SWOT analysis for global expansion to Panama City and three entry mode and Justification for Entry Mode

6-1 OVERCOMING THE LIABILITY OF FOREIGNNESS

It is not easy to succeed in an unfamiliar environment. foreign firms have to overcome a liability of foreignness, which is the inherent disadvantage that foreign firms experience in host countries because of their nonnative status. Such a liability is manifested in at least two ways. First, numerous differences in formal and informal institutions govern the rules of the game in different countries. While local firms are already well versed in these rules, foreign firms have to invest significant resources to learn such rules. Some of the rules are in favor of local firms. For example, after working for years to familiarize itself with US defense procurement rules, European Aeronautic Defence and Space (EADS), the maker of Airbus, in 2008 won a major $35 billion contract to supply the US Air Force with next-generation refueling tankers. Then EADS (along with its US partner, Northrop Grumman) was disappointed to find out that Boeing was able to twist the arms of politicians and change the rules. In 2010, Boeing emerged as the winner of this rich prize and EADS (which more recently changed its name to the Airbus Group) had to drop out.

Second, although customers in this age of globalization supposedly no longer discriminate against foreign firms, the reality is that foreign firms are often still discriminated against, sometimes formally and other times informally. For example, activists in India accused both Coca-Cola and PepsiCo that their products contained higher-than-permitted levels of pesticides but did not test any Indian branded soft drinks, even though pesticide residues are present in virtually all groundwater in India. Although both Coca-Cola and PepsiCo denied these charges, their sales suffered.

The Notion of Foreignness

Against such significant odds, how do foreign firms crack new markets? The answer boils down to our two core Perspectives. The institution-based view suggests that firms need to undertake actions deemed legitimate and appropriate by the various formal and informal institutions governing market entries. Differences in formal institutions may lead to regulatory risks due to differences in political, economic, and legal systems. There may be numerous trade and investment barriers on a national or regional basis. In addition, the existence of multiple currencies—and currency risks as a result—may be another formal barrier. Informally, numerous differences in cultures, norms, and values create another major source of liability of foreignness. The resource-based view argues that foreign firms need to deploy overwhelming resources and capabilities that after offsetting the liability of foreignness, there is still significant competitive advantage left. Applying the VRIO framework.

Overall, our two core perspectives shed a lot of light on firms’ internationalization. Sometimes, instead of having to overcome the liability of foreignness, some firms may leverage their asset of foreignness. Nevertheless, how to enter foreign markets remains an art rather than a science. Next, we investigate the 2W1H dimensions associated with foreign market entries.

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6-2 WHERE TO ENTER

What's behind China's growing presence in Latin America?

Similar to real estate, the motto for IB is “location, location, location.” In fact, such a spatial perspective (that is, doing business outside of one’s home country) is one of the defining features of IB. Two sets of considerations drive the location of foreign entries: (1) strategic goals and (2) cultural and institutional distances.

Location-Specific Advantages and Strategic Goals

Favorable locations in certain countries may give firms operating there what are called location-specific advantages.

Location-specific advantages are the benefits a firm reaps from features specific to a particular place. Certain locations simply possess geographical features that are difficult for others to match. Leading seaports and airports naturally attract a lot of foreign entrants. For example, Miami, the self-styled “Gateway of the Americas,” is an ideal location both for North American firms looking south and Latin American firms coming north. Vienna is an attractive site as multinational regional headquarters for Central and Eastern Europe. Dubai is an ideal stopping point for air traffic between Europe and Asia and between Africa and Asia. Two billion people live within four hours of flying time from Dubai, and four billion can be reached within seven hours. Dubai’s airport is already the third busiest international airport in terms of passengers behind only London Heathrow and Hong Kong airports. Similarly, Rotterdam, the Netherlands, is the main hub for sea-bound transportation into and out of Europe. More than 500 liner services connect Rotterdam with over 1,000 ports worldwide. Overall, we may regard the continuous expansion of global business as an unending saga in search of location- specific advantages.

