MKTG Discussion Questions

4-14

Chapter 4: Methods of Entry into Foreign Markets

4-13

Chapter 4: Methods of Entry into Foreign Markets

Chapter 4

Methods of Entry into Foreign Markets

lEARNING oBJECTIVES

At the end of this chapter, YOU SHOULD:

1 Understand the concepts of indirect exporting.

2 Understand the concepts of active exporting.

3 Understand the concepts of production abroad.

4 Be aware of the complications related to parallel imports.

5 Identify other issues in methods of entry into international trade.

Preview

The chapter looks at what is one of the first issues a company must examine when considering entering the realm of international trade: how to enter international markets. The chapter talks about methods of making that entry, including the ramifications of indirect exporting, active exporting using agents and distributors, marketing subsidiaries, and engaging in production abroad. In the area of production abroad, we examine issues relating to licensing, franchising, establishing joint ventures, and subsidiaries. Also looked at are problems with parallel imports and the unique advantages of foreign trade zones and maquiladoras.

Chapter Outline

Introduction

I. First international sales tend to be random, haphazard events.

II. Eventually, a firm realizes there is an international market worth exploring.

III. In going after the international market firms often fail to plan properly and end up developing problems for themselves.

4-1 Entry Strategy Factors

I. Firms need to develop a proper international strategy early on.

II. Of the parts of the marketing mix involved in international sales, distribution is the one with the longest timeline and is the least likely to be adjusted.

4-2 Indirect Exporting

4-2-1 Export Trading Company (ETC)

I. Export trading company purchases goods from a firm in one country and resells them in a foreign country

II. For the domestic seller, it is a domestic transaction—a sale to a company in the home country

III. For the foreign party purchasing from the export trading company, it is also a domestic transaction—a purchase from a company in the same country

IV. Old concept which faded late in the nineteenth century

V. Resurrected by Japan to handle its post-World War II exporting, the sogo shosha

VI. Often very large companies

a. Depth of knowledge of markets, products

b. Provide packages of varied logistical services: shipping, insuring, financing, and expediting international transactions

VII. Some are smaller export trading companies

a. Specialize in one geographical area or one product line

b. Offer same breadth of services as a sogo shosha

c. Export Trading Companies Act of 1982 has resulted in creation of a number of smaller-scale export trading companies in U.S.

VIII. ETCs are good for novice or less-than-serious exporters

4-2-2 Export Management Corporation (EMC)

I. Located in the exporting country and acts as an international manufacturer’s representative

II. Unlike an export trading company, an export management corporation is an agent. Agents do not take title of the property being sold

III. EMCs tend to be small

a. Tend to specialize in selling one product line in one country

b. Usually also represent other exporters abroad by selling complimentary product lines

c. Tend to keep large list of potential buyers

IV. An exporter tends to be more involved in international activity when using an EMC than when using an ETC. The amount of service the EMC provides depends upon its relationship with the exporter

V. As an exporter’s international business grows, it may absorb the EMC to capitalize on its skills and contacts

4-2-3 Piggy-Backing

I. Two types of piggybacking:

a. Suppliers piggyback on a firm

i. A customer of a firm sets up a manufacturing facility in a foreign market

ii. It tells its suppliers they need to provide parts for assembly and customer service

iii. Thus, suppliers are now selling abroad

iv. Franchisors do this by requiring overseas franchises to be equipped with same machinery and supplies as elsewhere

b. Successful exporter involves one of its suppliers or a company that makes a complementary product in international markets the exporter has developed

II. While piggybacking can be described as passive, it can be an opportunity for a supplier to eventually launch its own international marketing strategy

4-3 Active Exporting

4-3-1 Agent

I. Usually a small firm or individual located in the importing country

II. Acts as a manufacturer’s representative for the exporter

III. Does not take title, earns commission on sales

IV. In the relationship, the exporter is called the principal

V. Agent usually has several principals for which it sells complementary products

VI. Agent handles all sales functions from prospecting to closing the sale

VII. Principal’s support for agent varies, from a simple brochure and price list to extensive sales assistance and effort

VIII. Agents like to keep control over their schedule but know the principal’s support is important to their success

IX. Who should negotiate critical aspects of the sale such as price, delivery, terms of trade, terms of sale, and collection?

