Firms can use 6 different modes to enter a foreign market. Each entry mode is both advantageous and disadvantageous. By comparing each of them, managers need to decide the best mode of entry.
This mode of entry avoids substantial costs of establishing manufacturing operations in the host country. Also, it may help achieve experience curve and location economies.
Furthermore, by manufacturing the product in a centralized location and exporting it to other national markets, the businesses may realize substantial economies of scale from its global sales volume.
However, if lower cost locations for manufacturing the product are found in the host country, exporting will be a failure. Therefore, manufacturing must occur in a place where the mix of factor conditions are most favorable from a value creation perspective. Thereafter, the products can be exported from that location.
For example, many U.S. electronic firms have moved some of their manufacturing to the Far East due to the availability of low-cost, highly skilled labor. They then export to the rest of the world.
Another problem with exporting is the high transport costs which can make exporting uneconomical, specially for bulk products. One way to solve this is is to manufacture the required bulk products regionally. Thus, they can realize economies of scale.
But, there is also the tariff drawback. That includes the tariff barriers which can make exporting uneconomical. Also, with exports the distribution company may not provide a good service as the manufacturer.
The main solution for these problems are to set up wholly owned subsidiaries in foreign nations. They will handle the local marketing and sales .
In this type of entry, the contractor agrees to handle every detail of the project for a foreign client. At completion of the contract, the foreign client is handed the ‘key’ to a plant that is ready for full operation.
Thus, turnkey projects are a means of exporting process technology to other countries. These are most common in the chemical, pharmaceutical, petroleum refining and metal refining industries.
This entry mode is beneficial because it is a way of earning great economic returns from the technology and know how. This is specially beneficial when FDI is limited by host government regulations.
However, this entry mode can be risky specially under unstable political and economic environments. But, since most of the firms that enter in this way do not have a long term interest in the foreign country, it can be both beneficial and disadvantageous.
The next problem with this entry mode is that the firm that enters in this manner may create a competitor. For example, most of the Western firms that sold oil-refining technology to firms in the Middle East, now find themselves competing with these firms in the world oil market.
Also, if the firm’s process technology is a source of competitive advantage, then selling this technology through a turnkey project means also selling competitive advantage to potential competitors.
This is an arrangement where a licensor grants the rights to intangible property, to another entity (licensee) for a specified period. In return, the licensor receives a royalty fee from the licensee.
For example, Xeros licensed its xerographic know how to Fuji Xerox. In return, Fuji Xerox paid Xerox a royalty fee equal to 5% of the net sales revenue that Fuji Xerox earned from the sales of photocopiers based on Xerox’s patented know how.
The key benefits of this entry mode is that, the licensee puts up most of the capital necessary to get the overseas operation going. Therefore, the firm doesn’t have to bear the development costs and risks associated with opening a foreign market.
Therefore, this entry mode is very attractive for firms lacking the capital to develop operations overseas. It is also attractive when a firm is unwilling to commit substantial financial resources to an unfamiliar or politically volatile foreign market.
This entry mode is also used by firms that wish to participate in a foreign market, but are prohibited from doing so, due to barriers to investment. This is one major reason behind Fuji Xerox.
That is, Xerox wanted to participate in the Japanese market. But, it was prohibited from setting up a wholly owned subsidiary by the Japanese government. Therefore, Xerox set up the joint venture with Fuji and then licensed its know how to the joint venture.
Another instance in which licensing is used is when a firm possesses some intangible property that might have business applications, but they do not want to develop those applications themselves.
For example, Bell Laboratories at At&T originally invented the transistor circuit in the 1950s. But At&T decided that it did not want to produce transistors. So, it licensed technology to a number of other companies such as Texas Instruments.
Similarly, Coca Cola licensed its trademark to clothing manufacturers. Harley Davidson licenses its brand to Wolverine World Wide to make footwear.
However, licensing has several drawbacks. First, licensing does not give a firm the tight control over manufacturing, marketing and strategy that is required to realize experience curve and location economies. This is because, in this entry mode, the licensee sets up its own production operations.