In the past chapters we learned about agglomeration—location specific advantages that arise from the clustering of economic activities in certain locations. The basic idea dates back at least to Alfred Marshall, a British economist who first published it in 1890. Recall that location- specific advantages stem from (1) knowledge spillovers among closely located firms that attempt to hire individuals from competitors, (2) industry demand that creates a skilled labor force whose members may work for different firms without having to move out of the region, and (3) industry demand that facilitates a pool of specialized suppliers and buyers to also locate in the region. For example, due to agglomeration, Dallas has the world’s heaviest concentration of telecom companies. US firms such as AT&T, HP, Raytheon, Texas Instruments (TI), and Verizon cluster there. Moreover, numerous leading foreign telecom firms such as Alcatel-Lucent, Ericsson, Fujitsu, Huawei, Siemens, STMicroelectronics, and ZTE have also converged in this region.

Given that different locations offer different benefits, it is imperative that a firm match its strategic goals with potential locations. The four strategic goals are shown in the Exhibit below.

Firms seeking natural resources have to go to particular foreign locations where those resources are found. For example, the Middle East, Russia, and Venezuela are all rich in oil. Even when the Venezuelan government became more hostile, Western oil firms had to put up with it.

Market-seeking firms go to countries that have a strong demand for their products and services, and the ability of the consumers to pay for them. As China becomes the largest car market in the world, practically all the automakers in the world are now elbowing into it. General Motors (GM) has emerged as the leader. In 2010, GM for the first time sold more cars in China than in the United States. As demand for business aviation takes off in China, business jet makers are now intensely eyeing the new market.

Seeking market and investment in the Middle East

Efficiency-seeking firms often single out the most efficient locations featuring a combination of scale economies and low-cost factors. It is the search for efficiency that induced numerous multinational enterprises (MNEs) to enter China. China now manufactures two-thirds of the world’s photocopiers, shoes, toys, and microwave ovens; and one-third of the desktop computers, mobile phones, television sets, and steel. Shanghai alone reportedly has a cluster of over 400 of the Fortune Global 500 firms. It is important to note that China does not present the absolutely lowest labor costs in the world, and Shanghai is the highest cost city in China. However, its attractiveness lies in its ability to enhance efficiency for foreign entrants by lowering total costs.

Innovation-seeking firms target countries and regions renowned for generating world-class innovations, such as Silicon Valley and Bangalore (in IT), Dallas (in telecom), and Paris (in perfumes). Such entries can be viewed as “an option to maintain access to innovations resident in the host country, thus generating information spillovers that may lead to opportunities for future organizational learning and growth.”

What are the top cities for tech in the world?

It is important to note that location-specific advantages may grow, change, and/or decline, prompting a firm to relocate. If policy makers fail to maintain the institutional attractiveness (for example, by raising taxes) and if companies overcrowd and bid up factor costs such as land and talents, some firms may move out of certain locations previously considered advantageous. For example, the Chinese government has raised minimum wages and tightened environmental regulations. Also, thanks to the “one child” policy that was first implemented in the 1980s, the number of low-skill youth entering the labor market has declined. These changes have eroded the location- specific advantages of coastal China centered on low cost. As a result, many labor-intensive, cost-conscious firms have either moved to inland China (where labor cost has remained relatively low) or Southeast Asian countries such as Indonesia, Malaysia, Thailand, and Vietnam (where labor cost is now lower than that of coastal China).

Cultural/Institutional Distances and Foreign Entry Locations

In addition to strategic goals, another set of considerations centers on cultural/institutional distances. Cultural distance is the difference between two cultures along identifiable dimensions such as individualism. Considering culture as an informal part of institutional frameworks governing a particular country, institutional distance is “the extent of similarity or dissimilarity between the regulatory, normative, and cognitive institutions of two countries.” Broadly speaking, cultural distance is a subset of institutional distance. For example, many Western cosmetics products firms, such as L’Oreal and Victoria’s Secret, have shied away from Saudi Arabia, citing its stricter rules of personal behavior. In essence, Saudi Arabia’s cultural and institutional distance from Western cultures is too large.

