Global Business Today 6e

by Charles W.L. Hill

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 12
Entering Foreign
Markets
 Introduction

Question: How can firms enter foreign markets?

 Firms can enter foreign markets through
 exporting
 licensing or franchising to host country firms
 a joint venture with a host country firm
 a wholly owned subsidiary in the host
country to serve that market
 The advantages and disadvantages of each
entry mode is determined by
 transport costs and trade barriers
 political and economic risks
 firm strategy

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 Basic Entry Decisions

Question: What are the basic entry

decisions for firms expanding
internationally?

 A firm expanding internationally must

decide
which markets to enter
when to enter them and on what scale
how to enter them (the choice of entry
mode)
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 Which Foreign Markets?

 Firms need to assess the long run profit

potential of each market
 The most favorable markets are politically
stable developed and developing nations with
free market systems, low inflation, and low
private sector debt
 The less desirable markets are politically
unstable developing nations with mixed or
command economies, or developing nations
where speculative financial bubbles have led to
excess borrowing
 Success firms usually offer products that have
not been widely available in the market and that
satisfy an unmet need
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 Timing of Entry

 After a firm identifies which market to

enter, it must determine the timing of
entry
 Entry is early when an international
business enters a foreign market before
other foreign firms
 Entry is late when a firm enters after
other international businesses have
already established themselves in the
market

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 Timing of Entry

 Firms entering a market early can gain first

mover advantages including
 the ability to pre-empt rivals and capture
demand by establishing a strong brand name
 the ability to build up sales volume in that
country and ride down the experience curve
ahead of rivals and gain a cost advantage
over later entrants
 the ability to create switching costs that tie
customers into their products or services
making it difficult for later entrants to win
business

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 Timing of Entry

 First mover disadvantages are the

disadvantages associated with entering a
foreign market before other international
businesses
 These may result in pioneering costs (costs that
an early entrant has to bear that a later entrant
can avoid) such as
 the costs of business failure if the firm, due
to its ignorance of the foreign environment,
makes some major mistakes
 the costs of promoting and establishing a
product offering, including the cost of
educating the customers

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 Scale of Entry
and Strategic Commitments

 Firms that enter foreign markets on a significant

scale make a major strategic commitment that
changes the competitive playing field
 This involves decisions that have a long term
impact and are difficult to reverse
 Small-scale entry can be attractive because it
allows the firm to learn about a foreign market,
but at the same time it limits the firm’s exposure
to that market

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 Summary

 There are no “right” decisions with

foreign market entry, just decisions that
are associated with different levels of risk
and reward
 Firms in developing countries can learn
from the experiences of firms in
developed countries

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Classroom Performance System

The time and effort in learning the rules of

a new market, failure due to ignorance,
and the liability of being a foreigner are all
examples of
a) First mover advantages
b) Strategic commitments
c) Pioneering costs
d) Market entry costs

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 Entry Modes

Question: What is the best way to enter a foreign

market?
 Firms can enter foreign market through
1. Exporting
2. Turnkey projects
3. Licensing
4. Franchising
5. Joint ventures
6. Wholly owned subsidiaries
 Each mode has advantages and
disadvantages

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 Exporting

1. Exporting is often the first method firms use to

enter foreign market
 Exporting is attractive because
 it is relatively low cost
 firms may achieve experience curve
economies
 Exporting is not attractive when
 lower-cost manufacturing locations exist
 transport costs are high
 tariff barriers are high
 foreign agents fail to in the exporter’s best
interest
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 Turnkey Projects

2. Turnkey projects involve a contractor

that agrees to handle every detail of the
project for a foreign client, including the
training of operating personnel
 At completion of the contract, the foreign
client is handed the "key" to a plant that
is ready for full operation

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 Turnkey Projects

Turnkey projects are attractive because

 They allow firms to earn great economic
returns from the know-how required to
assemble and run a technologically complex
process
 They are less risky in countries where the
political and economic environment is such
that a longer-term investment might expose
the firm to unacceptable political and/or
economic risk
 Turnkey projects are not attractive when
 The firm's process technology is a source of
competitive advantage

