foreign market entry strategies

Foreign market entry strategies

By Ali Shams

Foreign direct investment (FDI)

Exporting

Licensing

Management contract

Joint venture

Manufacturing

Assembly operations

Turnkey operations

Acquisition

Strategic alliances

Analysis of entry strategies

Free trade zones (FTZs)

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The Foreign Market Entry Menu

© Kenneth A. Reinert, Cambridge University Press 2012

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Foreign direct investment (FDI)• For some reason, one noticeable feature of FDI flows is that their

share in total inflows is higher in countries where the quality of institutions is lower.

• One indisputable fact is that developed countries are both the largest recipients and sources of FDI.

• the countries that are successful in attracting FDI have certain traits: political and macroeconomic stability and structural reforms

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• the countries that are successful in attracting FDI have certain traits: political and macroeconomic stability and structural reforms

• Corruption has a negative impact on FDI. From the ethics standpoint, foreign investors generally avoid corruption because it is morally wrong

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Forms of FDI• Ownership

• Wholly owned operations• Green-field investment• Full acquisition

• Partially owned operations• Partial acquisition• Joint venture

• Relatedness • Horizontal FDI• Vertical FDI• Unrelated diversification

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Host CountryHome Country

MNE

New Entity

Local Firm

Joint Venture

Full Acquisition (i.e., 100%)

Green Field100% Owned

Partial Acquisition (e.g., 50%)

Ownership = s%Ownership = (1 - s)

%

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Exporting• Exporting is a strategy in which a company, without any marketing or production

organization overseas, exports a product from its home base.

• product is fundamentally the same as the one marketed in the home market.

• The main advantage of an exporting strategy is the ease in implementing the strategy.

• Risks are minimal because the company simply exports its excess production capacity when it receives orders from abroad.

• The exporting strategy functions poorly when the company’s home-country currency is strong.

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HOME COUNTRY HOST COUNTRY

Export of Goods

MNE

Revenues

Customers

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Licensing• Licensing is an agreement that permits a foreign company to use

industrial property (i.e., patents, trademarks, and copyrights), technical know-how and skills (e.g., feasibility studies, manuals, technical advice), architectural and engineering designs, or any combination of these in a foreign market.

• Essentially, a licensor allows a foreign company to manufacture a product for sale in the licensee’s country and sometimes in other specified markets.

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Local Firm

Licensing of TechnologyHOME COUNTRY HOST COUNTRY

MNEFees and Royalties

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Licensing AgreementAdvantages

• Low initial investment • Avoids trade barriers• Potential for utilizing

location economies• Access to local knowledge• Easier to respond to

customer needs

Disadvantages• Lack of control over

operations• Difficulty in transferring

tacit knowledge• Negotiation of a transfer

price• Monitoring transfer outcome

• Potential for creating a competitor

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Management contract• In some cases, government pressure and restrictions force a

foreign company either to sell its domestic operations or to relinquish control. In other cases, the company may prefer not to have any FDI.

• One way to generate revenue is to sign a management contract with the government or the new owner in order to manage the business for the new owner

• Management contracts may be used as a sound strategy for entering a market with a minimum investment and minimum political risks.

• Accor SA, a French hotel giant, for example, has purchased a large stake in Zenith Hotels International. Zenith itself manages nine hotels in China and one hotel in Thailand without owning them, and most of its hotels do not carry the Zenith name.

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Management Fees

Local Firm

Technological Inputs

HOME COUNTRY HOST COUNTRY

Profit

MNE

Wholly-Owned Subsidiary

Managerial Service

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Joint venture• A joint venture is simply a partnership at corporate level, and it can be

domestic or international. For the discussion here, an international joint venture is one in which the partners are from more than one country.

• One recent joint venture involves Advanced Micro Devices (AMD) and Fujitsu to replace a previous joint venture (Fujitsu–AMD Semiconductor Ltd.).

• There are two separate overseas investment processes that describe how joint ventures tend to evolve:1. the “natural,” nonpolitical investment process2. The second investment process occurs when the local firm’s “political”

leverage, through government persuasion, halts or reverses the “natural” economic process

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Joint Venture Company

Inputs

MNE Local Firm

HOME COUNTRY HOST COUNTRY

Inputs

Share of Profit

Share of Profit

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Joint ventureAdvantages

• Access to partner’s local knowledge

• Reduction of concern about overpayment

• Both parties have some performance incentives

• Significant control over operation

Disadvantages• Potential loss of

proprietary knowledge• Potential conflicts

between partners• Neither partner has full

performance incentive• Neither partner has full

control

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Manufacturing• The manufacturing process may be employed as a strategy

involving all or some manufacturing in a foreign country.• One kind of manufacturing procedure, known as sourcing, involves

manufacturing operations in a host country, not so much to sell there but for the purpose of exporting from that company’s home country to other countries.

• another manufacturing objective: the goal of a manufacturing strategy may be to set up a production base inside a target market country as a means of invading it. There are several variations on this method, ranging from complete manufacturing to contract manufacturing (with a local manufacturer) and partial manufacturing.