Halal cosmetics offer new beauty twist to Muslim faithful

Two schools of thought have emerged in overcoming these distances. The first is associated with the stage model. According to the stage model, firms will enter culturally similar countries during their first stage of internationalization and will then gain more confidence to enter culturally distant countries in later stages. This idea is intuitively appealing: It makes sense for Belgian firms to enter France first and for Mexican firms to enter Texas first to take advantage of common cultural and language traditions. On average, business between countries that share a language is three times greater than between countries without a common language. Firms from common-law countries (English speaking countries and Britain’s former colonies) are more likely to be interested in other common-law countries. Colony–colonizer links (such as Britain’s ties with the Commonwealth and Spain’s with Latin America) boost trade significantly. Overall, certain performance benefits seem to exist when competing in culturally and institutionally adjacent countries.

Citing numerous counterexamples, a second school of thought argues that it is more important to consider strategic goals such as market and efficiency rather than culture and institutions. For example, despite the often hostile Congress and the typically unfriendly US media, many Chinese firms are eager to do business in the United States. Because the United States is the largest market, cultural and institutional distances between China and the United States do not seem to matter. Overall, in the complex calculus underpinning entry decisions, location represents only one of several important considerations. As shown next, entry timing and modes are also crucial.

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6-3 WHEN TO ENTER?

Entry timing refers to whether there are compelling reasons to be an early or late entrant in a particular country. Some firms look for first-mover advantages, defined as the benefits that accrue to firms that enter the market first and that later entrants do not enjoy. Speaking of the power of first-mover advantages, “Xerox,” “FedEx,” and “Google” have now become verbs, such as “Google it.” In many African countries, “Colgate” is the generic term for toothpaste. Unilever, a late mover, is disappointed to find out that some of its African customers call its own toothpaste “the red Colgate.” However, first movers may also encounter significant disadvantages which, in turn, become late-mover advantages.

· First movers may gain advantage through proprietary technology. Think about Apple’s iPod, iPad, and iPhone.

· First movers may also make preemptive investments, specially for scarce resources . A number of Japanese MNEs have cherry-picked leading local suppliers and distributors in Southeast Asia as new members of the expanded keiretsu networks (alliances of Japanese businesses with interlocking business relationships and shareholdings) and have blocked access to the suppliers and distributors by late entrants from the West.

· First movers may erect significant entry barriers for late entrants, such as high switching costs due to brand loyalty. Buyers of expensive equipment are likely to stick with the same producers for components, training, and other services for a long time. That is why American, British, French, German, and Russian aerospace firms competed intensely for Poland’s first post–Cold War order of fighters— America’s F-16 eventually won.

· Intense domestic competition may drive some non-dominant firms abroad to avoid clashing with dominant firms head-on in their home market. Matsushita, Toyota, and NEC were the market leaders in Japan, but Sony, Honda, and Epson all entered the United States in their respective industries ahead of the leading firms.

· First movers may build precious relationships with key stakeholders such as customers and governments. For example, Citigroup, JP Morgan Chase, and Metallurgical Corporation of China have entered Afghanistan, earning a good deal of goodwill from the Afghan government that is interested in wooing more foreign direct investment (FDI).

The potential advantages of first movers may be counterbalanced by various disadvantages. Numerous first-mover firms— such as EMI in CT scanners and Netscape in Internet browsers— have lost market dominance in the long run. It is such late-mover firms as General Electric and Microsoft (Explorer), respectively, that win. Specifically, late mover advantages are manifested in three ways:

· Late movers may be able to free ride on the huge pioneering investments of first movers. In Saudi Arabia, Cisco invested millions of dollars to rub shoulders of dignitaries, including the king, in order to help officials grasp the promise of the Internet in fueling economic development. But it lost out to late movers such as Ericsson that offered lower cost solutions. For instance, the brand-new King Abdullah Economic City awarded an $84 million citywide telecom project to Ericsson whose bid was more than 20% lower than Cisco’s—in part because Ericsson did not have to offer a lot of basic education and did not have to entertain that much. “We’re very proud to have won against a company that did as much advance work as Cisco did,” an elated Ericsson executive noted.

· First movers face greater technological and market uncertainties. Nissan, for example, has launched the world’s first all-electric car, the Leaf, which can run without a single drop of gasoline. However, there are tremendous uncertainties. After some of these uncertainties are removed, late movers such as BMW, GM, and Toyota have joined the game with their own electric cars.