a. Some say it should be the agent

b. Rather, it should be the principal. Direct negotiation on these items between the agent and the importer (buyer) means many countries will consider the agent as a binding agent, an agent that can make decisions and statements that the principal will be required to follow. With a binding agent, the principal:

i. Is considered to be permanently established in the country

ii. Can have significant tax obligations

X. Criteria in choosing an agent:

a. Ability to accurately represent exporter and product

b. Ability to sell

c. Contacts

d. Knowledge of the targeted industry

e. Compatibility with exporter

XI. Although principals and agents enter into one-year contracts, their relationships tend to be much longer

XII. Finding agents by:

a. Trade show

b. Trade missions

c. Commercial attachés of the embassies of the exporter’s country

d. Contacts with other successful exporters

XIII. Factors which may call for use of an agent:

a. Potential sales are small

b. Product is not a stock item, but is designed for a particular customer

c. Product is very expensive

d. When there is expectation of a short product life cycle

e. When there is little requirement of after-sale service

f. When there is little expectation of the exporter becoming a dominant force in the market

g. When the company is reasonably well-equipped to handle export sales

h. When the company does not have a “top-of-the-line” strategy, and does not seek premium prices

i. When the company wants reasonable amount of control over prices and delivery policies

4-3-2 Distributor

I. Usually a firm in the importing country which buys (takes title of) goods from the exporter

II. Relationship is characterized by two sets of invoices:

a. One set of international invoices between the exporter and the distributor (who in this case is actually the importer)

b. Another set of domestic invoices between the distributor and its customers (who see this as domestic sales of foreign product)

c. Distributor carries inventory:

i. Of exporters products

ii. Possibly of spare parts (and provides after-sale service)

iii. Of complementary products

iv. Possibly of products that compete directly with exporter

III. Distributor takes more risks than agent (and has higher costs)

a. Inventory carrying costs

b. Usually expected to participate in costs of promotion

i. Advertising

ii. Trade shows

c. Distributor usually has benefits agent does not have (although many exporting firms try to limit these)

i. More freedom in setting prices

ii. More freedom in negotiating with customers

iii. Is basically only limited by exporter’s copyrights and trademarks

IV. Distributor should be considered a long-term partner

a. It makes substantial investment in inventory

b. It trains its employees

c. Important that exporter and distributor are a good match

i. Distributor needs to be able to accurately represent exporter and product

ii. Distributor needs to be able to invest in exporter’s products

iii. Distributor needs to be able to sell exporter’s products

iv. Distributor needs to be able to provide after-sale service

v. Distributor needs knowledge of the industry

vi. Distributor needs to have objectives compatible with those of exporter

V. Finding distributors

a. Trade show

b. Trade missions

c. Commercial attachés of the embassies of the exporter’s country

d. Contacts with other successful exporters

VI. Factors which may call for the use of a distributor:

a. Potential sales are substantial

b. Product is a stock item, not designed for a particular customer

c. Product is moderately priced

d. When there is expectation of a long product life cycle

e. When the product requires frequent after-sale service and/or parts

f. When the exporter believes it will not be much more than a minor player in the market

g. When the exporter prefers to export to only one customer

h. When the company does not have a strategy of premium prices and service

i. When the exporter is comfortable relinquishing control of price and delivery terms

4-3-3 Additional Issues in the Agent-Distributorship Decision

I. Some countries do not allow agents

a. If they allow agents, they will not allow them to represent foreign manufacturers

b. They may require a physical after-sale service presence (which would require a distributor)

II. Most countries’ judicial systems vary on how they differentiate between agents and distributors

a. Since most agents are small businesses, many governments place them under their labor law

i. This may affect termination notices on the part of the exporter

ii. This may affect the agent’s working conditions and issues such as taxation, certifications, licenses, …etc.

b. Distributors, usually being larger, are covered in most countries by contract law, which is much less restrictive than labor law

4-3-4 Marketing Subsidiary

I. An exporter opens its own sales or marketing office in a foreign country and staffs it with its own employees to sell its products

II. Since it is incorporated in the importing country it is the importer of record

III. As far as the foreign government is concerned the “export” is between two legal companies that are part of the same company at a transfer price

