Marketing of the Acquisition by EDUS

Module 4 Readings and Assignments

Complete the following reading before starting work on the assignments:

Module 4 online lectures

From your course text, Global Business Today,9th read the following:

The Strategy of International Business

Entering Foreign Markets

Exporting, Importing & Countertrade

https://digitalbookshelf.argosy.edu/#/books/1259669432/cfi/6/38!/4/4/2/2/4/2@0:0

learning objectives

12-1 Explain the concept of strategy.

12-2 Recognize how firms can profit by expanding globally.

12-3 Understand how pressures for cost reductions and pressures for local responsiveness influence strategic choice.

12-4 Identify the different strategies for competing globally and their pros and cons.

12-5 Explain the pros and cons of using strategic alliances to support global strategies.

Page 337

The Strategy of International Business

IKEA

opening case

Walk into an IKEA store anywhere in the world, and you would recognize it instantly. The warehouse-type stores all sell the same broad range of affordable home furnishings, kitchens, and accessories. Most of the products are instantly recognizable as IKEA merchandise, with their clean yet tasteful lines and functional design. The outside of the store will be wrapped in the blue and yellow colors of the Swedish flag. The store itself will be laid out as a maze that requires customers to walk through every department before they reach the checkout stations. Immediately before the checkout, there is an in-store warehouse where customers can pick up the items they purchased. The furniture is all flat, packed for ease of transportation, and requires assembly by the customer. If you look at the customers in the store, you will see that many of them are in there 20s and 30s. IKEA sells to the same basic customer set the world over: young upwardly mobile people who are looking for tasteful yet inexpensive “disposable” furniture.

A global network of more than 1,050 suppliers based in 53 countries manufactures most of the 9,500 or so products that IKEA sells. IKEA itself focuses on the design of products and works closely with suppliers to bring down manufacturing costs. Developing a new product line can be a painstaking process that takes years. IKEA’s designers will develop a prototype design—a small couch, for example—look at the price that rivals charge for a similar piece, and then work with suppliers to figure out a way to cut prices by 40 percent without compromising on quality. IKEA also manufactures about 10 percent of what it sells in-house and uses the knowledge gained to help its suppliers improve their productivity, thereby lowering costs across the entire supply chain.

It’s a formula that has worked remarkably well. From its roots in Scandinavia, IKEA has grown to become the largest furniture retailer in the world with almost 300 stores in 26 countries and revenues of more than 27 billion euros. IKEA is particularly strong in Europe, where it has 227 stores, but it also has around 50 stores in North America. Its strongest growth recently has been in China, where it had 17 stores in 2013, and Russia, where it had 14 stores.

Page 338Look a little closer, however, and you will see subtle differences between the IKEA offerings in North America, Europe, and China. In North America, sizes are different to reflect the American demand for bigger beds, furnishings, and kitchenware. This adaptation to local tastes and preferences was the result of a painful learning experience for IKEA. When the company first entered the United States in the late 1980s, it thought that consumers would flock to their stores the same way that they had in western Europe. At first they did, but they didn’t buy as much, and sales fell short of expectations. IKEA discovered that its European-style sofas were not big enough, wardrobe drawers were not deep enough, glasses were too small, and kitchens didn’t fit U.S. appliances. So the company set about redesigning its offerings to better match American tastes and was rewarded with accelerating sales growth.

Lesson learned, when IKEA entered China in the 2000s, it made adaptations to the local market. The store layout reflects the layout of many Chinese apartments, where most people live, and because many Chinese apartments have balconies, IKEA’s Chinese stores include a balcony section. IKEA has also had to shift its locations in China, where car ownership lags behind that in Europe and North America. In the West, IKEA stores are located in suburban areas and have lots of parking space. In China, stores are located near public transportation, and IKEA offers a delivery service so that Chinese customers can get their purchases home. images

Sources: J. Leland, “How the Disposable Sofa Conquered America,” The New York Times Magazine, October 5, 2005, p. 45; “The Secret of IKEA’s Success,” The Economist, February 24, 2011; B. Torekull, Leading by Design: The IKEA Story (New York: Harper Collins, 1998); and P. M. Miller, “IKEA with Chinese Characteristics,” Chinese Business Review, July–August 2004, pp. 36–69.

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Introduction

The primary concern thus far in this book has been with aspects of the larger environment in which international businesses compete. As described in the preceding chapters, this environment has included the different political, economic, and cultural institutions found in nations; the international trade and investment framework; and the international monetary system. Now, our focus shifts from the environment to the firm itself and, in particular, to the actions managers can take to compete more effectively as an international business. This chapter looks at how firms can increase their profitability by expanding their operations in foreign markets. We discuss the different strategies that firms pursue when competing internationally, consider the pros and cons of these strategies, and study the various factors that affect a firm’s choice of strategy. We also look at why firms often enter into strategic alliances with their global competitors, and we discuss the benefits, costs, and risks of strategic alliances.

The strategy of furniture retailer IKEA, which was discussed in the opening case, gives us a preview of some of the key issues discussed in this chapter. IKEA’s business-level strategy is to target young, upwardly mobile people and offer them affordable, tastefully designed, furniture and accessories. IKEA differentiates its offering by design. At the same time, the company does everything it can to lower the costs of the products it sells, thereby enabling it to underprice its rivals and still make good profits. IKEA developed its basic formula for competing in Scandinavia in the 1950s and 1960s. This formula, or business model, includes self-service warehouse-type stores, a maze-like store layout that funnels customers through every department and maximizes impulse purchases, the design of furniture so that it can be flat-packed, an in-store warehouse, and so on. IKEA initially expanded into other countries by using exactly the same segmentation strategy and retailing formula and selling the same set of products. We refer to such a standardized approach as a global strategy. One of its great Page 339virtues is that it can help a company attain a low-cost position through the realization of economies of scale. However, as the opening case makes clear, while this worked in the western European region, it did not work in North America where IKEA had to adapt its product design to the tastes and preferences of North American consumers. In other words, IKEA found that it needed to localize some of its offerings. As we shall see in this chapter, there is often a tension between the desire to standardize a product offering in order to attain low costs and the need to localize the offering to better match the tastes and preferences of local consumers, which can make it more difficult to attain scale economies and raise costs.

images LO 12-1

Explain the concept of strategy.

Strategy and the Firm

Before we discuss the strategies that managers in the multinational enterprise can pursue, we need to review some basic principles of strategy. A firm’s strategy can be defined as the actions that managers take to attain the goals of the firm. For most firms, the preeminent goal is to maximize the value of the firm for its owners, its shareholders (subject to the constraint that this is done in a legal, ethical, and socially responsible manner—see Chapter 5 for details). To maximize the value of a firm, managers must pursue strategies that increase the profitability of the enterprise and its rate of profit growth over time (see Figure 12.1). Profitability can be measured in a number of ways, but for consistency, we shall define it as the rate of return that the firm makes on its invested capital (ROIC), which is calculated by dividing the net profits of the firm by total invested capital.1 Profit growth is measured by the percentage increase in net profits over time. In general, higher profitability and a higher rate of profit growth will increase the value of an enterprise and thus the returns garnered by its owners, the shareholders.2

Strategy

Actions managers take to attain the firm’s goals.

Profitability

A ratio or rate of return concept.

Profit Growth

The percentage increase in net profits over time.

Managers can increase the profitability of the firm by pursuing strategies that lower costs or by pursuing strategies that add value to the firm’s products, which enables the firm to raise prices. Managers can increase the rate at which the firm’s profits grow over time by pursuing strategies to sell more products in existing markets or by pursuing strategies to enter new markets. As we shall see, expanding internationally can help managers boost the firm’s profitability and increase the rate of profit growth over time.

VALUE CREATION The way to increase the profitability of a firm is to create more value. The amount of value a firm creates is measured by the difference between its costs of production and the value that consumers perceive in its products. In general, the more value customers place on a firm’s products, the higher the price the firm can charge for those products. However, the price a firm charges for a good or service is typically less than the value placed on that good or service by the customer. This is because the customer captures some of that value in the form of what economists call a consumer surplus.3 The customer is able to do this because the firm is competing with other firms for the customer’s business, so the firm must charge a lower price than it could were it a monopoly supplier. Also, it is normally impossible to segment the market to such a degree that the firm can charge each customer a price that reflects that individual’s assessment of the value of a product, which economists refer to as a customer’s reservation price. For these reasons, the price that gets charged tends to be less than the value placed on the product by many customers.

12.1 FIGURE

Determinants of Enterprise Value

12.2 FIGURE

Value Creation

Figure 12.2 illustrates these concepts. The value of a product to an average consumer is V, the average price that the firm can charge a consumer for that product given competitive pressures and its ability to segment the market is P, and the average unit cost of producing that product is C (C comprises all relevant costs, including the firm’s cost of capital). The firm’s profit per unit sold (π) is equal to P − C, while the consumer surplus per unit is equal to V − P (another way of thinking of the consumer surplus is as “value for the money”; the greater the consumer surplus, the greater the value for the money the consumer gets). The firm makes a profit so long as P is greater than C, and its profit will be greater the lower C is relative to P. The difference between V and P is in part determined by the intensity of competitive pressure in the marketplace; the lower the intensity of competitive pressure, the higher the price charged relative to V.4 In general, the higher the firm’s profit per unit sold is, the greater its profitability will be, all else being equal.

The firm’s value creation is measured by the difference between V and C (V − C); a company creates value by converting inputs that cost C into a product on which consumers place a value of V. A company can create more value (V − C) either by lowering production costs, C, or by making the product more attractive through superior design, styling, functionality, features, reliability, after-sales service, and the like, so that consumers place a greater value on it (V increases) and, consequently, are willing to pay a higher price (P increases). This discussion suggests that a firm has high profits when it creates more value for its customers and does so at a lower cost. We refer to a strategy that focuses primarily on lowering production costs as a low-cost strategy. We refer to a strategy that focuses primarily on increasing the attractiveness of a product as a differentiation strategy.5 IKEA’s strategy is primarily about lowering costs, although you will note from the opening case that the company also tries to differentiate itself by design.

Value Creation

Performing activities that increase the value of goods or services to consumers.

Michael Porter has argued that low cost and differentiation are two basic strategies for creating value and attaining a competitive advantage in an industry.6 According to Porter, superior profitability goes to those firms that can create superior value, and the way to create superior value is to drive down the cost structure of the business and/or differentiate the Page 341product in some way so that consumers value it more and are prepared to pay a premium price. Superior value creation relative to rivals does not necessarily require a firm to have the lowest cost structure in an industry, or to create the most valuable product in the eyes of consumers. However, it does require that the gap between value (V) and cost of production (C) be greater than the gap attained by competitors.