· As incumbents, first movers may be locked into a given set of fixed assets or are reluctant to cannibalize existing product lines in favor of new ones. Late movers may be able to take advantage of the inflexibility of first movers by leapfrogging them. Although Greyhound, the incumbent in intercity bus service in the United States, is financially struggling, it cannot get rid of the expensive bus depots in inner cities that are often ill-maintained and dreadful. Megabus, the new entrant from Britain, simply has not bothered to build and maintain a single bus depot. Instead, Megabus uses curbside stops (like regular city bus stops), which have made travel by bus more appealing to a large number of passengers.

Overall, evidence points out both first-mover advantages and late-mover advantages. Unfortunately, a mountain of research is still unable to conclusively recommend a particular entry timing strategy. Although first movers may have an opportunity to win, their pioneering status is not a guarantee of success. For example, among the three first movers into the Chinese automobile industry in the 1980s, Volkswagen captured significant advantages, Chrysler had very moderate success, and Peugeot failed and had to exit. Although many of the late movers that entered in the 1990s struggled, GM, Honda, and Hyundai gained significant market shares. It is obvious that entry timing cannot be viewed in isolation, and entry timing per se is not the sole determinant of success and failure of foreign entries. It is through interaction with other strategic variables that entry timing has an impact on performance.

The Half-Truth of First Mover Advantage

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7-4 HOW TO ENTER

In this section, we first consider on what scale—large or small—a firm may enter foreign markets. Then we look at a comprehensive model for entering foreign markets. The first step is to determine whether to pursue an equity or non-equity mode of entry. As we will see, this crucial decision differentiates MNEs (involving equity modes) from non-MNEs (relying on non-equity modes). Finally, we outline the pros and cons of various equity and non-equity modes.

Scale of Entry: Commitment and Experience

One key dimension in foreign entry decisions is the scale of entry, which refers to the amount of resources committed to entering a foreign market. Large-scale entries demonstrate a strategic commitment to certain markets. This helps assure local customers and suppliers (“We are here for the long haul!”) while deterring potential entrants. The drawbacks of such a hard-to-reverse strategic commitment are (1) limited strategic flexibility elsewhere and (2) huge losses if these large-scale bets turn out to be wrong.

Small-scale entries are less costly. They focus on organizational learning by getting a firm’s feet wet— learning by doing—while limiting the downside risk. For example, to enter the market of Islamic finance whereby no interest can be charged (according to the Koran), Citibank set up a subsidiary Citibank Islamic Bank. On a small scale, it was designed to experiment with different interpretations of the Koran on how to make money while not committing religious sins. Overall, the longer foreign firms stay in host countries, the less liability of foreignness they experience. The drawback of small-scale entries is a lack of strong commitment, which may lead to difficulties in building market share and capturing first-mover advantages.

Modes of Entry: The First Step on Equity versus Non-equity Modes

Entry mode decision - Internationalization - Global Marketing

Managers are unlikely to consider the numerous modes of entry—methods used to enter a foreign market—at the same time. Given the complexity of entry decisions, it is imperative that managers prioritize and consider only a few key variables first and then consider other variables later. The comprehensive model shown in Exhibit below is helpful.

In the first step, considerations for small-scale versus large-scale entries usually boil down to the equity (ownership) issue. None-equity modes include exports and contractual agreements, and tend to reflect relatively smaller commitments to overseas markets. Equity modes, on the other hand, are indicative of relatively larger, harder-to-reverse commitments. Equity modes call for the establishment of independent organizations overseas (partially or wholly controlled). Non-equity modes do not require such independent establishments. Overall, these modes differ significantly in terms of cost, commitment, risk, return, and control.

The distinction between equity and non-equity modes is not trivial. In fact, it is what defines an MNE: An MNE enters foreign markets via equity modes through FDI. A firm that merely exports/imports with no FDI is usually not regarded as an MNE. As discussed at length in Chapter 6, an MNE, relative to a non-MNE, enjoys the three-pronged advantages of ownership, location, and internalization—collectively known as the OLI advantages. Overall, the first step in entry mode considerations is crucial. A strategic decision must be made in terms of whether or not to undertake FDI and to become an MNE.