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 Licensing

3. Licensing is an arrangement whereby a licensor grants

the rights to intangible property to another entity (the
licensee) for a specified time period, and in return, the
licensor receives a royalty fee from the licensee
 Intangible property includes patents, inventions,
formulas, processes, designs, copyrights, and
trademarks
 Licensing is attractive when
 The firm does not have to bear the development costs
and risks associated with opening a foreign market
 The firm avoids barriers to investment
 It allows a firm with intangible property that might
have business applications, but which doesn’t want to
develop those applications itself, to capitalize on
market opportunities

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 Licensing

 Licensing is unattractive when

 the firm doesn’t have the tight control over
manufacturing, marketing, and strategy
necessary to realize experience curve and
location economies
 the firm’s ability to coordinate strategic
moves across countries by using profits
earned in one country to support competitive
attacks in another is compromised
 There is the potential for loss of proprietary (or
intangible) technology or property
 To reduce this risk, firms can use cross-
licensing agreements or link the agreement
with the decision to form a joint venture
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 Franchising

4. Franchising is a form of licensing in which the

franchisor sells intangible property to the
franchisee, and requires the franchisee agree to
abide by strict rules as to how it does business
 Franchising is attractive because
 firms avoid many costs and risks of opening
up a foreign market
 Franchising is unattractive because
 It may inhibit the firm's ability to take profits
out of one country to support competitive
attacks in another
 the geographic distance of the firm from its
foreign franchisees can make poor quality
difficult for the franchisor to detect
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 Joint Ventures

5. Joint ventures involve the establishment of a

firm that is jointly owned by two or more
otherwise independent firms
 Joint ventures are attractive because
 a firm can benefit from a local partner's
knowledge of the host country's competitive
conditions, culture, language, political
systems, and business systems
 the costs and risks of opening a foreign
market are shared with the partner
 they can help firms avoid the risk of
nationalization or other adverse government
interference

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 Joint Ventures

 Joint ventures can be unattractive because

 the firm risks giving control of its technology
to its partner
 the firm may not have the tight control over
subsidiaries that it might need to realize
experience curve or location economies
 shared ownership can lead to conflicts and
battles for control if goals and objectives
differ or change over time

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Wholly Owned Subsidiaries

6. Wholly owned subsidiaries involve 100 percent

ownership of the stock of the subsidiary
 Firms establishing a wholly owned subsidiary
can
 set up a new operation in that country
 acquire an established firm

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Wholly Owned Subsidiaries

 Wholly owned subsidiaries are attractive because

 they reduce the risk of losing control over core
competencies
 they gives the firm the tight control over operations in
different countries that is necessary for engaging in
global strategic coordination
 they may be required if a firm is trying to realize
location and experience curve economies
 Wholly owned subsidiaries are unattractive because
firms bear the full costs and risks of setting up overseas
operations

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Classroom Performance System

Most firms begin their foreign expansion

with
a) Exporting
b) Joint ventures
c) Licensing or franchising
d) Wholly owned subsidiaries

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Selecting an Entry Mode

Question: How should a firm choose a

specific entry mode?

 All entry modes have advantages and

disadvantages
 The optimal choice of entry mode
involves trade-offs

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Selecting an Entry Mode

Advantages and Disadvantages of Entry

Modes

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Core Competencies and Entry Mode

 The optimal entry mode depends to

some degree on the nature of a firm’s
core competencies
 Core competencies can involve
1. technological know-how
2. management know-how

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Core Competencies and Entry Mode

1. Technological Know-How
 When competitive advantage is based
on proprietary technological know-how,
firms should avoid licensing and joint
venture arrangements in order to
minimize the risk of losing control over
the technology
 However, if a technological advantage
is only transitory, or the firm can
establish its technology as the
dominant design in the industry, then
licensing may be attractive
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Core Competencies and Entry Mode

2. Management Know-How
 The competitive advantage of many
service firms is based upon
management know-how
 International trademark laws are
generally effective for protecting
trademarks
 Since the risk of losing control over
management skills to franchisees or
joint venture partners is not high, the
benefits from getting greater use of
brand names is significant
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Pressures for Cost Reductions
and Entry Mode