STRATEGIC POSITIONING Porter notes that it is important for a firm to be explicit about its choice of strategic emphasis with regard to value creation (differentiation) and low cost, and to configure its internal operations to support that strategic emphasis.7 Figure 12.3 illustrates his point. The convex curve in Figure 12.3 is what economists refer to as an efficiency frontier. The efficiency frontier shows all of the different positions that a firm can adopt with regard to adding value to the product (V) and low cost (C) assuming that its internal operations are configured efficiently to support a particular position (note that the horizontal axis in Figure 12.3 is reverse scaled—moving along the axis to the right implies lower costs). The efficiency frontier has a convex shape because of diminishing returns. Diminishing returns imply that when a firm already has significant value built into its product offering, increasing value by a relatively small amount requires significant additional costs. The converse also holds, when a firm already has a low-cost structure, it has to give up a lot of value in its product offering to get additional cost reductions.

Figure 12.3 plots three hotel firms with a global presence that cater to international travelers: Four Seasons, Marriott International, and Starwood (Starwood owns the Sheraton and Westin chains). Four Seasons positions itself as a luxury chain and emphasizes the value of its product offering, which drives up its costs of operations. Marriott and Starwood are positioned more in the middle of the market. Both emphasize sufficient value to attract international business travelers, but are not luxury chains like Four Seasons. In Figure 12.3, Four Seasons and Marriott are shown to be on the efficiency frontier, indicating that their internal operations are well configured to their strategy and run efficiently. Starwood is inside the frontier, indicating that its operations are not running as efficiently as they might be and that its costs are too high. This implies that Starwood is less profitable than Four Seasons and Marriott and that its managers must take steps to improve the company’s performance.

Porter emphasizes that it is very important for management to decide where the company wants to be positioned with regard to value (V) and cost (C), to configure operations accordingly, and to manage them efficiently to make sure the firm is operating on the efficiency frontier. However, not all positions on the efficiency frontier are viable. In the international hotel industry, for example, there might not be enough demand to support a chain that emphasizes very low cost and strips all the value out of its product offering (see Figure 12.3). International travelers are relatively affluent and expect a degree of comfort (value) when they travel away from home.

12.3 FIGURE

Strategic Choice in the International Hotel Industry

A central tenet of the basic strategy paradigm is that to maximize its profitability, a firm must do three things: (1) pick a position on the efficiency frontier that is viable in the sense that there is enough demand to support that choice; (2) configure its internal operations, such as manufacturing, marketing, logistics, information systems, human resources, and so on, so that they support that position; and (3) make sure that the firm has the right organization structure in place to execute its strategy. The strategy, operations, and organization of the firm must all be consistent with each other if it is to attain a competitive advantage and garner superior profitability. By operations we mean the different value creation activities a firm undertakes, which we shall review next.

OPERATIONS: THE FIRM AS A VALUE CHAIN The operations of a firm can be thought of as a value chain composed of a series of distinct value creation activities, including production, marketing and sales, materials management, R&D, human resources, information systems, and the firm infrastructure. We can categorize these value creation activities, or operations, as primary activities and support activities (see Figure 12.4).8 As noted earlier, if a firm is to implement its strategy efficiently, and position itself on the efficiency frontier shown in Figure 12.3, it must manage these activities effectively and in a manner that is consistent with its strategy.

Operations

The various value creation activities a firm undertakes.

Primary Activities Primary activities have to do with the design, creation, and delivery of the product; its marketing; and its support and after-sale service. Following normal practice, in the value chain illustrated in Figure 12.4, the primary activities are divided into four functions: research and development, production, marketing and sales, and customer service.

Research and development (R&D) is concerned with the design of products and production processes. Although we think of R&D as being associated with the design of physical products and production processes in manufacturing enterprises, many service companies also undertake R&D. For example, banks compete with each other by developing new financial products and new ways of delivering those products to customers. Online banking and smart debit cards are two examples of product development in the banking industry. Earlier examples of innovation in the banking industry included automated teller machines, credit cards, and debit cards. Through superior product design, R&D can increase the functionality of products, which makes them more attractive to consumers (raising V). Alternatively, R&D may result in more efficient production processes, thereby cutting production costs (lowering C). Either way, the R&D function can create value.

12.4 FIGURE

The Value Chain

Production is concerned with the creation of a good or service. For physical products, when we talk about production, we generally mean manufacturing. Thus, we can talk about the production of an automobile. For services such as banking or health care, “production” typically occurs when the service is delivered to the customer (e.g., when a bank originates a loan for a customer it is engaged in “production” of the loan). For a retailer such as Walmart, “production” is concerned with selecting the merchandise, stocking the store, and ringing up the sale at the cash register. For MTV, production is concerned with the creation, programming, and broadcasting of content, such as music videos and thematic shows. The production activity of a firm creates value by performing its activities efficiently so lower costs result (lower C) and/or by performing them in such a way that a higher-quality product is produced (which results in higher V).

A Caterpillar motor factory in Germany helps to ensure product after-sales and service outside the U.S.

The marketing and sales functions of a firm can help to create value in several ways. Through brand positioning and advertising, the marketing function can increase the value (V) that consumers perceive to be contained in a firm’s product. If these create a favorable impression of the firm’s product in the minds of consumers, they increase the price that can be charged for the firm’s product. For example, Ford produced a high-value version of its Ford Expedition SUV. Sold as the Lincoln Navigator and priced around $10,000 higher, the Navigator has the same body, engine, chassis, and design as the Expedition, but through skilled advertising and marketing, supported by some fairly minor features changes (e.g., more accessories and the addition of a Lincoln-style engine grille and nameplate), Ford has fostered the perception that the Navigator is a “luxury SUV.” This marketing strategy has increased the perceived value (V) of the Navigator relative to the Expedition and enables Ford to charge a higher price for the car (P).

Marketing and sales can also create value by discovering consumer needs and communicating them back to the R&D function of the company, which can then design products that better match those needs. For example, the allocation of research budgets at Pfizer, the world’s largest pharmaceutical company, is determined by the marketing function’s assessment of the potential market size associated with solving unmet medical needs. Thus, Pfizer is currently directing significant monies to R&D efforts aimed at finding treatments for Alzheimer’s disease, principally because marketing has identified the treatment of Alzheimer’s as a major unmet medical need in nations around the world where the population is aging.

The role of the enterprise’s service activity is to provide after-sale service and support. This function can create a perception of superior value (V) in the minds of consumers by solving customer problems and supporting customers after they have purchased the product. Caterpillar, the U.S.-based manufacturer of heavy earthmoving equipment, can get spare parts to any point in the world within 24 hours, thereby minimizing the amount of downtime its customers have to suffer if their Caterpillar equipment malfunctions. This is an extremely valuable capability in an industry where downtime is very expensive. It has helped to increase the value that customers associate with Caterpillar products and thus the price that Caterpillar can charge.

Support Activities The support activities of the value chain provide inputs that allow the primary activities to occur (see Figure 12.4). In terms of attaining a competitive advantage, support activities can be as important as, if not more important than, the primary activities of the firm. Consider information systems; these systems refer to the electronic systems for managing inventory, tracking sales, pricing products, selling products, dealing with customer service inquiries, and so on. Information systems, when coupled with the communications features of the Internet, can alter the efficiency and effectiveness with which a firm manages its other value creation activities. Dell, for example, has used its information systems to attain a competitive advantage over rivals. When customers place an order for a Dell product over the firm’s website, that information is immediately transmitted, via the Internet, to suppliers, who then configure their production schedules to produce and ship that product so that it arrives at the right assembly plant at the right time. These systems have reduced the amount of inventory that Dell holds at assembly plants to under two days, which is a major source of cost savings.

Page 344images International Business Resources

In Chapter 12, we are bringing you closer to running a globally oriented company based on the issues we have covered on country differences, global trade and investment environment, and the global money system. This is where many of you will “make your money” as strategic decision makers in corporations. This also means you need to know what is current, important, and strategic in the global marketplace; your company’s products or services; and your company’s uniqueness in satisfying the needs and wants of customers. The globalEDGE Business Review (gBR) is a leading source for cutting-edge global business knowledge with a main target audience of business executives (globaledge.msu.edu/gbr). Note that gBR complements the overall globalEDGE site content by publishing cutting-edge articles dealing with a variety of international business issues facing managers in different world areas, industries, and management functions. With millions of visitors to the site and some 30,000 subscribers, gBR reaches farther and has more impact and visibility than any business journal in international business. One gBR article is titled “From Domestic to International to Global Sourcing.” Based on this article, how much should a company engage in “international/global purchasing activities” versus “domestic purchasing only” to best operate a global strategy?

The logistics function controls the transmission of physical materials through the value chain, from procurement through production and into distribution. The efficiency with which this is carried out can significantly reduce cost (lower C), thereby creating more value. The combination of logistics systems and information systems is a particularly potent source of cost savings in many enterprises, such as Dell, where information systems tell Dell on a real-time basis where in its global logistics network parts are, when they will arrive at an assembly plant, and thus how production should be scheduled.

The human resource function can help create more value in a number of ways. It ensures that the company has the right mix of skilled people to perform its value creation activities effectively. The human resource function also ensures that people are adequately trained, motivated, and compensated to perform their value creation tasks. In a multinational enterprise, one of the things human resources can do to boost the competitive position of the firm is to take advantage of its transnational reach to identify, recruit, and develop a cadre of skilled managers, regardless of their nationality, who can be groomed to take on senior management positions. They can find the very best, wherever they are in the world. Indeed, the senior management ranks of many multinationals are becoming increasingly diverse, as managers from a variety of national backgrounds have ascended to senior leadership positions.

Is Education Creating Value for You?

The concept of a value chain can be used to examine the role your education plays in your life plans, if you look closely at your personal development plans (education, internship, work, physical and emotional fitness, and extracurricular activities) and think about them in terms of primary and support activities. If we use the logic that the amount of value you receive from your education is the difference between the costs (e.g., tuition, time, lost income) and what you receive in the form of education (e.g., knowledge, tools, networks), how does your choice of major area of focus in your education fit into your personal development strategy? How do your choices of how you spend your time fit into your value chain? Do you ever spend time doing things that do not support the strategic goals of your personal value chain? But, most importantly, what is the one thing you should do more of to drive the value higher for yourself today and in the future?

The final support activity is the company infrastructure, or the context within which all the other value creation activities occur. The infrastructure includes the organizational structure, control systems, and culture of the firm. Because top management can exert considerable influence in shaping these aspects of a firm, top management should also be viewed as part of the firm’s infrastructure. Through strong leadership, top management can consciously shape the infrastructure of a firm and through that the performance of all its value creation activities.

Page 34512.5 FIGURE

Organization Architecture

Organization: The Implementation of Strategy The strategy of a firm is implemented through its organization. For a firm to have superior ROIC, its organization must support its strategy and operations. The term organization architecture can be used to refer to the totality of a firm’s organization, including formal organizational structure, control systems and incentives, organizational culture, processes, and people.9 Figure 12.5 illustrates these different elements. By organizational structure, we mean three things: first, the formal division of the organization into subunits such as product divisions, national operations, and functions (most organizational charts display this aspect of structure); second, the location of decision-making responsibilities within that structure (e.g., centralized or decentralized); and third, the establishment of integrating mechanisms to coordinate the activities of subunits including cross functional teams and or pan-regional committees.

Organization Architecture

The totality of a firm’s organization, including formal organizational structure, control systems and incentives, organizational culture, processes, and people.