Also, licensing limits a firm’s ability to coordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another.
Next, when technological know how is licensed, a firm can quickly lose control over its technology. For example, RCA corporation once licensed its color TV technology to Japanese firms including Sony and Matsushita. These firms quickly assimilated the technology, improved on it and entered the U.S. market.
This problem can be minimized by entering into a cross licensing agreement with a foreign firm. This is where valuable intangible property is licensed to a foreign partner. In this case, in addition to a royalty payment, the firm also requested that the foreign partner license some of its valuable know how to the firm.
Thus, cross licensing enables the firms to hold each other hostage. This reduces the probability that they will behave opportunistically towards each other.
Also, the risk of licensing can be reduced by linking an agreement to license know how with the formation of a joint venture in which the licensor and licensee takes important equity stakes.
This is similar to licensing. However, in this there are long term commitments than licensing. This entry mode is specially a form of licensing in which the franchiser not only sells intangible property to the franchisee, but also insists that the franchisee agrees to abide by strict rules.
This entry mode is primarily used by service firms. For example, Mc Donalds.
With this mode of entry, firms are relieved of many costs and risks of opening in the foreign market on its own. But, franchising may inhibit the firm’s ability to take profits out of one country, to support competitive attacks in another.
Also, there is a problem of quality control. However, this can be sorted by setting up a subsidiary in each country in which the firm expands. Then, the subsidiary will have the rights and obligations to establish franchisees in that country.
This entails establishing a firm that is jointly owned by two or more other independent firms. The key benefit of this is that firms benefit from the local partner’s knowledge of the host country’s competitive conditions, culture, language, political systems and business.
Also, when the development costs of opening a foreign market are high, a firm might gain by sharing these costs or risks with a local partner. Furthermore, in many countries, political considerations make joint ventures the only feasible entry mode.
Based on research, joint ventures with local partners face a low risk of being subject to nationalization or adverse government interference. This is mainly because local equity partners may have some influence on host government policy.
However, a firm that enters into a joint venture risks giving control of its technology to its partner. However, joint venture agreements can be constructed, to minimize these risks.
- Hold majority ownership in the venture, which allows the dominant partner to exercise greater control over its technology. Yet, it is difficult to find a foreign partner who is willing to settle for minority ownership.
- “Wall off” from a partner technology that is central to the core competence of the firm, while sharing other technology.
Another problem with joint ventures, is it does not give a firm the tight control over subsidiaries that it might need to realize experience curve or location economies. Further, it does not give a firm the tight control over a foreign subsidiary, which might be needed to engage in coordinated global attacks against its rivals.
For example, when Texas Instruments established semi conductor facilities in Japan, the main aims were to check the Japanese manufacturers’market share and then limit their cash available for invading the global market. They used global strategic coordination.
To implement this strategy, TI’s subsidiary in Japan had to be prepared to take instructions from corporate head quarters regarding competitive strategy. This strategy also required the Japanese subsidiary to run at a loss if necessary.
Also, the shared ownership arrangement in joint ventures lead to conflicts and battles for control between the investing firms in most cases. Such conflicts are usually triggered by shifts in the relative bargaining power of venture partners. However, these problems have been limited by some joint ventures by entering into joint ventures in which one partner has a controlling interest.
Wholly owned subsidiaries
In a wholly owned subsidiary, the firm owns 100% of the stock. This can be done in two ways.
- Set up a new operation in that country(greenfield venture)
- Acquire an established firm in the host nation and use that firm to promote its products
One advantage of this entry mode is, when a firm’s competitive advantage is based on technological competence, this mode reduces risk of losing control over that competence.
Also, this entry mode gives a firm tight control over operations in different countries, which is usually required to engage in global strategic coordination.
Next, this entry mode allows realization of location economies and experience curve economies. It even gives a firm 100% share in the profits generated in a foreign market.
However, this is the most costly method of serving a foreign market, in terms of capital investment. This is because the firm must bear the full capital costs and risks of setting up overseas operations.
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