IV. Sales in the foreign country by the marketing subsidiary are considered to be domestic sales

V. Costs of marketing subsidiary are higher and are more long-term

a. Include fixed costs (real estate, inventory, employees)

b. Agents represent variable costs (commissions)

c. Distributors bear all the costs of establishing the business in a foreign country

VI. Factors which may call for the use of a marketing subsidiary:

a. When the exporter estimates that the market potential (sales, growth, or profit) is considerable

b. When the product is technologically driven, with substantial intellectual property content

c. When the product is rather complicated to sell

d. When the company expects to be in for the long run, with more products forthcoming

e. When the product requires sophisticated after-sale support

f. When the company expects to become a major player in the market

g. When the company can command premium prices

h. When the company does not want to relinquish control of its products and prices

4-3-5 Coordinating Direct Export Strategies

I. Two factors in exporter’s entry decision:

a. Market-driven

b. Company- or product-driven

c. Some firms have a specific strategy they follow for exporting

i. Advantages:

1. Simplifies export management

2. Provides united marketing front

3. Can develop similar standard for all of their import entities

a. Agents/sales subsidiaries: can coordinate prices and control after-sale policies

b. Distributors: can contractually control prices

ii. Disadvantages: one-size-fits-all may result in poor match with market

1. Potentially good market may be given away to an agent

2. Establishing a sales subsidiary may be wasteful in a small market

3. Firm may miss market opportunities by waiting for enough resources to establish a subsidiary

4. Other firms decide their exporting strategy on a country-by-country basis

d. Some firms have different entry strategies in different countries

i. Advantage: best strategy is chosen for each country and profits usually will be higher

ii. Disadvantages:

1. Coordination of prices and after-sale service is more difficult to achieve

2. There is the possibility of parallel imports

e. Switching from agents or distributors to sales subsidiaries can cause serious problems

i. Agents/distributors have usually heavily invested to develop market

ii. Customers have loyalty to agents/distributors

iii. Changing to a subsidiary can cause a drop in sales

iv. Slighted distributor may successfully seek redress in court

4-3-6 Foreign Sales Corporation

I. Method for U.S. companies to reduce income tax on exports from 45 percent of profit to 30 percent

II. Export products must have at least 50 percent U.S. content

III. Exporter must incorporate subsidiary in pre-approved foreign location such as Virgin Islands, Barbados or Jamaica

IV. Does not include Export Trading Company, since those are domestic sales

V. Based on a European Union complaint, the World Trade Organization has ruled that Foreign Sales Corporations are prohibited subsidies to exports, but Congress does not want the tax break to go away

4-4 Production Abroad

I. Effective when manufacturing costs are lower

II. Effective when costs are prohibitive

III. Effective when domestic manufacturing capacity reached

IV. Effective when product has significant intangible content, such as services

4-4-1 Contract Manufacturing/Subcontracting

I. Company contracts with foreign producer to manufacture its goods

II. Not truly a means of entry, just a way to get the product manufactured in the foreign country

III. Product still must be marketed and distributed

a. Usually through distributor or marketing subsidiary

b. Sometimes local contractor uses their own marketing channels

IV. Contract manufacturing may be used to offset significant barriers to entry (high tariffs, quotas), but countries with such practices usually do not have manufacturing firms up to world standards

4-4-2 Licensing

I. Granting of rights of intellectual property from one company, the licensor to another, the licensee

II. Common in manufacturing

III. International licensing

a. Licensor “exports” intellectual property to licensee in a foreign country

b. Advantages:

i. Good solution to tariffs or other barriers

ii. Licensor does not need to risk a lot of capital

iii. Licensor can generate worldwide income fairly rapidly

c. Disadvantage: piracy

4-4-3 Franchising

I. Similar to licensing, except franchisor grants large number of intellectual property items to franchisee

II. Often used in retailing

a. Consumers like consistency

b. Entrepreneurs like proven business plan

c. Somewhat limited to low-skill service businesses like retailing

III. Generates substantial amounts of piggy-backing by franchisor’s equipment suppliers

4-4-4 Joint Venture

I. Exporter invests in foreign country with one or more partners to create a new corporation

II. Politically-connected local partner helps to prevent seizure of company by local government, as was common in some countries from the 1950s through the 1970s

III. Local governments not interested in nationalization, but in local ownership of capital have been advocates of joint ventures

IV. Problem is they are like a marriage where the spouses continually change: personnel and corporate ownerships do not remain static