Organizational Structure

The three-part structure of an organization, including its formal division into subunits such as product divisions, its location of decision-making responsibilities within that structure, and the establishment of integrating mechanisms to coordinate the activities of all subunits.

Controls are the metrics used to measure the performance of subunits and make judgments about how well managers are running those subunits. Incentives are the devices used to reward appropriate managerial behavior. Incentives are very closely tied to performance metrics. For example, the incentives of a manager in charge of a national operating subsidiary might be linked to the performance of that company. Specifically, she might receive a bonus if her subsidiary exceeds its performance targets.

Controls

The metrics used to measure the performance of subunits and make judgments about how well managers are running those subunits.

Incentives

The devices used to reward appropriate managerial behavior.

Processes are the manner in which decisions are made and work is performed within the organization. Examples are the processes for formulating strategy, for deciding how to allocate resources within a firm, or for evaluating the performance of managers and giving feedback. Processes are conceptually distinct from the location of decision-making responsibilities within an organization, although both involve decisions. While the CEO might have ultimate responsibility for deciding what the strategy of the firm should be (i.e., the decision-making responsibility is centralized), the process he or she uses to make that decision might include the solicitation of ideas and criticism from lower-level managers.

Processes

The manner in which decisions are made and work is performed within any organization.

Organizational culture is the norms and value systems that are shared among the employees of an organization. Just as societies have cultures (see Chapter 4 for details), so do organizations. Organizations are societies of individuals who come together to perform collective tasks. They have their own distinctive patterns of culture and subculture.10 As we shall see, organizational culture can have a profound impact on how a firm performs. Finally, by people we mean not just the employees of the organization, but also the strategy used to recruit, compensate, and retain those individuals and the type of people that they are in terms of their skills, values, and orientation (discussed in depth in Chapter 17).

Organizational Culture

The values and norms shared among an organization’s employees.

People

The employees of the organization, the strategy used to recruit, compensate, and retain those individuals and the type of people that they are in terms of their skills, values, and orientation.

As illustrated by the arrows in Figure 12.5, the various components of an organization’s architecture are not independent of each other: Each component shapes, and is shaped by, Page 346other components of architecture. An obvious example is the strategy regarding people. This can be used proactively to hire individuals whose internal values are consistent with those that the firm wishes to emphasize in its organization culture. Thus, the people component of architecture can be used to reinforce (or not) the prevailing culture of the organization. If a firm is going to maximize its profitability, it must pay close attention to achieving internal consistency among the various components of its architecture, and the architecture must support the strategy and operations of the firm.

12.6 FIGURE

Strategic Fit

In Sum: Strategic Fit In sum, as we have repeatedly stressed, for a firm to attain superior performance and earn a high return on capital, its strategy (as captured by its desired strategic position on the efficiency frontier) must make sense given market conditions (there must be sufficient demand to support that strategic choice). The operations of the firm must be configured in a way that supports the strategy of the firm, and the organization architecture of the firm must match the operations and strategy of the firm. In other words, as illustrated in Figure 12.6, market conditions, strategy, operations, and organization must all be consistent with each other, or fit each other, for superior performance to be attained.

images test PREP

Use LearnSmart to help retain what you have learned. Access your instructor’s Connect course to check out LearnSmart or go to learnsmartadvantage.com for help.

Of course, the issue is more complex than illustrated in Figure 12.6. For example, the firm can influence market conditions through its choice of strategy—it can create demand by leveraging core skills to create new market opportunities. In addition, shifts in market conditions caused by new technologies, government action such as deregulation, demographics, or social trends can mean that the strategy of the firm no longer fits the market. In such circumstances, the firm must change its strategy, operations, and organization to fit the new reality—which can be an extraordinarily difficult challenge. And last but by no means least, international expansion adds another layer of complexity to the strategic challenges facing the firm. We shall now consider this.

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Recognize how firms can profit by expanding globally.

Global Expansion, Profitability, and Profit Growth

Expanding globally allows firms to increase their profitability and rate of profit growth in ways not available to purely domestic enterprises.11 Firms that operate internationally are able to:

1. Expand the market for their domestic product offerings by selling those products in international markets.

Page 3472. Realize location economies by dispersing individual value creation activities to those locations around the globe where they can be performed most efficiently and effectively.

3. Realize greater cost economies from experience effects by serving an expanded global market from a central location, thereby reducing the costs of value creation.

4. Earn a greater return by leveraging any valuable skills developed in foreign operations and transferring them to other entities within the firm’s global network of operations.

As we will see, however, a firm’s ability to increase its profitability and profit growth by pursuing these strategies is constrained by the need to customize its product offering, marketing strategy, and business strategy to differing national or regional conditions—that is, by the imperative of localization.

EXPANDING THE MARKET: LEVERAGING PRODUCTS AND COMPETENCIES A company can increase its growth rate by taking goods or services developed at home and selling them internationally. Almost all multinationals started out doing just this. For example, Procter & Gamble developed most of its best-selling products (such as Pampers disposable diapers and Ivory soap) in the United States and subsequently sold them around the world. Likewise, although Microsoft developed its software in the United States, from its earliest days the company has always focused on selling that software in international markets. Automobile companies such as Volkswagen and Toyota also grew by developing products at home and then selling them in international markets. The returns from such a strategy are likely to be greater if indigenous competitors in the nations that a company enters lack comparable products. Thus, Toyota increased its profits by entering the large automobile markets of North America and Europe, offering products that were different from those offered by local rivals (Ford and GM) by their superior quality and reliability.

The success of many multinational companies that expand in this manner is based not just upon the goods or services that they sell in foreign nations, but also upon the core competencies that underlie the development, production, and marketing of those goods or services. The term core competence refers to skills within the firm that competitors cannot easily match or imitate.12 These skills may exist in any of the firm’s value creation activities—production, marketing, R&D, human resources, logistics, general management, and so on. Such skills are typically expressed in product offerings that other firms find difficult to match or imitate. Core competencies are the bedrock of a firm’s competitive advantage. They enable a firm to reduce the costs of value creation and/or to create perceived value in such a way that premium pricing is possible. For example, Toyota has a core competence in the production of cars. It is able to produce high-quality, well-designed cars at a lower delivered cost than any other firm in the world. The competencies that enable Toyota to do this seem to reside primarily in the firm’s production and logistics functions.13 Similarly, IKEA has a core competence in the design of stylish and affordable furniture that can be manufactured at a low cost and flat-packed, McDonald’s has a core competence in managing fast-food operations (it seems to be one of the most skilled firms in the world in this industry), and Procter & Gamble has a core competence in developing and marketing name-brand consumer products (it is one of the most skilled firms in the world in this business.

Core Competence

Firm skills that competitors cannot easily match or imitate.

Because core competencies are, by definition, the source of a firm’s competitive advantage, the successful global expansion by manufacturing companies such as Toyota and P&G was based not just on leveraging products and selling them in foreign markets, but also on the transfer of core competencies to foreign markets where indigenous competitors lacked them. The same can be said of companies engaged in the service sectors of an economy, such as financial institutions, retailers like IKEA, restaurant chains, and hotels. Expanding the market for their services often means replicating their business model in foreign nations (albeit with some changes to account for local differences, which we will discuss in more detail shortly). Firms like Star-bucks and IKEA, for example, expanded rapidly outside of their home markets the United States by taking the basic business model that they developed at home and using that as a blueprint for establishing international operations.

P&G’s core competency in marketing is evidenced in this photo of Olay men’s skin care products for sale in a Shanghai, China supermarket.

Page 348LOCATION ECONOMIES Earlier chapters revealed that countries differ along a range of dimensions—including the economic, political, legal, and cultural—and that these differences can either raise or lower the costs of doing business in a country. The theory of international trade also teaches that due to differences in factor costs, certain countries have a comparative advantage in the production of certain products. Japan might excel in the production of automobiles and consumer electronics; the United States in the production of computer software, pharmaceuticals, biotechnology products, and financial services; Switzerland in the production of precision instruments and pharmaceuticals; South Korea in the production of semiconductors; and Vietnam in the production of apparel.14

For a firm that is trying to survive in a competitive global market, this implies that trade barriers and transportation costs permitting, the firm will benefit by basing each value creation activity it performs at that location where economic, political, and cultural conditions—including relative factor costs—are most conducive to the performance of that activity. Thus, if the best designers for a product live in France, a firm should base its design operations in France. If the most productive labor force for assembly operations is in Mexico, assembly operations should be based in Mexico. If the best marketers are in the United States, the marketing strategy should be formulated in the United States. And so on.

Firms that pursue such a strategy can realize what we refer to as location economies, which are the economies that arise from performing a value creation activity in the optimal location for that activity, wherever in the world that might be (transportation costs and trade barriers permitting). Locating a value creation activity in the optimal location for that activity can have one of two effects. It can lower the costs of value creation and help the firm to achieve a low-cost position, and/or it can enable a firm to differentiate its product offering from those of competitors. In terms of Figure 12.2, it can lower C and/or increase V (which, in general, supports higher pricing), both of which boost the profitability of the enterprise.

Location Economies

Cost advantages from performing a value creation activity at the optimal location for that activity.

For an example of how this works in an international business, consider Clear Vision, a manufacturer and distributor of eyewear. Started by David Glassman, the firm now generates annual gross revenues of more than $100 million. Not exactly small, but no corporate giant either, Clear Vision is a multinational firm with production facilities on three continents and customers around the world. Clear Vision began its move toward becoming a multinational when its sales were still less than $20 million. At the time, the U.S. dollar was very strong, and this made U.S.-based manufacturing expensive. Low-priced imports were taking an ever-larger share of the U.S. eyewear market, and Clear Vision realized it could not survive unless it also began to import. Initially, the firm bought from independent overseas manufacturers, primarily in Hong Kong. However, the firm became dissatisfied with these suppliers’ product quality and delivery. As Clear Vision’s volume of imports increased, Glassman decided the best way to guarantee quality and delivery was to set up Clear Vision’s own manufacturing operation overseas. Accordingly, Clear Vision found a Chinese partner, and together they opened a manufacturing facility in Hong Kong, with Clear Vision being the majority shareholder.

The choice of the Hong Kong location was influenced by its combination of low labor costs, a skilled workforce, and tax breaks given by the Hong Kong government. The firm’s objective at this point was to lower production costs by locating value creation activities at an appropriate location. After a few years, however, the increasing industrialization of Hong Kong and a growing labor shortage had pushed up wage rates to the extent that it was no longer a low-cost location. In response, Glassman and his Chinese partner moved part of their manufacturing to a plant in mainland China to take advantage of the lower wage rates there. Again, the goal was to lower production costs. The parts for eyewear frames manufactured at this plant are shipped to the Hong Kong factory for final assembly and then distributed to markets in North and South America. The Hong Kong factory employs 80 people and the China plant between 300 and 400.