Modes of Entry: The Second Step on Making Actual Selections

During the second step, managers consider variables within each group of non-equity and equity modes. If the decision is to export, then the next consideration is direct exports or indirect exports.

Direct exports are the most basic mode of entry, capitalizing on economies of scale in production concentrated in the home country and providing better control over distribution. The world’s largest piano maker, Pearl River, exports its pianos from China to over 80 countries. This strategy essentially treats foreign demand as an extension of domestic demand, and the firm is geared toward designing and producing first and foremost for the domestic market. While direct exports may work if the export volume is small, it is not optimal when the firm has many foreign buyers. Marketing 101 suggests that the firm needs to be closer, both physically and psychologically, to its customers, prompting the firm to consider more intimate overseas involvement such as FDI. Direct exports may also be accused of dumping, triggering anti-dumping actions.

Another export strategy is indirect exports— namely, exporting through domestically based export intermediaries. This strategy not only enjoys the economies of scale in domestic production (similar to direct exports) but is also relatively worry free. A significant amount of export trade in commodities such as textiles, woods, and meats, which compete primarily on price, is indirect through intermediaries. Indirect exports have some drawbacks. For example, third parties such as export trading companies may not share the same agendas and objectives as exporters. Exporters choose intermediaries primarily because of information asymmetries concerning risks and uncertainties associated with foreign markets. Intermediaries with international contacts and knowledge essentially make a living by taking advantage of such information asymmetries. They may have a vested interest in making sure that such asymmetries are not reduced. Intermediaries, for example, may repackage the products under their own brand and insist on monopolizing the communication with overseas customers. If the exporter is interested in knowing more about how its products perform overseas, indirect exports would not provide such knowledge.

The next group of non-equity entry modes involves the following types of contractual agreement: (1) licensing or franchising, (2) turnkey projects, (3) research and development contracts, and (4) co-marketing.

In licensing/franchising agreements, the licensor/franchisor sells the rights to intellectual property such as patents and know-how to the licensee/franchisee for a royalty fee. The licensor/franchisor thus does not have to bear the full costs and risks associated with foreign expansion. Coca-Cola, for example, has licensed its trademark to clothing manufacturers in Brazil. On the other hand, the licensor/franchisor does not have tight control over production and marketing. Pizza Hut, for example, was disappointed when its franchise in Thailand discontinued the relationship and launched a competing pizza restaurant to eat Pizza Hut’s lunch.

In turnkey projects, clients pay contractors to design and construct new facilities and train personnel. At project completion, contractors hand clients the proverbial key to facilities ready for operations—hence the term “turnkey.” This mode allows firms to earn returns from process technology (such as power generation) in countries where FDI is restricted. The drawbacks, however, are twofold. First, if foreign clients are competitors, selling them state-of-the-art technology through turnkey projects may boost their competitiveness. Second, turnkey projects do not allow for a long-term presence after the key is handed to clients. To obtain a longer-term presence, build-operate-transfer agreements are now often used instead of the traditional build-transfer type of turnkey projects. A build-operate-transfer (BOT) agreement is a non-equity mode of entry used to build a longer-term presence by building and then operating a facility for a period of time before transferring operations to a domestic agency or firm. For example, Safi Energy, a consortium among GDF Suez (France), Mitsui (Japan), and Nareva Holdings (Morocco), has been awarded a BOT power-generation project in Morocco.

Research and development (R&D) contracts refer to outsourcing agreements in R&D between firms. Firm A agrees to perform certain R&D work for Firm B. Firms thereby tap into the best locations for certain innovations at relatively low costs. However, three drawbacks may emerge. First, given the uncertain and multidimensional nature of R&D, these contracts are often difficult to negotiate and enforce. While delivery time and costs are relatively easy to negotiate, quality is often difficult to assess. Second, such contracts may cultivate competitors. A number of Indian IT firms, nurtured by such work, are now on a global offensive to take on their Western rivals. Finally, firms that rely on outsiders to perform a lot of R&D may lose some of their core R&D capabilities in the long run.