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Host country Reasons• job creation • Technology• management expertise• access to export

markets

MNEs Reasons• gaining access either to

raw materials or to take advantage of resources

• take advantage of lower labor costs or other abundant factors of production (e.g., labor, energy, and other inputs)

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Assembly operations• An assembly operation is a variation on a manufacturing strategy. • According to the U.S. Customs Service, “Assembly means the fitting

or joining together of fabricated components.”• In this strategy, parts or components are produced in various

countries in order to gain each country’s comparative advantage. Capital-intensive parts may be produced in advanced nations, and labor-intensive assemblies may be produced in a less developed country, where labor is abundant and labor costs are low

• In general, a host country objects to the establishment of a screwdriver assembly that merely assembles imported parts. If a product’s local content is less than half of all the components used, the product may be viewed as imported, subjected to tariffs and quota restrictions.

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Turnkey operations• A turnkey operation is 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.

• the term is usually associated with giant projects that are sold to governments or government-run companies.

• Large-scale plants requiring technology and large-scale construction processes unavailable in local markets commonly use this strategy.

• Such large-scale projects include building steel mills; cement, fertilizer, and chemical plants; and those related to such advanced technologies as telecommunications.

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Acquisition• When a manufacturer wants to enter a foreign market rapidly and

yet retain maximum control, direct investment through acquisition should be considered.

• The reasons for wanting to acquire a foreign company include:1. product/geographical diversification2. acquisition of expertise (technology, marketing, and management)3. and rapid entry

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Local FirmInvestment

HOME COUNTRY HOST COUNTRY

MNEProfit

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Acquisition

Advantages• Access to target’s local

knowledge• Control over foreign

operations• Control over own

technology

Disadvantages• Uncertainty about

target’s value• Difficulty in “absorbing”

acquired assets • Infeasible if local market

for corporate control is underdeveloped

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How to make a successful acquisition• Jack Welch, the highly successful and former CEO of General Electric, lists the

“six sins” of mergers and acquisitions:1. First, any “merger of equals” sounds good in theory but is a mess in practice.

2. Second, the cultural fit of the two partners is as important as (if not more so than) a strategic fit.

3. Third, run away from a “reverse hostage” situation when an acquirer makes so many concessions to the point that the acquired company will be in charge.

4. Fourth, “be not afraid” as boldness is necessary and sensible for integration.

5. Fifth, avoid the “conqueror syndrome” by installing own people everywhere in the new territory.

6. Sixth and finally, “don’t pay too much.”Source: Jack Welch and Suzy Welch, “The Six Sins of M&A,” Business Week, October 23, 2006, 148.

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Green Field Entry• A government generally welcomes foreign investment that starts

up a new enterprise (called a greenfield enterprise), since that investment increases employment and enlarges the tax base.

• A special case of acquisition is the brownfield entry mode. This mode occurs when an investor’s transferred resources dominate over those provided by an acquired firm.

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New Subsidiary Company

Investment

HOME COUNTRY HOST COUNTRY

MNEProfit

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Strategic alliances• There is no clear and precise definition of strategic alliance. There

is no one way to form a strategic alliance. An alliance may be in the areas of production, distribution, marketing, and research and development.

• Strategic alliances may be the result of mergers, acquisitions, joint ventures, and licensing agreements.

• Joint ventures are naturally strategic alliances, but not all strategic alliances are joint ventures.

• Unlike joint ventures which require two or more partners to create a separate entity, a strategic alliance does not necessarily require a new legal entity.

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Analysis of entry strategies• To enter a foreign market, a manufacturer has a number of

strategic options, each with its own strengths and weaknesses.• Many companies employ multiple strategies. • IBM has employed strategies ranging from licensing, joint ventures,

and strategic alliances on the one hand to local manufacturing and subsidiaries on the other hand

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Analysis of entry strategies• There are a number of characteristics that determine the

appropriateness of entry strategies, and many variables affect which strategy is chosen. These characteristics include:

1. political risks,

2. regulations,

3. type of country,

4. type of product,

5. and other competitive and market characteristics.

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Free trade zones (FTZs)• An FTZ is a secured domestic area in international commerce,

considered to be legally outside a country’s customs territory.

• It is an area designated by a government for the duty-free entry of goods.

• It is also a location where imports can be handled with few regulations, and little or no customs duties and excise taxes are collected

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Variations among FTZs1. freeports,2. tariff-free trade zones,3. airport duty-free arcades,4. export-processing zones,5. and other foreign grade zones.

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• China has set up special economic zones (SEZs) for manufacturing, banking, exporting and importing, and foreign investment.

• Some countries, for political reasons, are not able to open up their economies completely. Instead they have set up export-processing zones, a special type of FTZ, in order to attract foreign capital for manufacturing for export.

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The benefits of FTZ• country-specific in the sense that some countries offer superior

facilities for lower costs (e.g., utilities and telecommunications).• Other benefits are zone-specific in that certain zones may be better

than others within the same country in terms of tax and transportation facilities.

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From the eighth chapter of the book