Page 349At the same time, Clear Vision was looking for opportunities to invest in foreign eyewear firms with reputations for fashionable design and high quality. Its objective was not to reduce production costs but to launch a line of high-quality, differentiated, “designer” eye-wear. Clear Vision did not have the design capability in-house to support such a line, but Glassman knew that certain foreign manufacturers did. As a result, Clear Vision invested in factories in Japan, France, and Italy, holding a minority shareholding in each case. These factories now supply eyewear for Clear Vision’s Status Eye division, which markets high-priced designer eyewear.15

Thus, to deal with a threat from foreign competition, Clear Vision adopted a strategy intended to lower its cost structure (lower C): shifting its production from a high-cost location, the United States, to a low-cost location, first Hong Kong and later China. Then Clear Vision adopted a strategy intended to increase the perceived value of its product (increase V) so it could charge a premium price (P). Reasoning that premium pricing in eyewear depended on superior design, its strategy involved investing capital in French, Italian, and Japanese factories that had reputations for superior design. In sum, Clear Vision’s strategies included some actions intended to reduce its costs of creating value and other actions intended to add perceived value to its product through differentiation. The overall goal was to increase the value created by Clear Vision and thus the profitability of the enterprise. To the extent that these strategies were successful, the firm should have attained a higher profit margin and greater profitability than if it had remained a U.S.-based manufacturer of eyewear.

Creating a Global Web Generalizing from the Clear Vision example, one result of this kind of thinking is the creation of a global web of value creation activities, with different stages of the value chain being dispersed to those locations around the globe where perceived value is maximized or where the costs of value creation are minimized.16 Consider Lenovo’s ThinkPad laptop computers (Lenovo is the Chinese computer company that purchased IBM’s personal computer operations in 2005).17 This product is designed in the United States by engineers because Lenovo believes that the United States is the best location in the world to do the basic design work. The case, keyboard, and hard drive are made in Thailand; the display screen and memory in South Korea; the built-in wireless card in Malaysia; and the microprocessor in the United States. In each case, these components are manufactured and sourced from the optimal location given current factor costs. These components are then shipped to an assembly operation in China, where the product is assembled before being shipped to the United States for final sale. Lenovo assembles the ThinkPad in Mexico because managers have calculated that due to low labor costs, the costs of assembly can be minimized there. The marketing and sales strategy for North America is developed by Lenovo personnel in the United States, primarily because managers believe that due to their knowledge of the local marketplace, U.S. personnel add more value to the product through their marketing efforts than personnel based elsewhere.

Global Web

When different stages of value chain are dispersed to those locations around the globe where value added is maximized or where costs of value creation are minimized.

In theory, a firm that realizes location economies by dispersing each of its value creation activities to its optimal location should have a competitive advantage vis-à-vis a firm that bases all of its value creation activities at a single location. It should be able to better differentiate its product offering (thereby raising perceived value, V) and lower its cost structure (C) than its single-location competitor. In a world where competitive pressures are increasing, such a strategy may become an imperative for survival.

Some Caveats Introducing transportation costs and trade barriers complicates this picture. Due to favorable factor endowments, New Zealand may have a comparative advantage for automobile assembly operations, but high transportation costs would make it an uneconomical location from which to serve global markets. Another caveat concerns the importance of assessing political and economic risks when making location decisions. Even if a country looks very attractive as a production location when measured against all the standard criteria, if its government is unstable or totalitarian, the firm might be advised not to base production there. (Political risk is discussed in Chapter 3.) Similarly, if the government appears to be pursuing inappropriate economic policies that could lead to foreign Page 350exchange risk, that might be another reason for not basing production in that location, even if other factors look favorable.

12.7 FIGURE

The Experience Curve

EXPERIENCE EFFECTS The experience curve refers to systematic reductions in production costs that have been observed to occur over the life of a product.18 A number of studies have observed that a product’s production costs decline by some quantity about each time cumulative output doubles. The relationship was first observed in the aircraft industry, where each time cumulative output of airframes was doubled, unit costs typically declined to 80 percent of their previous level.19 Thus, production cost for the fourth airframe would be 80 percent of production cost for the second airframe, the eighth airframe’s production costs 80 percent of the fourth’s, the sixteenth’s 80 percent of the eighth’s, and so on. Figure 12.7 illustrates this experience curve relationship between unit production costs and cumulative output (the relationship is for cumulative output over time, and not output in any one period, such as a year). Two things explain this: learning effects and economies of scale.

Experience Curve

Systematic production cost reductions that occur over the life of a product.

Learning Effects Learning effects refer to cost savings that come from learning by doing. Labor, for example, learns by repetition how to carry out a task, such as assembling airframes, most efficiently. Labor productivity increases over time as individuals learn the most efficient ways to perform particular tasks. Equally important in new production facilities, management typically learns how to manage the new operation more efficiently over time. Hence, production costs decline due to increasing labor productivity and management efficiency, which increases the firm’s profitability.

Learning Effects

Cost savings from learning by doing.

Learning effects tend to be more significant when a technologically complex task is repeated because there is more that can be learned about the task. Thus, learning effects will be more significant in an assembly process involving 1,000 complex steps than in one of only 100 simple steps. No matter how complex the task, however, learning effects typically disappear after a while. It has been suggested that they are important only during the startup period of a new process and that they cease after two or three years.20 Any decline in the experience curve after such a point is due to economies of scale.

Economies of Scale Economies of scale refer to the reductions in unit cost achieved by producing a large volume of a product. Attaining economies of scale lowers a firm’s unit costs and increases its profitability. Economies of scale have a number of sources. One is the ability to spread fixed costs over a large volume.21 Fixed costs are the costs required to set up a production facility, develop a new product, and the like. They can be substantial. For example, the fixed cost of establishing a new production line to manufacture semiconductor chips now exceeds $1 billion. Similarly, according to one estimate, developing a new drug and bringing it to market costs about $800 million and takes about 12 years.22 The only way to recoup such high fixed costs may be to sell the product worldwide, which reduces average unit costs by spreading fixed costs over a larger volume. The more rapidly that cumulative sales volume is built up, the more rapidly fixed costs can be amortized over a large production volume, and the more rapidly unit costs will fall.

Economies of Scale

Cost advantages associated with large-scale production.

Page 351Second, a firm may not be able to attain an efficient scale of production unless it serves global markets. In the automobile industry, for example, an efficiently scaled factory is one designed to produce about 200,000 units a year. Automobile firms would prefer to produce a single model from each factory because this eliminates the costs associated with switching production from one model to another. If domestic demand for a particular model is only 100,000 units a year, the inability to attain a 200,000-unit output will drive up average unit costs. By serving international markets as well, however, the firm may be able to push production volume up to 200,000 units a year, thereby reaping greater scale economies, lowering unit costs, and boosting profitability. By serving domestic and international markets from its production facilities, a firm may be able to utilize those facilities more intensively. For example, if Intel sold microprocessors only in the United States, it might be able to keep its factories open for only one shift, five days a week. By serving international markets from the same factories, Intel can utilize its productive assets more intensively, which translates into higher capital productivity and greater profitability.

Finally, as global sales increase the size of the enterprise, its bargaining power with suppliers increases as well, which may allow it to attain economies of scale in purchasing, bargaining down the cost of key inputs and boosting profitability that way. For example, Walmart has used its enormous sales volume as a lever to bargain down the price it pays suppliers for merchandise sold through its stores.

Strategic Significance The strategic significance of the experience curve is clear. Moving down the experience curve allows a firm to reduce its cost of creating value (to lower C in Figure 12.2) and increase its profitability. The firm that moves down the experience curve most rapidly will have a cost advantage vis-à-vis its competitors. Firm A in Figure 12.7, because it is farther down the experience curve, has a clear cost advantage over firm B.

Many of the underlying sources of experience-based cost economies are plant based. This is true for most learning effects as well as for the economies of scale derived by spreading the fixed costs of building productive capacity over a large output, attaining an efficient scale of output, and utilizing a plant more intensively. Thus, one key to progressing downward on the experience curve as rapidly as possible is to increase the volume produced by a single plant as rapidly as possible. Because global markets are larger than domestic markets, a firm that serves a global market from a single location is likely to build accumulated volume more quickly than a firm that serves only its home market or that serves multiple markets from multiple production locations. Thus, serving a global market from a single location is consistent with moving down the experience curve and establishing a low-cost position. In addition, to get down the experience curve rapidly, a firm may need to price and market aggressively so demand will expand rapidly. It will also need to build sufficient production capacity for serving a global market. Also, the cost advantages of serving the world market from a single location will be even more significant if that location is the optimal one for performing the particular value creation activity.

Once a firm has established a low-cost position, it can act as a barrier to new competition. Specifically, an established firm that is well down the experience curve, such as firm A in Figure 12.7, can price so that it is still making a profit while new entrants, which are farther up the curve, are suffering losses. Intel is one of the masters of this kind of strategy. The costs of building a state-of-the-art facility to manufacture microprocessors are so large (now around $5 billion) that to make this investment pay Intel must pursue experience curve effects, serving world markets from a limited number of plants to maximize the cost economies that derive from scale and learning effects.

Page 352LEVERAGING SUBSIDIARY SKILLS Implicit in our earlier discussion of core competencies is the idea that valuable skills are developed first at home and then transferred to foreign operations. However, for more mature multinationals that have already established a network of subsidiary operations in foreign markets, the development of valuable skills can just as well occur in foreign subsidiaries.23 Skills can be created anywhere within a multinational’s global network of operations, wherever people have the opportunity and incentive to try new ways of doing things. The creation of skills that help to lower the costs of production, or to enhance perceived value and support higher product pricing, is not the monopoly of the corporate center.

Leveraging the skills created within subsidiaries and applying them to other operations within the firm’s global network may create value. McDonald’s is increasingly finding that its foreign franchisees are a source of valuable new ideas. Faced with slow growth in France, its local franchisees began to experiment not only with the menu, but also with the layout and theme of restaurants. Gone are the ubiquitous golden arches; gone too are many of the utilitarian chairs and tables and other plastic features of the fast-food giant. Many McDonald’s restaurants in France now have hardwood floors, exposed brick walls, and even armchairs. The menu, too, has been changed to include premier sandwiches, such as chicken on focaccia bread, priced some 30 percent higher than the average hamburger. In France at least, the strategy seems to be working. Following the change, increases in same-store sales rose from 1 percent annually to 3.4 percent, and France is now the second largest national market for McDonald’s. Impressed with the impact, McDonald’s executives are considering similar changes at other McDonald’s restaurants in markets where same-store sales growth is sluggish, including the United States.24

For the managers of the multinational enterprise, this phenomenon creates important new challenges. First, they must have the humility to recognize that valuable skills that lead to competencies can arise anywhere within the firm’s global network, not just at the corporate center. Second, they must establish an incentive system that encourages local employees to acquire new skills. This is not as easy as it sounds. Creating new skills involves a degree of risk. Not all new skills add value. For every valuable idea created by a McDonald’s subsidiary in a foreign country, there may be several failures. The management of the multinational must install incentives that encourage employees to take the necessary risks. The company must reward people for successes and not sanction them unnecessarily for taking risks that did not pan out. Third, managers must have a process for identifying when valuable new skills have been created in a subsidiary. And finally, they need to act as facilitators, helping to transfer valuable skills within the firm.