 Firms facing strong pressures for cost

reductions are likely to pursue some
combination of exporting and wholly
owned subsidiaries
 This will allow the firms to achieve
location and scale economies as well as
retain some degree of control over
worldwide product manufacturing and
distribution

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Classroom Performance System

A firm that wants the ability to engage in

global strategic coordination should choose
a) Franchising
b) Joint ventures
c) Licensing
d) Wholly owned subsidiaries

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Greenfield or Acquisition?

Question: Should a firm establish a

wholly owned subsidiary in a country by
building a subsidiary from the ground up
(greenfield strategy), or by acquiring an
established enterprise in the target
market (acquisition strategy)?

 The number of cross border acquisitions

are increasing
 Over the last decade, 50-80 percent of
all FDI inflows have been mergers and
acquisitions
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Pros and Cons of Acquisitions

 Acquisitions
are quick to execute
enable firms to preempt their
competitors
can be less risky than green-field
ventures
 However, many acquisitions are not
successful

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Pros and Cons of Acquisitions

Question: Why do acquisitions fail?

 Acquisitions fail when

 the firm overpays for the assets of the
acquired firm
 there is a clash between the cultures of the
acquiring and acquired firm
 attempts to realize synergies by integrating
the operations of the acquired and acquiring
entities run into roadblocks and take much
longer than forecast
 there is inadequate pre-acquisition screening
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Pros and Cons of Acquisitions

Question: How can firms reduce the problems

associated with acquisitions?

 Firms can reduce the problems associated with

acquisitions
 through careful screening of the firm to be
acquired
 by moving rapidly once the firm is acquired
to implement an integration plan

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 Pros and Cons of
Greenfield Ventures

 Question: Why are greenfield ventures

attractive?

 Greenfield ventures are attractive because they

allow the firm to build the kind of subsidiary
company that it wants
 However, greenfield ventures
 are slower to establish
 are risky because they have no proven track
record
 can be problematic if a competitor enters via
acquisition and quickly builds market share
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Classroom Performance System

Which of the following is not an advantage

of acquisitions as compared to greenfield
investments?
a) They are quicker to execute
b) Attempts to realize synergies by
integrating the operations of the acquired
entities can be challenging and take time
c) They enable firms to preempt their
competitors
d) They may be less risky
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Critical Discussion Question

1. Review the Management Focus on Tesco. Then answer

the following questions:
a) Why did Tesco’s initial international expansion strategy
focus on developing nations?
b) How does Tesco create value in its international
operations?
c) In Asia, Tesco has a long history of entering into joint
venture agreements with local partners. What are the
benefits of doing this for Tesco? What are the risks? How
are those risks mitigated?
d) In March 2006, Tesco announced that it would enter the
United States. This represents a departure from its historic
strategy of focusing on developing nations. Why do you
think Tesco made this decision? How is the U.S. market
different from others Tesco has entered? What are the risks
here? How do you think Tesco will do?

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Critical Discussion Question

2. Licensing propriety technology to foreign

competitors is the best way to give up a
firm's competitive advantage. Discuss.

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Critical Discussion Question

3. Discuss how the need for control over

foreign operations varies with firms’
strategies and core competencies. What
are the implications for the choice of entry
mode?

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Critical Discussion Question

4. A small Canadian firm that has developed some valuable

new medical products using its unique biotechnology know-
how is trying to decide how best to serve the European
Community market. Its choices are given below. The cost
of investment in manufacturing facilities will be a major one
for the Canadian firm, but it is not outside its reach. If these
are the firm’s only options, which one would you advise it to
choose? Why?
Manufacture the product at home and let foreign sales
agents handle marketing.
Manufacture the products at home but set up a wholly
owned subsidiary in Europe to handle marketing.
Enter into a strategic alliance with a large European
pharmaceutical firm. The product would be manufactured in
Europe by a 50/50 joint venture, and marketed by the
European firm.

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