V. Foreign investors find joint ventures less and less attractive

4-4-5 Subsidiary

I. Sometimes called Wholly-Owned Foreign Enterprise or Wholly Foreign-Owned Enterprise (WFOE, “Woofie”)

II. Advantages:

a. Firm retains control

b. Firm protects trade secrets

c. Firm does not have to share profits

d. Does not rely on any one else for information on customers

e. Can pull out when it wants

f. Creates jobs for host country

g. Favorable duty rates

III. Disadvantages:

a. High costs establishing it

b. High risk exposure

c. Managing in a foreign country with limited understanding of local customs and culture

4-5 Parallel Imports

I. Parallel imports, or gray market goods, are goods sold outside regular distribution channels of a company

II. Gray market sometimes develops when there is a price differential between one country and the next. Someone buys the goods in the lower-priced country and re-sells them in the higher-priced country in outlets outside the regular channel and at prices lower than those of the regular channel

III. Best defense is to avoid price discrepancies from country to country

IV. No legal recourse—when a company sells a product it can no longer control it

4-6 Counterfeit

I. Lots of consumer goods, and some industrial goods, can be counterfeited

II. The largest culprits are countries in which intellectual property rights are not well protected (China, India, Russia, ...etc.)

III. The goods are made by an unauthorized manufacturer, and are frequently, but not always, of lower quality

IV. Counterfeit goods can represent problems for the owner of the brand, as warranty claims (and liability claims) are made

V. Perceptions of lower quality are also attributed to the owner of the brand and not the counterfeiter

4-7 Other Issues in Methods of Entry

4-7-1 Foreign Trade Zones

I. Although a FTZ is in a country, as far as Customs is concerned, the FTZ is considered to be “outside” the country

II. Goods can be imported duty-free into the FTZ, then transformed, assembled, repackaged and shipped elsewhere without ever having been considered to be in the country where the FTZ is located

III. Products from the FTZ sold to the host country are only subject to duty when they leave the FTZ

IV. They stimulate foreign investment and create local jobs

V. Attractive to manufacturers subject to tariffs on materials that are higher than on the finished product

VI. Good place to hold inventory while waiting on import quota

VII. WTO’s progress in securing lower tariffs may reduce future role of FTZs

4-7-2 Maquiladoras

I. Mexican countries with a Customs status similar to being in an FTZ in both Mexico and the United States

II. Companies can import goods duty-free from the United States, transform them, then re-export them to the United States where the duty is only for the value added in Mexico

III. North American Free Trade Agreement (NAFTA) has reduced attractiveness of the maquiladoras

4-7-3 Anti-Bribery Convention

I. Much international business is driven by bribery and corruption

II. U.S. Foreign Corrupt Practices Act prohibits Americans from engaging in bribery

III. The Organisation for Economic Co-operation and Development (OECD) wants an end to bribery, and as of May 2009, 38 countries have ratified it

Key terms

Anti-Bribery Convention

An OECD convention that requires countries to penalize companies engaging in bribery.

agent

An individual or firm, located in an importing country, that is allowed to represent an exporter in sales negotiations. The firm being represented is called the principal.

binding agent

An agent who can make decisions that are binding on the principal; the principal must abide by whatever statements the representative has made.

contract law

A set of laws that govern relationships established by contracts between two parties.

contract manufacturing

A situation in which an exporter that needs to manufacture a product abroad finds a corporation in the importing country to make the product for the exporter.

counterfeit goods

Goods that appear to have been produced by the legitimate manufacturer but that were actually produced by another company intent on deceiving customers and imitating the genuine goods. Counterfeit goods are generally sold for a much lower price than the authentic goods.

distributor

An individual or a firm, located in an importing country, that purchases goods from the exporter with the idea of reselling them for a profit.

duty

The amount of tax paid to Customs authorities in the importing country on imported goods

export management corporation

A company that puts suppliers in touch with potential buyers, and earns a commission if a sale is completed.

export trading company

A company that purchases goods in one country for the purpose of reselling them in another country at a profit.

sogo sosha

The Japanese term for a trading company.