PROFITABILITY AND PROFIT GROWTH SUMMARY We have seen how firms that expand globally can increase their profitability and profit growth by entering new markets where indigenous competitors lack similar competencies, by lowering costs and adding value to their product offering through the attainment of location economies, by exploiting experience curve effects, and by transferring valuable skills among their global network of subsidiaries. For completeness, it should be noted that strategies that increase profitability may also expand a firm’s business and thus enable it to attain a higher rate of profit growth. For example, by simultaneously realizing location economies and experience effects, a firm may be able to produce a more highly valued product at a lower unit cost, thereby boosting profitability. The increase in the perceived value of the product may also attract more customers, thereby growing revenues and profits as well. Furthermore, rather than raising prices to reflect the higher perceived value of the product, the firm’s managers may elect to hold prices low in order to increase global market share and attain greater scale economies (in other words, they may elect to offer consumers better “value for money”). Such a strategy could increase the firm’s rate of profit growth even further, because consumers will be attracted by prices that are low relative to value. The strategy might also increase profitability if the scale economies that result from market share gains are substantial. In sum, managers need to keep in mind the complex relationship between profitability and profit growth when making strategic decisions about pricing.

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e 353images LO 12-3

Understand how pressures for cost reductions and pressures for local responsiveness influence strategic choice.

Cost Pressures and Pressures for Local Responsiveness

Firms that compete in the global marketplace typically face two types of competitive pressure that affect their ability to realize location economies and experience effects, and to leverage products and transfer competencies and skills within the enterprise. They face pressures for cost reductions and pressures to be locally responsive (see Figure 12.8).25 These competitive pressures place conflicting demands on a firm. Responding to pressures for cost reductions requires that a firm try to minimize its unit costs. But responding to pressures to be locally responsive requires that a firm differentiate its product offering and marketing strategy from country to country (or in some cases region to region) in an effort to accommodate the diverse demands arising from national (or regional) differences in consumer tastes and preferences, business practices, distribution channels, competitive conditions, and government policies. Because differentiation across countries can involve significant duplication and a lack of product standardization, it may raise costs.

While some enterprises, such as firm A in Figure 12.8, face high pressures for cost reductions and low pressures for local responsiveness, and others, such as firm B, face low pressures for cost reductions and high pressures for local responsiveness, many companies are in the position of firm C. They face high pressures for both cost reductions and local responsiveness. Dealing with these conflicting and contradictory pressures is a difficult strategic challenge, primarily because being locally responsive tends to raise costs.

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Pressures for Cost Reductions

In competitive global markets, international businesses often face pressures for cost reductions. Responding to pressures for cost reduction requires a firm to try to lower the costs of value creation. A manufacturer, for example, might mass-produce a standardized product at the optimal locations in the world, wherever that might be, to realize economies of scale, learning effects, and location economies. Alternatively, a firm might outsource certain functions to low-cost foreign suppliers in an attempt to reduce costs. Thus, many computer companies have outsourced their telephone-based customer service functions to India, where qualified technicians who speak English can be hired for a lower wage rate than in the United States. In the same manner, a retailer such as Walmart might push its suppliers (manufacturers) to do the same. (The pressure that Walmart has placed on its suppliers to reduce prices has been cited as a major cause of the trend among North American manufacturers to shift production to China.26) A service business such as a bank might respond to cost pressures by moving some back-office functions, such as information processing, to developing nations where wage rates are lower.

12.8 FIGURE

Pressures for Cost Reductions and Local Responsiveness

Pressures for cost reduction can be particularly intense in industries producing commodity-type products where meaningful differentiation on nonprice factors is difficult and price is the main competitive weapon. This tends to be the case for products that serve universal needs. Universal needs exist when the tastes and preferences of consumers in different nations or regions are similar if not identical. This is the case for conventional commodity products such as bulk chemicals, petroleum, steel, sugar, and the like. It also tends to be the case for many industrial and consumer products—for example, smartphones, semiconductor chips, personal computers, and liquid crystal display screens. Pressures for cost reductions are also intense in industries where major competitors are based in low-cost locations, where there is persistent excess capacity, and where consumers are powerful and face low switching costs. The liberalization of the world trade and investment environment in recent decades, by facilitating greater international competition, has generally increased cost pressures.27

Universal Needs

Needs that are the same all over the world, such as steel, bulk chemicals, and industrial electronics.

PRESSURES FOR LOCAL RESPONSIVENESS Pressures for local responsiveness arise from national or regional differences in consumer tastes and preferences, infrastructure, accepted business practices, and distribution channels and from host-government demands. Responding to pressures to be locally responsive requires a firm to differentiate its products and marketing strategy from country to country, or region to region, to accommodate these factors—all of which tends to raise the firm’s cost structure.

Differences in Customer Tastes and Preferences Strong pressures for local responsiveness emerge when customer tastes and preferences differ significantly among countries, as they often do for deeply embedded historic or cultural reasons. In such cases, a multinational’s products and marketing message have to be customized to appeal to the tastes and preferences of local customers. This typically creates pressure to delegate production and marketing responsibilities and functions to a firm’s overseas subsidiaries.

For example, the automobile industry in the 1990s moved toward the creation of “world cars.” The idea was that global companies such as General Motors, Ford, and Toyota would be able to sell the same basic vehicle the world over, sourcing it from centralized production locations. If successful, the strategy would have enabled automobile companies to reap significant gains from global scale economies. However, this strategy frequently ran aground upon the hard rocks of consumer reality. Consumers in different automobile markets seem to have different tastes and preferences, and they demand different types of vehicles. North American consumers show a strong demand for pickup trucks. This is particularly true in the South and West of the United States, where many families have a pickup truck as a second or third car. But in European countries, pickup trucks are seen purely as utility vehicles and are purchased primarily by firms rather than individuals. As a consequence, the product mix and marketing message needs to be tailored to consider the different nature of demand in North America and Europe.

Some have argued that customer demands for local customization are on the decline worldwide.28 According to this argument, modern communications and transport technologies have created the conditions for a convergence of the tastes and preferences of consumers from different nations. The result is the emergence of enormous global markets for standardized consumer products. The worldwide acceptance of McDonald’s hamburgers, Coca-Cola, Gap clothes, Apple iPhones, and Microsoft’s Xbox—all of which are sold globally as standardized products—are often cited as evidence of the increasing homogeneity of the global marketplace.

However, this argument may not hold in many consumer goods markets. Significant differences in consumer tastes and preferences still exist across nations, regions, and cultures. Managers in international businesses do not yet have the luxury of being able to ignore these differences, and they may not for a long time to come. For an example of a company that has discovered how important pressures for local responsiveness can still be, read the accompanying Management Focus on MTV Networks.

Page 355management FOCUS

Local Responsiveness at MTV Networks

MTV Networks has become a symbol of globalization. Established in 1981, the U.S.-based TV network has been expanding outside of its North American base since 1987 when it opened MTV Europe. Today, MTV Networks figures that every second of every day more than 2 million people are watching MTV around the world, the majority outside the United States. Despite its international success, MTV’s global expansion got off to a weak start. In the 1980s, when the main programming fare was still music videos, it piped a single feed across Europe almost entirely composed of American programming with English-speaking veejays. Naively, the network’s U.S. managers thought Europeans would flock to the American programming. But while viewers in Europe shared a common interest in a handful of global superstars, their tastes turned out to be surprisingly local. After losing share to local competitors, who focused more on local tastes, MTV changed its strategy in the 1990s. It broke its service into “feeds” aimed at national or regional markets. While MTV Networks exercises creative control over these different feeds, and while all the channels have the same familiar frenetic look and feel of MTV in the United States, a significant share of the programming and content is now local.

Today, an increasing share of programming is local in conception. Although a lot of programming ideas still originate in the United States, with staples such as The Real World having equivalents in different countries, an increasing share of programming is local in conception. In Italy, MTV Kitchen combines cooking with a music countdown. Erotica airs in Brazil and features a panel of youngsters discussing sex. The Indian channel produces 21 homegrown shows hosted by local veejays who speak “Hinglish,” a city-bred version of Hindi and English. Many feeds still feature music videos by locally popular performers. This localization push reaped big benefits for MTV, allowing the network to capture viewers back from local imitators.

Sources: M. Gunther, “MTV’s Passage to India,”Fortune, August 9, 2004, pp. 117–22; B. Pulley and A. Tanzer, “Sumner’s Gemstone,”Forbes, February 21, 2000, pp. 107–11; K. Hoffman, “Youth TV’s Old Hand Prepares for the Digital Challenge,”Financial Times, February 18, 2000, p. 8; presentation by Sumner M. Redstone, chairman and CEO, Viacom Inc., delivered to Salomon Smith Barney 11th Annual Global Entertainment Media, Telecommunications Conference, Scottsdale, AZ, January 8, 2001, archived at www.viacom.com; and Viacom 10K Statement, 2005.

Differences in Infrastructure and Traditional Practices Pressures for local responsiveness arise from differences in infrastructure or traditional practices among countries, creating a need to customize products accordingly. Fulfilling this need may require the delegation of manufacturing and production functions to foreign subsidiaries. For example, in North America, consumer electrical systems are based on 110 volts, whereas in some European countries, 240-volt systems are standard. Thus, domestic electrical appliances have to be customized for this difference in infrastructure. Traditional practices also often vary across nations. For example, in Britain, people drive on the left-hand side of the road, creating a demand for right-hand-drive cars, whereas in France (and the rest of Europe), people drive on the right-hand side of the road and therefore want left-hand-drive cars. Obviously, automobiles have to be customized to accommodate this difference in traditional practice.

Although many national and regional differences in infrastructure are rooted in history, some are quite recent. For example, in the wireless telecommunications industry, different technical standards exist in different parts of the world. A technical standard known as GSM is common in Europe, and an alternative standard, CDMA, is more common in the United States and parts of Asia. Equipment designed for GSM will not work on a CDMA network, and vice versa. Thus, companies in this industry—such as Apple, Nokia, Motorola, Samsung, and Ericsson—that manufacture smartphones or infrastructure such as switches need to customize their product offering according to the technical standard prevailing in a given country or region.

Differences in Distribution Channels A firm’s marketing strategies may have to be responsive to differences in distribution channels among countries, which may necessitate the delegation of marketing functions to national subsidiaries. In the pharmaceutical industry, for example, the British and Japanese distribution systems are radically different from the U.S. system. British and Japanese doctors will not accept or respond favorably to a U.S.-style high-pressure sales force. Thus, pharmaceutical companies have to adopt different marketing practices in Britain and Japan compared with the United States—soft sell versus hard sell. Similarly, Poland, Brazil, and Russia all have similar per capita income on a purchasing power parity basis, but there are big differences in distribution systems across the three countries. In Brazil, supermarkets account for 36 percent of food retailing, in Poland Page 356for 18 percent, and in Russia for less than 1 percent.29 These differences in channels require that companies adapt their own distribution and sales strategies.

Host-Government Demands Economic and political demands imposed by host-country governments may require local responsiveness. For example, pharmaceutical companies are subject to local clinical testing, registration procedures, and pricing restrictions—all of which make it necessary that the manufacturing and marketing of a drug should meet local requirements. Because governments and government agencies control a significant proportion of the health care budget in most countries, they are in a powerful position to demand a high level of local responsiveness.

