 2016, Frances in 2019, Germanys in 2023 and Japans in 2032 2nd most attractive destination A. T. Kearney Business Confidence Index, 2005 2nd most attractive investment destination among TNCs UNCTADs World Investment report, 2005 Most Attractive location for offshoring of service activities A. T. Kearney Global Services Location Index, 2005
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FOREIGN DIRECT INVESTMENT - PROHIBITED SECTORS

Foreign direct investment is prohibited in the following cases: Gambling and Betting Lottery Business Retail Trading (except single brand retail trading-not provided in Master Circular) Atomic Energy Agriculture (with certain exceptions) and Plantations (Other than Tea plantations
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ENTRY STRATEGIES FOR FOREIGN INVESTOR

Foreign Company has the following options to set up business operations in India :

By incorporating a company under the Companies Act, 1956 A wholly owned subsidiary Joint venture company - existing company or new company with domestic partner
As an unincorporated entity Liaison Office Project Office Branch Office
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Liberalization of foreign direct investment norms

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Liberalization of foreign direct investment norms

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Liberalization of foreign direct investment norms

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Joint Ventures
A joint venture is a strategic alliance between two or more parties to undertake economic activity together. The parties agree to create a new entity together by both contributing equity, and they then share in the revenues, expenses, and control of the enterprise. The venture can be for one specific project only, or a continuing business relationship such as the Sony Ericsson joint venture.

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Reasons for Forming JVs

Internal reasons
1. 2.

3.
4. 5.

Spreading costs and risks Improving access to financial resources Economies of scale and advantages of size Access to new technologies and customers Access to innovative managerial practices

Competitive goals
1.

2.
3. 4. 5. 6.

Influencing structural evolution of the industry Pre-empting competition Defensive response to blurring industry boundaries Creation of stronger competitive units Speed to market Improved agility

Strategic goals
1. Synergies 2. Transfer of technology/skills 3. Diversification

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Joint Ventures
Advantages

Disadvantages

Typically 50/50 with contributed team of managers to share operating control Firm benefits from local partners knowledge of competitive conditions, culture, language, political system & business system Sharing market development costs & risks with local partner In some countries, political considerations make JVs the only feasible entry mode

Risk of giving away your technology to a partner Hold majority ownership for more control in venture Wall-off technology that is central to your core competency Does not give firm control over subsidiaries that it might need to realize experience curve or location economies Global strategic coordination firm use JV for checking competitor market share and limiting cash available for invading other markets (TI & Japan) Shared ownership can lead to conflicts & battles for control if goals/objectives change or they take different views on strategy
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Joint venture versus wholly owned subsidiary

Some advantages of a MNE working with a local joint venture partner are:
Better understanding of local customs, mores and institutions of government Providing for capable mid-level management Some countries do not allow 100% foreign ownership Local partners have their own contacts and reputation which aids in business

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Joint venture versus wholly owned subsidiary

However, joint ventures are not as common as 100%owned foreign subsidiaries as a result of potential conflicts or difficulties including:
Increased political risk if the wrong partner is chosen Divergent views about the need for cash dividends, or the best source of funds for growth (new financing versus internally generated funds) Transfer pricing issues Difficulties in the ability to rationalize production on a worldwide basis
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Cross-Border Mergers & Acquisitions

Mergers & acquisition refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business entity. Cross-border mergers, acquisitions, and strategic alliances all face similar challenge: they must value the target enterprise on the basis of its projected performance in its market. An enterprises potential value is a combination of the intended strategic plan and the expected operational effectiveness to be implemented post-acquisition.
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Cross-Border Mergers and Acquisitions

The number and dollar value of cross-border mergers and acquisitions (M&A) have grown rapidly in recent years, but the growth and magnitude of activity are taking place in the developed countries, not developing countries. Among the developing regions of the world, crossborder M&A activity has been focused nearly exclusively on Latin America and Asia. West Asia, Eastern Europe and Africa have largely been bypassed in the international rush to acquire.
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Merger Synergies

The

key principle behind buying or merging a company is to create shareholders value over and above that of the sum of the two companies. They intend to create value through either revenue synergies or cost synergies

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Merger Synergies
Revenue

synergy implies the increased cash flows (revenue gains) of the merged entity because of its ability to cross-sell products and services, better leverage the sales channels and marketing programmes, offer products at a higher selling prices and other similar competitive advantages.
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Merger Synergies
Cost synergies deal with reduced cash outflows (cost savings) from economies of scale, reduction in capital expenditures, production efficiencies, elimination of duplicate costs in areas such as R&D, administration etc. 70% of the mergers fall short in achieving their revenue targets and 40% face cost synergy disappointments Where Mergers Go Wrong, McKinsey & Co

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The Cross-Border Acquisition Strategy

The process of acquiring an enterprise anywhere in the world has three common elements: Identification and valuation of the target Completion of the ownership change transaction (the tender) Management of the post-acquisition transition
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Cross-Border Mergers and Acquisitions

As opposed to a greenfield investment, a crossborder acquisition has a number of significant advantages. First, it is quicker (shortening the time required to gain a presence and facilitate competitive entry into the market). Second, acquisition may be a cost-effective way of gaining competitive advantages such as technology, brand names, and/or logistic/distribution capabilities while eliminating a local competitor. Third, specific to cross-border acquisitions, international economic, political, and foreign exchange conditions may result in market imperfections, allowing target firms to be undervalued.
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Cross-Border Mergers and Acquisitions

Cross-border acquisitions are not, however, without their pitfalls. There are still problems with paying too much or suffering excessive financing costs. Melding corporate cultures can also be traumatic. In addition, management of the post-acquisition process is extremely difficult to do successfully. Internationally, additional difficulties arise from host governments intervening in pricing, financing, employment guarantees, market segmentation, and general nationalism and favoritism.
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