Co-marketing refers to efforts among a number of firms to jointly market their products and services. Toy makers and movie studios often collaborate in co-marketing campaigns with fast-food chains such as McDonald’s to package toys based on movie characters in kids’ meals. Airline alliances such as One World, Sky Team, and Star Alliance engage in extensive co-marketing through code sharing. The advantages are the ability to reach more customers. The drawbacks center on limited control and coordination.

Next are equity modes, all of which entail some FDI and transform the firm to become an MNE. A joint venture (JV) is a corporate child, a new entity jointly created and owned by two or more parent companies. It has three principal forms: Minority JV (less than 50% equity), 50–50 JV (equal equity), and majority JV (more than 50% equity). JVs, such as Shanghai Volkswagen, have three advantages. First, an MNE shares costs, risks, and profits with a local partner, so the MNE possesses a certain degree of control but limits risk exposure. Second, the MNE gains access to knowledge about the host country; the local firm, in turn, benefits from the MNE’s technology, capital, and management. Third, JVs may be politically more acceptable in host countries.

In terms of disadvantages, JVs often involve partners from different backgrounds and with different goals, so conflicts are natural. Furthermore, effective equity and operational control may be difficult to achieve since everything has to be negotiated—in some cases, fought over. Finally, the nature of the JV does not give an MNE the tight control over a foreign subsidiary that it may need for global coordination. Overall, all sorts of non-equity-based contractual agreements and equity-based JVs can be broadly considered as strategic alliances.

The last entry mode is to establish a wholly owned subsidiary (WOS), defined as a subsidiary located in a foreign country that is entirely owned by the parent multinational. There are two primary means to set up a WOS. One is to establish greenfield operations, building new factories and offices from scratch (on a proverbial piece of “green field” formerly used for agricultural purposes). For example, Microsoft established a wholly owned greenfield R&D center in Beijing. There are three advantages. First, a greenfield WOS gives an MNE complete equity and management control, thus eliminating the headaches associated with JVs. Second, this undivided control leads to better protection of proprietary technology. Third, a WOS allows for centrally coordinated global actions. Sometimes, a subsidiary will be ordered to launch actions that by design will lose money. In the semiconductor market, TI faced competition from Japanese rivals such as NEC and Toshiba that maintained low prices outside of Japan by charging high prices in Japan and using domestic profits to cross-subsidize overseas expansion. By entering Japan via a WOS and slashing prices there, TI incurred a loss but forced the Japanese firms to defend their home market. This was because Japanese rivals had a much larger market share in Japan. When the price level in Japan collapsed thanks to the aggressive price cutting unleashed by TI’s WOS in the country, NEC and Toshiba would suffer much more significant losses. Consequently, Japanese rivals had to reduce the ferocity of their price wars outside of Japan. Local licensees/franchisees or JV partners are unlikely to accept such a subservient role as being ordered to lose money.

In terms of drawbacks, a greenfield WOS tends to be expensive and risky, not only financially but also politically. Its conspicuous foreignness may become a target for nationalistic sentiments. Another drawback is that greenfield operations add new capacity to an industry, which will make a competitive industry more crowded. For example, think of all the Japanese automobile plants built in the United States, which have severely squeezed the market share of US automakers and forced Chrysler and GM into bankruptcy. Finally, greenfield operations suffer from a slow entry speed of at least one to several years (relative to acquisitions).

The other way to establish a WOS is through an acquisition. Fiat’s acquisition of Chrysler is a case in point. Although this is the last mode we discuss here, it represents approximately 70% of worldwide FDI. Acquisition shares all the benefits of greenfield WOS but enjoys two additional advantages: (1) adding no new capacity and (2) faster entry speed. In terms of drawbacks, acquisition shares all of the disadvantages of greenfield WOS except adding new capacity and slow entry speed. But acquisition has a unique and potentially devastating disadvantage: post-acquisition integration problems.

Overall, while we have focused on one entry mode at a time, firms in practice are not limited by any single-entry mode. For example, IKEA stores in China are JVs, and its stores in Hong Kong and Taiwan are separate franchises. In addition, entry modes may change over time. Starbucks, for instance, first used franchising. It then switched to JVs and, more recently, to acquisitions.