More generally, threats of protectionism, economic nationalism, and local content rules (which require that a certain percentage of a product should be manufactured locally) dictate that international businesses manufacture locally. For example, consider Bombardier, the Canadian-based manufacturer of railcars, aircraft, jet boats, and snowmobiles. Bombardier has 12 railcar factories across Europe. Critics of the company argue that the resulting duplication of manufacturing facilities leads to high costs and helps explain why Bombardier makes lower profit margins on its railcar operations than on its other business lines. In reply, managers at Bombardier argue that in Europe, informal rules with regard to local content favor people who use local workers. To sell railcars in Germany, they claim, you must manufacture in Germany. The same goes for Belgium, Austria, and France. To try to address its cost structure in Europe, Bombardier has centralized its engineering and purchasing functions, but it has no plans to centralize manufacturing.30

The Rise of Regionalism Traditionally, we have tended to think of pressures for local responsiveness as being derived from national differences in tastes and preferences, infrastructure, and the like. While this is still often the case, there is also a tendency toward the convergence of tastes, preferences, infrastructure, distribution channels, and host-government demands with a broader region that is composed of two or more nations.31 We tend to see this when there are strong pressures for convergence due to, for example, a shared history and culture or the establishment of a trading block where there are deliberate attempts to harmonize trade policies, infrastructure, regulations, and the like.

The most obvious example of a region is the European Union, and particularly the euro zone countries within that trade block, where there are institutional forces that are pushing towards convergence (see Chapter 9 for details). The creation of a single EU market—with a single currency, common business regulations, standard infrastructure, and so on—cannot help but result in the reduction of certain national differences among countries within the EU and the creation of one regional rather than several national markets. Indeed, at the economic level at least, that is the explicit intent of the EU.

Another example of regional convergence is North America, which includes the United States, Canada, and to some extent in some product markets, Mexico. Canada and the United States share history, language, and much of their culture, and both are members of NAFTA. Mexico is clearly different in many regards, but its proximity to the United States, along with its membership in NAFTA, implies that for some product markets (e.g., automobiles), it might be reasonable to consider Mexico as part of a relatively homogenous regional market. We might also talk about the Latin America region, where shared Spanish history, cultural heritage, and language (with the exception of Brazil, which was colonized by the Portuguese) means that national differences are somewhat moderated. It can also be argued that Greater China, which includes the city-states of Honk Kong and Singapore along with Taiwan, is a coherent region, as is much of the Middle East, where a strong Arab culture and shared history may limit national differences. Similarly, Russia and some of the former states of the Soviet Union, such as Belarus and the Ukraine, might be considered part of a larger regional market, at least for some products.

Taking a regional perspective is important because it may suggest that localization at the regional rather than the national level is the appropriate strategic response. For example, rather than produce cars for each national market within the Europe or North America, it makes far more sense for car manufacturers to build cars for the European or North American Page 357regions. The ability to standardize product offering within a region allows for the attainment of greater scale economies, and hence lower costs, than if each nation had to have its own offering. At the same time, this perspective should not be pushed too far. There are still deep and profound cultural differences among the United Kingdom, France, Germany, and Italy—all members of the EU—that may in turn require some degree of local customization at the national level. Managers must thus make a judgment call about the appropriate level of aggregation given (1) the product market they are looking at and (2) the nature of national differences and trends for regional convergence. What might make sense for automobiles, for example, might not be appropriate for packaged food products.

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Identify the different strategies for competing globally and their pros and cons.

Choosing a Strategy

Pressures for local responsiveness imply that it may not be possible for a firm to realize the full benefits from economies of scale, learning effects, and location economies. It may not be possible to serve the global marketplace from a single low-cost location, producing a globally standardized product, and marketing it worldwide to attain the cost reductions associated with experience effects. The need to customize the product offering to local conditions, whether national or regional, may work against the implementation of such a strategy. For example, as noted automobile firms have found that Japanese, American, and European consumers demand different kinds of cars, and this necessitates producing products that are customized for regional markets. In response, firms such as Honda, Ford, and Toyota are pursuing a strategy of establishing top-to-bottom design and production facilities in each of these regions so that they can better serve local demands. Although such customization brings benefits, it also limits the ability of a firm to realize significant scale economies and location economies.

In addition, pressures for local responsiveness imply that it may not be possible to leverage skills and products associated with a firm’s core competencies wholesale from one nation or region to another. Concessions often have to be made to local conditions. Despite being depicted as “poster boy” for the proliferation of standardized global products, even McDonald’s has found that it has to customize its product offerings (i.e., its menu) to account for national differences in tastes and preferences.

How do differences in the strength of pressures for cost reductions versus those for local responsiveness affect a firm’s choice of strategy? Firms typically choose among four main strategic postures when competing internationally. These can be characterized as a global standardization strategy, a localization strategy, a transnational strategy, and an international strategy.32 The appropriateness of each strategy varies given the extent of pressures for cost reductions and local responsiveness. Figure 12.9 illustrates the conditions under which each of these strategies is most appropriate.

More Customized Products in the Global Marketplace?

The Coca-Cola Company’s (TCCC) Minute Maid Pulpy became the cola giant’s 14th brand to reach US$1 billion in global retail sales (in 2011). As opposed to cola carbonates, which often rely on global brand recognition and cross-generational formulas for success, Minute Maid Pulpy has relied on product development and innovations inspired by local flavors and textures. Minute Maid released Minute Maid Pulpy toward the end of 2004, which contained less than 24 percent actual fruit juice, but TCCC was able to retail the product at a much lower price point. In China and throughout the Asia-Pacific region, consumer notions of freshness and health are connected much more to the consumption of actual fruit. Minute Maid Pulpy acknowledged this by including pieces of fruit in the drink, thereby creating a thicker texture that would not appeal to most North American consumers but has proven very popular in this region of the world. In customizing the product, Minute Maid Pulpy went from the 10th most popular fruit/vegetable juice brand in China in 2004 to 1st by the time it had achieved $1 billion in total sales in 2011. But isn’t the world becoming more globalized? Do we still need large multinational corporations customizing their products to local markets?

Source: http://blog.euromonitor.com/2012/05/flavours-and-textures-how-local-consumer-taste-palates-aredefining-global-soft-drinks.html.

GLOBAL STANDARDIZATION STRATEGY Firms that pursue a global standardization strategy focus on increasing profitability and profit growth by reaping the cost reductions that come from economies of scale, learning effects, and location economies; that is, their strategic goal is to pursue a low-cost strategy on a global scale. The production, marketing, and R&D activities of firms pursuing a global standardization strategy are concentrated in a few favorable locations. Firms pursuing a global standardization strategy try not to customize their product offering and marketing strategy to local conditions because customization involves shorter production runs and the duplication of functions, which tends to raise costs. Instead, they prefer to market a standardized product worldwide so that they can reap the maximum benefits from economies of scale and learning effects. They also tend to use their cost advantage to support aggressive pricing in world markets.

Global Standardization Strategy

A firm focuses on increasing profitability and profit growth by reaping the cost reductions that come from economies of scale, learning effects, and location economies.

12.9 FIGURE Page 358

Four Basic Strategies

This strategy makes most sense when there are strong pressures for cost reductions and demands for local responsiveness are minimal. Increasingly, these conditions prevail in many industrial goods industries, whose products often serve universal needs. In the semiconductor industry, for example, global standards have emerged, creating enormous demands for standardized global products. Accordingly, companies such as Intel, Texas Instruments, and Motorola all pursue a global standardization strategy. However, these conditions are not always found in many consumer goods markets, where demands for local responsiveness can remain high. The strategy is inappropriate when demands for local responsiveness are high. The experience of Vodafone, which is discussed in the accompanying Management Focus, illustrates what can happen when a global standardization strategy does not match market realities.

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Vodafone in Japan

In 2002, Vodafone Group of the United Kingdom, the world’s largest provider of wireless telephone service, made a big splash by paying $14 billion to acquire J-Phone, the number-three player in Japan’s fast-growing market for wireless communications services. J-Phone was considered a hot property, having just launched Japan’s first cell phones that were embedded with digital cameras, winning over large numbers of young people who wanted to e-mail photos to their friends. Four years later, after losing market share to local competitors, Vodafone sold J-Phone and took an $8.6 billion charge against earnings related to the sale. What went wrong?

According to analysts, Vodafone’s mistake was to focus too much on building a global brand and not enough on local market conditions in Japan. In the early 2000s, Vodafone’s vision was to offer consumers in different countries the same technology so that they could take their phones with them when they traveled across international borders. The problem, however, was that Japan’s most active cell phone users—many of them young people who don’t regularly travel abroad—care far less about this capability than about game playing and other features that are embedded in their cell phones.

Vodafone’s emphasis on global services meant that it delayed its launch in Japan of phones that use 3G technology, which allowed users to do things such as watch video clips and teleconference on their cell phones. The company, in line with its global branding ambitions, had decided to launch 3G cell phones that worked both inside and outside Japan. The delay was costly. Its Japanese competitors launched 3G phones a year ahead of Vodafone. Although these phones only worked in Japan, they rapidly gained share as consumers adopted these leading-edge devices. When Vodafone did finally introduce a 3G phone, design problems associated with making a phone that worked globally meant that the supply of phones was limited, and the launch fizzled despite strong product reviews, simply because consumers could not get the phones.

Sources: C. Bryan-Low, “Vodafone’s Global Ambitions Got Hung Up in Japan,”The Wall Street Journal, March 18, 2006, p. A1; and G. Parket, “Going Global Can Hit Snags Vodafone Finds,”The Wall Street Journal, June 16, 2004, p. B1.

Page 359LOCALIZATION STRATEGY A localization strategy focuses on increasing profitability by customizing the firm’s goods or services so that they provide a good match to tastes and preferences in different national or regional markets. Localization is most appropriate when there are substantial differences across nations or regions with regard to consumer tastes and preferences and where cost pressures are not too intense. By customizing the product offering to local demands, the firm increases the value of that product in the local market. On the downside, because it involves some duplication of functions and smaller production runs, customization limits the ability of the firm to capture the cost reductions associated with mass-producing a standardized product for global consumption. The strategy may make sense, however, if the added value associated with local customization supports higher pricing, which enables the firm to recoup its higher costs, or if it leads to substantially greater local demand, enabling the firm to reduce costs through the attainment of some scale economies in the local market.

Localization Strategy

Increasing profitability by customizing the firm’s goods and services so that they provide a good match to tastes and preferences in different national markets.

At the same time, firms still have to keep an eye on costs. Firms pursuing a localization strategy still need to be efficient and, whenever possible, to capture some scale economies from their global reach. As noted earlier, many automobile companies have found that they have to customize some of their product offerings to local market demands—for example, producing large pickup trucks for North American consumers and small fuel-efficient cars for Europeans and Japanese. At the same time, these multinationals try to get some scale economies from their global volume by using common vehicle platforms and components across many different models and manufacturing those platforms and components at efficiently scaled factories that are optimally located. By designing their products in this way, these companies have been able to localize their product offering, yet simultaneously capture some scale economies, learning effects, and location economies.

