modes of entry into foreign market

7/28/2019 Modes of Entry Into Foreign Market

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Modes of entry into foreign market

It is a strategic decision, its implications will

have long term effect on the growth and

profitability of firm

The company may have to adopt different

modes to enter in different foreign markets

These modes can be trade mode, contractual

entry mode or investment mode


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Factors affecting entry modes

Corporate objective

If co. wants complete control over productionthen trade mode is suitable

If co. wants to expand its production activities toother nations to get the benefit of cheap factorsof production then investment mode is better

Resources of parent company

If resources of the company are sufficiently large

then investment mode is suitable Resources includes financial resources, human

resources, managerial capability, technology, R&D,brand image etc.


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Environment of host nation

Political , cultural, legal, economic environmentaffects mode of entry

If environment of host nation is supportive theninvestment mode is selected

If market of host nation is small then trade modeis suitable

Cost of factors of production

Factors of production includes raw material,

labour, machines etc If it is low then investment mode is better

If raw material is cheap in host nation theninvestment mode is better


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Infrastructure of host nation

It includes roads, railways, ports, electricity,

warehouses, intermediaries etc If infrastructure is good then investment mode is

better

China has highly developed infrastructure

Level of risk

Risk is more in investment mode as compared to

trade mode

If company can bear risk than it should go for

investment mode otherwise trade mode is

suitable


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Modes of entry in foreign market

Modes of

entry

Trademode

Contractualentry mode

Investmentmode


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Trade mode

Direct and Indirect export In direct export company sells its product directly

to the consumers on its own or through agent

Exporter bears the risk

It is suitable when products are industrial goods or

are costly

In indirect export product is not sold to end users

It is sold to distributors or middlemen

In indirect export middlemen bears the risk

Export management company


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Counter trade

Import as a condition of export

Goods of equal value are exported and imported

between two nations

Bilateral trade agreement that other country will

also import products of same value This does not require foreign exchange

It is a type of barter trade


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Types of counter trade

Types ofcounter trade

Barter

Trade

Counter

PurchaseOffset Compensation

Switch

trading

Clearingagreement


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Barter Trade

Simplest form of counter trade

Export and import takes place simultaneously orwithin a specific time period

Some nations may have to import goods which are

not of much significance

Counter purchase

A firm agrees to purchase specific goods from

country to which sales are made in a specific time

period

Money exchange takes place in accounting books

only, in reality money doesnt change hands


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Offset

In this agreement a firm agrees to purchase goodsfrom the country to which sales are made

It is similar to counter purchase agreement exceptthat in counter purchase agreement the exporter hasto buy specific goods only

In offset the exporter is free to import any goods

It provides flexibility to the exporter

Compensation

It is also known as buy-back agreement

Business unit of one nation helps to build a factory inother nation by providing capital or technology orboth

In return the exporter agrees to accept a specificpercentage of output of the same factory


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Switch trading

Exporter is given counter purchase credits in considerationof goods sold by him

These credits can be sold to any third party at somediscount

The third party can use these credits to import something

Clearing agreement

Exporter and importer maintains clearing accounts in thecentral banks of two nations

The export and import takes place with no currencytransactions

The exporter doesnt receive any payment from importer,

rather it receives payment from its central bank in itsdomestic currency

The importer makes payment to its central bank in his owncurrency

The central banks acts as clearing houses


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Contractual Mode

When a company has developed technology

through its own efforts, it can sell technology to

other nations to cover R & D cost or to earn profit

Technology can be sold by charging lump sum or

through royalty These contracts are for specific period and for

specific geographical location

This mode is adopted when company havingtechnology doesnt have sufficient funds/ size of

host market is small or direct investment is

banned


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Types of contractual modes

Types of

contractual

modes

Licensing andFranchising

ManagementContracting

TurnkeyProjects


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Licensing and Franchising

Licensing

Business unit of one nation (licensor) allows the

business unit of other nation (licensee) to use its

technological know how for a given time period

Licensor charges royalty for this which may vary

from 5% - 8% of sales

Licensor makes maximum utilization of intellectualproperty

Licensee too makes profit


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Franchising

Business unit of one nation (Franchisor) grants

rights to do business in a particular manner to the

business unit of other nation (Franchisee)

It may include selling the product in the name of

franchisor, the key components are provided byfranchisor

Example Pepsi & Coca Cola


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Management Contracting

Parent organisation of one country sets up

management agencies in host nation

Parent organisation manages the business unit of

host country without any ownership or capital

investment

Some fee can be charged for this purpose either in

the form of percentage of profit or in lump sum


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Turnkey Project

Business unit of one nation (licensor) agrees to

construct entire plant for the business unit ofother country (licensee)

Licensor possesses the technical skills, expertise

and experience in constructing such plants Licensor either charges in lump sum or a fixed

percentage of the total cost of project

Licensee gets the benefit of world class design

Licensee also gets technological support if needed

in future


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Investment Mode

Investment

Mode

Foreign DirectInvestment

Mergers &Acquisitions

StrategicAlliance


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Foreign Direct Investment (FDI)

FDI is made by foreign companies in order toestablish wholly owned companies in othercountry

Company can buy shares of host company forthe purpose of managing the host company

New companies may be set up in host nation

by foreign company (wholly owned subsidiary) New company may be set up jointly by foreign

company and host company


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FDI can be horizontal or vertical

In horizontal FDI parent company invests in

same type of industry in the foreign nation

Vertical FDI can be backward (supplies) or

forward (using the end product)


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Mergers & Acquisitions

Business unit of parent company joins hands with

the existing company operating in host nation

It helps in getting better knowledge of business

environment of host nation

Mergers can be horizontal, vertical or

conglomerate

In case ofhorizontal merger a company

performing similar activities, producing almostsimilar products collaborate with each other

It allows large scale production and hence

economies of scale


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Vertical mergers and acquisition occur when

business unit collaborate with suppliers of

inputs or components

It reduces uncertainty in supply of inputs or

components

In conglomerate merger two business units

engaged in different unrelated activities

collaborate with each other

It reduces risk through diversification


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Strategic Alliance

Entered between two business units for achieving

a specific goal like setting up common R & D unit,providing training to employees, common

customer service center

Sometimes strategic alliance is done to enterforeign market

Both business units maintain their identity

Little interference in working of each other

This mode provides easy exit

Toyota and General Motors


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Advantages of Investment mode

Overcoming tariff and non tariff barriers

Benefit of cheap local resources

Saving in transportation cost

Benefit of polycentric mode

Setting up different production centers in different nations

Consumer choices are heterogeneous worldwide

Through investment mode products that suits local tastesand preferences can be made

Risk diversification

Strengthens political ties

Long term investment


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Advantages of trade mode Economies of scale

Needs lesser resources Trade mode doesnt require investment in other

nations

Suitable for universal products Calculators, watches, printers, computers etc Such products can be manufactured at one place

Suitable in nations where business environmentis unpredictable

Easy exit

Entry for short period

Control over technology

Employment generation in home country

modes of entry into foreign market

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