Foreign Corrupt Practices ActA U.S. law that punishes severely U.S. companies engaging in bribery outside of the borders of the United States.

foreign sales corporation

A subsidiary, created for tax-reduction purposes only, that handles an exporter's overseas sales.

foreign trade zone

An area that is physically within the borders of a country, but that is considered outside of its borders for Customs' purposes.

franchisee

The party granted the right to use an array of intellectual property items owned by another party in exchange for payment of royalties.

franchising

A process by which a firm possessing an array of several intellectual property items (patents, copyrights, trademarks, trade secrets) grants another company the right to use these intellectual property items in exchange for royalties. In general, the firm that is granted the rights to use the items (called the franchisee) and the firm granting the rights to the use of the items (called the franchisor) are, in the eyes of their customers, indistinguishable

franchisor

The owner of an array of several intellectual property items that grants another firm (the licensee or franchisee) the rights to use that group of intellectual property items in exchange for the payment of royalties.

gray market goods

Goods purchased in one country by unauthorized intermediaries and sold to unauthorized retailers in another country.

intellectual property

A type of intangible good that an individual or a firm can own; it is either a copyright (the rights to a work of art, a musical piece, or a written article), a patent (the rights to a process, a material, or a design), a trademark (the rights to a commercial name or slogan), or a trade secret (a unique way to manufacture a particular product). Copyrights, patents, and trademarks are protected by governments, preventing non-owners from using intellectual property without authorization. Trade secrets are protected by being kept secret.

joint venture

An overseas company that is jointly owned by two or more companies.

labor law

A set of laws that govern relationships between employees and employers.

licensee

The party that is granted the right to use an intellectual property item owned by another party (the licensor) in exchange for payment of a royalty.

licensing

A process by which a firm possessing some intellectual property item (a patent, a copyright, a trademark, a trade secret) grants another company the right to use the intellectual property item in exchange for a payment, called a royalty.

licensor

The owner of an intellectual property item that grants another firm (the licensee) the right to use that intellectual property in exchange for the payment of a royalty.

maquiladora

A plant located in Mexico that have the same status as a foreign trade zone located both in the United States and Mexico.

marketing subsidiary

A firm, incorporated in the importing county and owned by the exporter, whose purpose is to sell the exporter’s products.

parallel imports

Goods purchased in one country by unauthorized intermediaries and sold to unauthorized retailers in another country.

piggy-backing

When a manufacturer goes overseas and asks its suppliers to continue doing business abroad with him, the suppliers are said to be piggy backing on that customer's efforts.

permanent establishment

A fixed place of business abroad that subjects the exporter to tax liability in the importing country.

principal

The party represented by the agent in an international agency agreement; the exporter.

royalty

The amount of money paid by a licensee to a licensor for the right to use the licensor’s intellectual property. Royalty fees are generally determined in function of the number of times that the licensee or franchisee used the intellectual property.

subsidiary

A corporation entirely owned by another corporation.

wholly-owned foreign enterprise

Another term for a subsidiary.

PowerPoint SLIDES – STUDY THEM – PRINT THEM OUT !

· Entry Strategy Determinant Factors (4 slides)

· Indirect Exporting (6 slides)

· Active Exporting (10 slides)

· Production Abroad (11 slides)

· Parallel Imports (2 slides)

· Counterfeit Goods (1 slide)

· FTZs and Maquiladoras (3 slides)

· Foreign Corrupt Practices Act (1 slide)

Additional Resources

Bello, Daniel C. and Ritu Lohtia, “Export Channel Design: The Use of Foreign Distributors and Agents,” Journal of the Academy of Marketing Science, Spring 1995, pp. 83–93.

Root, Franklin R., Entry Strategies for International Markets, Revised and Expanded Edition, Lexington Books, 1994.

Rosenbloom, Bert and G. Behrens Ulrich, Marketing Channels: A Management View, Sixth Edition, The Dryden Press, 1998.

“Country Descriptions of Tax Legislation on the Tax Treatment of Bribes,” Organisation for Economic Co-operation and Development, June 2006, http://www.oecd.org/dataoecd/42/43/37116153.pdf, October 1, 2007.

“Foreign Corrupt Practices Act Antibribery Provisions,” United States Department of Justice—Fraud Division, and United States Department of Commerce—Office of the Chief Counsel for International Commerce, http://www.justice.gov/criminal/fraud/fcpa/docs/lay-persons-guide.pdf, June 4, 2010.