TRANSNATIONAL STRATEGY We have argued that a global standardization strategy makes most sense when cost pressures are intense and demands for local responsiveness are limited. Conversely, a localization strategy makes most sense when demands for local responsiveness are high, but cost pressures are moderate or low. What happens, however, when the firm simultaneously faces both strong cost pressures and strong pressures for local responsiveness? How can managers balance the competing and inconsistent demands such divergent pressures place on the firm? According to some researchers, the answer is to pursue what has been called a transnational strategy.

Two of these researchers, Christopher Bartlett and Sumantra Ghoshal, argue that in the modern global environment, competitive conditions are so intense that to survive, firms must do all they can to respond to pressures for cost reductions and local responsiveness.33 They must try to realize location economies and experience effects, to leverage products internationally, to transfer core competencies and skills within the company, and to simultaneously pay attention to pressures for local responsiveness.34 Bartlett and Ghoshal note that in the modern multinational enterprise, core competencies and skills do not reside just in the home country but can develop in any of the firm’s worldwide operations. Thus, they maintain that the flow of skills and product offerings should not be all one way, from home country to foreign subsidiary. Rather, the flow should also be from foreign subsidiary to home country and from foreign subsidiary to foreign subsidiary. Transnational enterprises, in other words, must also focus on leveraging subsidiary skills.

In essence, firms that pursue a transnational strategy are trying to simultaneously achieve low costs through location economies, economies of scale, and learning effects; differentiate their product offering across geographic markets to account for local differences; and foster a multidirectional flow of skills between different subsidiaries in the firm’s global network of operations. As attractive as this may sound in theory, the strategy is not an easy one to pursue because it places conflicting demands on the company. Differentiating the product to respond to local demands in different geographic markets raises costs, which runs counter to the goal of reducing costs. Companies such as 3M and ABB (one of the world’s largest engineering conglomerates) have tried to embrace a transnational strategy and found it difficult to implement.

Transnational Strategy

Attempt to simultaneously achieve low costs through location economies, economies of scale, and learning effects while also differentiating product offerings across geographic markets to account for local differences and fostering multidirectional flows of skills between different subsidiaries in the firm’s global network of operations.

How best to implement a transnational strategy is one of the most complex questions that large multinationals are grappling with today. Few if any enterprises have perfected this Page 360strategic posture. But some clues as to the right approach can be derived from a number of companies. For an example, consider the case of Caterpillar. The need to compete with low-cost competitors such as Komatsu of Japan forced Caterpillar to look for greater cost economies. However, variations in construction practices and government regulations across countries and regions mean that Caterpillar also has to be responsive to local demands. Therefore, Caterpillar confronted significant pressures for cost reductions and for local responsiveness.

Is Citigroup Now the Best in Financials?

Recent earnings reports of the financials showed a separation between the more internationally focused business models of Bank of America and Citigroup, from the more domestic focused growth strategies of JP Morgan and Wells Fargo. The banking sector in the United States is heavily saturated, and the financials who rely primarily on the domestic economy for growth continue to struggle. Today, when you look at Citi’s business model, the company looks like an international bank headquartered in the United States because the company gets nearly 70 percent of its revenue overseas. The company is strongly positioned in almost every major emerging market economy, with bold plans for continued future growth. In Latin America, for instance, Eduardo Cruz, one of the most respected executives in the banking industry, continues to successfully build out Citi’s retail and investment banking presence. Also, in Asia, where Citi has its largest international footprint, the company continues to be similarly successful in building out its core banking business across the region, with a particularly strong retail franchise in India. Based on the material in Chapter 12, do you think Citigroup is using a global standardization strategy, localization strategy, transnational strategy, or international strategy? And, perhaps more interestingly, is Citigroup now the best in financials?

Source: http://seekingalpha.com/article/307549-is-citigroup-now-the-best-infinancials.

To deal with cost pressures, Caterpillar redesigned its products to use many identical components and invested in a few large-scale component manufacturing facilities, sited at favorable locations, to fill global demand and realize scale economies. At the same time, the company augments the centralized manufacturing of components with assembly plants in each of its major global markets. At these plants, Caterpillar adds local product features, tailoring the finished product to local needs. Thus, Caterpillar is able to realize many of the benefits of global manufacturing while reacting to pressures for local responsiveness by differentiating its product among national markets.35 Caterpillar started to pursue this strategy in the 1980s; by the 2000s, it had succeeded in doubling output per employee, significantly reducing its overall cost structure in the process. Meanwhile, Komatsu and Hitachi, which are still wedded to a Japan-centric global strategy, have seen their cost advantages evaporate and have been steadily losing market share to Caterpillar.

Changing a firm’s strategic posture to build an organization capable of supporting a transnational strategy is a complex and challenging task. Some would say it is too complex because the strategy implementation problems of creating a viable organizational structure and control systems to manage this strategy are immense.

INTERNATIONAL STRATEGY Sometimes it is possible to identify multinational firms that find themselves in the fortunate position of being confronted with low cost pressures and low pressures for local responsiveness. Many of these enterprises have pursued an international strategy, taking products first produced for their domestic market and selling them internationally with only minimal local customization. The distinguishing feature of many such firms is that they are selling a product that serves universal needs, but they do not face significant competitors; thus, unlike firms pursuing a global standardization strategy, they are not confronted with pressures to reduce their cost structure. Xerox found itself in this position in the 1960s after its invention and commercialization of the photocopier. The technology underlying the photocopier was protected by strong patents, so for several years Xerox did not face competitors—it had a monopoly. The product serves universal needs, and it was highly valued in most developed nations. Thus, Xerox was able to sell the same basic product the world over, charging a relatively high price for that product. Because Xerox did not face direct competitors, it did not have to deal with strong pressures to minimize its cost structure.

International Strategy

Trying to create value by transferring core competencies to foreign markets where indigenous competitors lack those competencies.

Enterprises pursuing an international strategy have followed a similar developmental pattern as they expanded into foreign markets. They tend to centralize product development functions such as R&D at home. However, they also tend to establish manufacturing and marketing functions in each major country or geographic region in which they do business. The resulting duplication can raise costs, but this is less of an issue if the firm does not face strong pressures for cost reductions. Although they may undertake some local customization of product offering and marketing strategy, this tends to be rather limited in scope. Ultimately, in most firms that pursue an international strategy, the head office retains fairly tight control over marketing and product strategy.

management FOCUS

Evolution of Strategy at Procter & Gamble

Founded in 1837, Cincinnati-based Procter & Gamble has long been one of the world’s most international companies. Today, P&G is a global colossus in the consumer products business with annual sales in excess of $80 billion, some 54 percent of which are generated outside of the United States. P&G sells more than 300 brands—including Ivory soap, Tide, Pampers, IAMS pet food, Crisco, and Folgers—to consumers in 180 countries. Historically, the strategy at P&G was well established. The company developed new products in Cincinnati and then relied on semiautonomous foreign subsidiaries to manufacture, market, and distribute those products in different nations. In many cases, foreign subsidiaries had their own production facilities and tailored the packaging, brand name, and marketing message to local tastes and preferences. For years, this strategy delivered a steady stream of new products and reliable growth in sales and profits. By the 1990s, however, profit growth at P&G was slowing.

The essence of the problem was simple; P&G’s costs were too high because of extensive duplication of manufacturing, marketing, and administrative facilities in different national subsidiaries. The duplication of assets made sense in the world of the 1960s, when national markets were segmented from each other by barriers to cross-border trade. Products produced in Great Britain, for example, could not be sold economically in Germany due to high tariff duties levied on imports into Germany. By the 1980s, however, barriers to cross-border trade were falling rapidly worldwide and fragmented national markets were merging into larger regional or global markets. Also, the retailers through which P&G distributed its products were growing larger and more global, such as Walmart, Tesco from the United Kingdom, and Carrefour from France. These emerging global retailers were demanding price discounts from P&G.

In the 1990s, P&G embarked on a major reorganization in an attempt to control its cost structure and recognize the new reality of emerging global markets. The company shut down some 30 manufacturing plants around the globe, laid off 13,000 employees, and concentrated production in fewer plants that could better realize economies of scale and serve regional markets. It wasn’t enough! Profit growth remained sluggish, so in 1999 P&G launched its second reorganization of the decade. Named “Organization 2005,” the goal was to transform P&G into a truly global company. The company tore up its old organization, which was based on countries and regions, and replaced it with one based on seven self-contained global business units, ranging from baby care to food products. Each business unit was given complete responsibility for generating profits from its products and for manufacturing, marketing, and product development. Each business unit was told to rationalize production, concentrating it in fewer larger facilities; to try to build global brands wherever possible, thereby eliminating marketing differences among countries; and to accelerate the development and launch of new products. P&G announced that as a result of this initiative, it would close another 10 factories and lay off 15,000 employees, mostly in Europe where there was still extensive duplication of assets. The annual cost savings were estimated to be about $800 million. P&G planned to use the savings to cut prices and increase marketing spending in an effort to gain market share, and thus further lower costs through the attainment of scale economies. This time, the strategy seemed to be working. For most of the 2000s, P&G reported strong growth in both sales and profits. Significantly, P&G’s global competitors, such as Unilever, Kimberly-Clark, and Colgate-Palmolive, were struggling during the same time period.

Sources: J. Neff, “P&G Outpacing Unilever in Five-Year Battle,”Advertising Age, November 3, 2003, pp. 1–3; G. Strauss, “Firm Restructuring into Truly Global Company,”USA Today, September 10, 1999, p. B2;Procter & Gamble 10K Report, 2005; and M. Kolbasuk McGee, “P&G Jump-Starts Corporate Change,”Information Week, November 1, 1999, pp. 30–34.

Firms that have pursued this strategy include Procter & Gamble and Microsoft. Historically, Procter & Gamble developed innovative new products in Cincinnati and then transferred them wholesale to local markets (see the accompanying Management Focus). Similarly, the bulk of Microsoft’s product development work occurs in Redmond, Washington, where the company is headquartered. Although some localization work is undertaken elsewhere, this is limited to producing foreign-language versions of popular Microsoft programs.

THE EVOLUTION OF STRATEGY The Achilles’ heel of the international strategy is that over time, competitors inevitably emerge, and if managers do not take proactive steps to reduce their firm’s cost structure, it will be rapidly outflanked by efficient global competitors. This is what happened to Xerox. Japanese companies such as Canon ultimately invented their way around Xerox’s patents, produced their own photocopiers in very efficient manufacturing plants, priced them below Xerox’s products, and rapidly took global market share from Xerox. In the final analysis, Xerox’s demise was not due to the emergence of competitors—because, ultimately, that was bound to occur—but due to its failure to pro-actively reduce its cost structure in advance of the emergence of efficient global competitors. The message in this story is that an international strategy may not be viable in the long term, and to survive, firms need to shift toward a global standardization strategy or a trans-national strategy in advance of competitors (see Figure 12.10).

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Changes in Strategy over Time

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The same can be said about a localization strategy. Localization may give a firm a competitive edge, but if it is simultaneously facing aggressive competitors, the company will also have to reduce its cost structure, and the only way to do that may be to shift toward a trans-national strategy. This is what Procter & Gamble has been doing (see the accompanying Management Focus). Thus, as competition intensifies, international and localization strategies tend to become less viable, and managers need to orient their companies toward either a global standardization strategy or a transnational strategy.

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Explain the pros and cons of using strategic alliances to support global strategies.

Strategic Alliances

Strategic alliances refer to cooperative agreements between potential or actual competitors. In this section, we are concerned specifically with strategic alliances between firms from different countries. Strategic alliances run the range from formal joint ventures, in which two or more firms have equity stakes (e.g., Fuji Xerox), to short-term contractual agreements, in which two companies agree to cooperate on a particular task (such as developing a new product). Collaboration between competitors is fashionable; recent decades have seen an explosion in the number of strategic alliances.

A moviegoer walks past a poster of the Warner Bros movie, Gravity, in Shanghai, China. The strategic alliance between Warner Bros and their Chinese partners has helped streamline the process for film distribution.

THE ADVANTAGES OF STRATEGIC ALLIANCES Firms ally themselves with actual or potential competitors for various strategic purposes.36 First, strategic alliances may facilitate entry into a foreign market. For example, many firms believe that if they are to successfully enter the Chinese market, they need a local partner who understands business conditions and who has good connections (or guanxi—see Chapter 4). Thus, Warner Brothers entered into a joint venture with two Chinese partners to produce and distribute films in China. As a foreign film company, Warner found that if it wanted to produce films on its own for the Chinese market, it had to go through a complex approval process for every film, and it had to farm out distribution to a local company, which made doing business in China very difficult. Due to the participation of Chinese firms, however, the joint-venture films will go through a streamlined approval process, Page 363and the venture will be able to distribute any films it produces. Also, the joint venture will be able to produce films for Chinese TV, something that foreign firms are not allowed to do.37

Strategic alliances also allow firms to share the fixed costs (and associated risks) of developing new products or processes. An alliance between Boeing and a number of Japanese companies to build Boeing’s latest commercial jetliner, the 787, was motivated by Boeing’s desire to share the estimated $8 billion investment required to develop the aircraft.

Third, an alliance is a way to bring together complementary skills and assets that neither company could easily develop on its own.38 In 2003, for example, Microsoft and Toshiba established an alliance aimed at developing embedded microprocessors (essentially tiny computers) that can perform a variety of entertainment functions in an automobile (e.g., run a backseat DVD player or a wireless Internet connection). The processors run a version of Microsoft’s Windows operating system. Microsoft brings its software engineering skills to the alliance and Toshiba its skills in developing microprocessors.39

Fourth, it can make sense to form an alliance that will help the firm establish technological standards for the industry that will benefit the firm. For example, in 2011 Nokia, one of the leading makers of smartphones, entered into an alliance with Microsoft under which Nokia agreed to license and use Microsoft’s Windows Mobile operating system in Nokia’s phones. The motivation for the alliance was in part to help establish Windows Mobile as the industry standard for smartphones as opposed to the rival operating systems such as Apple’s iPhone and Google’s Android. Unfortunately for Microsoft, the Nokia’s Windows phones failed to gain sufficient market share. In 2013, Microsoft decided to acquire Nokia’s mobile phone business and bring it in house so that it could ensure a continued aggressive push into the smartphone hardware business.

Was Nokia a Risky Purchase for Microsoft?

Microsoft Corporation’s acquisition of Nokia Corporation’s devices and services business was seen as a bold but risky gamble in the software giant’s bid for a larger footprint in the fast-growing mobile market. Initially, it relied heavily on a strategic alliance with Nokia, which in 2011 announced that it was embracing Microsoft’s Windows Phone as its main operating system. This partnership produced Lumia, a Windows-based Nokia phone. It has won up-beat reviews but remains an insignificant player in a market dominated by Apple’s iPhone and other devices based on Google’s Android operating system. Nokia got caught in a tough transition from its phones based on its Symbian operating system to Windows-based devices, and this transition has been more painful than Nokia anticipated. Despite the somewhat rocky start to their alliance, in September 2013, Microsoft and Nokia announced that the two companies “have decided to enter into a transaction whereby Microsoft will purchase substantially all of Nokia’s Devices and Services business, license Nokia’s patents, and license and use Nokia’s mapping services.” Experts, the markets, and customers are skeptical. Was Nokia a risky purchase for Microsoft?

Source: “Microsoft to Acquire Nokia’s Devices and Services Business, License Nokia’s Patents and Mapping Services,” Microsoft News Center, September 3, 2013.

THE DISADVANTAGES OF STRATEGIC ALLIANCES The advantages we have discussed can be very significant. Despite this, some have criticized strategic alliances on the grounds that they give competitors a low-cost route to new technology and markets.40 For example, two decades ago, critics argued that many strategic alliances between U.S. and Japanese firms were part of an implicit Japanese strategy to keep high-paying, high-value-added jobs in Japan while gaining the project engineering and production process skills that underlie the competitive success of many U.S. companies.41 They argued that Japanese success in the machine tool and semiconductor industries was built on U.S. technology acquired through strategic alliances. And they argued that U.S. managers were aiding the Japanese by entering alliances that channel new inventions to Japan and provide a U.S. sales and distribution network for the resulting products. Although such deals may generate short-term profits, so the argument goes, in the long run the result is to “hollow out” U.S. firms, leaving them with no competitive advantage in the global marketplace. The same arguments are now made regarding alliances with Chinese firms.

These critics have a point; alliances have risks. Unless a firm is careful, it can give away more than it receives. But there are so many examples of apparently successful alliances between firms—including alliances between U.S. and Japanese firms—that the critics’ position seems extreme. It is difficult to see how the Microsoft–Toshiba alliance, the Boeing–Mitsubishi alliance for the 787, and the Fuji–Xerox alliance fit the critics’ thesis. In these cases, both partners seem to have gained from the alliance. Why do some alliances benefit both firms while others benefit one firm and hurt the other? The next section provides an answer to this question.

Page 364MAKING ALLIANCES WORK The failure rate for international strategic alliances seems to be high. One study of 49 international strategic alliances found that two-thirds run into serious managerial and financial troubles within two years of their formation, and that although many of these problems are solved, 33 percent are ultimately rated as failures by the parties involved.42 The success of an alliance seems to be a function of three main factors: partner selection, alliance structure, and the manner in which the alliance is managed.

Partner Selection One key to making a strategic alliance work is to select the right ally. A good ally, or partner, has three characteristics. First, a good partner helps the firm achieve its strategic goals, whether they are market access, sharing the costs and risks of product development, or gaining access to critical core competencies. The partner must have capabilities that the firm lacks and that it values. Second, a good partner shares the firm’s vision for the purpose of the alliance. If two firms approach an alliance with radically different agendas, the chances are great that the relationship will not be harmonious, will not flourish, and will end in divorce. Third, a good partner is unlikely to try to opportunistically exploit the alliance for its own ends, that is, to expropriate the firm’s technological know-how while giving away little in return. In this respect, firms with reputations for “fair play” to maintain probably make the best allies. For example, companies such as General Electric are involved in so many strategic alliances that it would not pay the company to trample over individual alliance partners.43 This would tarnish GE’s reputation of being a good ally and would make it more difficult for GE to attract alliance partners. Because IBM attaches great importance to its alliances, it is unlikely to engage in the kind of opportunistic behavior that critics highlight. Similarly, their reputations make it less likely (but by no means impossible) that such Japanese firms as Sony, Toshiba, and Fuji, which have histories of alliances with non-Japanese firms, would opportunistically exploit an alliance partner.

To select a partner with these three characteristics, a firm needs to conduct comprehensive research on potential alliance candidates. To increase the probability of selecting a good partner, the firm should:

1. Collect as much pertinent, publicly available information on potential allies as possible.

2. Gather data from informed third parties. These include firms that have had alliances with the potential partners, investment bankers that have had dealings with them, and former employees.

3. Get to know the potential partner as well as possible before committing to an alliance. This should include face-to-face meetings between senior managers (and perhaps middle-level managers) to ensure that the chemistry is right.

Alliance Structure A partner having been selected, the alliance should be structured so that the firm’s risks of giving too much away to the partner are reduced to an acceptable level. First, alliances can be designed to make it difficult (if not impossible) to transfer technology not meant to be transferred. The design, development, manufacture, and service of a product manufactured by an alliance can be structured so as to wall off sensitive technologies to prevent their leakage to the other participant. In a long-standing alliance between General Electric and Snecma to build commercial aircraft engines for single-aisle commercial jet aircraft, for example, GE reduced the risk of excess transfer by walling off certain sections of the production process. The modularization effectively cut off the transfer of what GE regarded as key competitive technology, while permitting Snecma access to final assembly. Formed in 1974, the alliance has been remarkably successful, and today it dominates the market for jet engines used on the Boeing 737 and Airbus 320.44 Similarly, in the alliance between Boeing and the Japanese to build the 767, Boeing walled off research, design, and marketing functions considered central to its competitive position, while allowing the Japanese to share in production technology. Boeing also walled off new technologies not required for 767 production.45

Second, contractual safeguards can be written into an alliance agreement to guard against the risk of opportunism by a partner. (Opportunism includes the theft of technology and/or markets.) For example, TRW Inc. entered into three strategic alliances with large Japanese auto component suppliers to produce seat belts, engine valves, and steering gears for sale to

Page 365Japanese-owned auto assembly plants in the United States. TRW put clauses in each of its alliance contracts that barred the Japanese firms from competing with TRW to supply U.S.-owned auto companies with component parts. By doing this, TRW protected itself against the possibility that the Japanese companies were entering into the alliances merely to gain access to the North American market to compete with TRW in its home market.

Third, both parties to an alliance can agree in advance to swap skills and technologies that the other covets, thereby ensuring a chance for equitable gain. Cross-licensing agreements are one way to achieve this goal. Fourth, the risk of opportunism by an alliance partner can be reduced if the firm extracts a significant credible commitment from its partner in advance. The long-term alliance between Xerox and Fuji to build photocopiers for the Asian market perhaps best illustrates this. Rather than enter into an informal agreement or a licensing arrangement (which Fuji Photo initially wanted), Xerox insisted that Fuji invest in a 50/50 joint venture to serve Japan and East Asia. This venture constituted such a significant investment in people, equipment, and facilities that Fuji Photo was committed from the outset to making the alliance work in order to earn a return on its investment. By agreeing to the joint venture, Fuji essentially made a credible commitment to the alliance. Given this, Xerox felt secure in transferring its photocopier technology to Fuji.46

Managing the Alliance Once a partner has been selected and an appropriate alliance structure has been agreed on, the task facing the firm is to maximize its benefits from the alliance. As in all international business deals, an important factor is sensitivity to cultural differences (see Chapter 4). Many differences in management style are attributable to cultural differences, and managers need to make allowances for these in dealing with their partner. Beyond this, maximizing the benefits from an alliance seems to involve building trust between partners and learning from partners.47

Managing an alliance successfully requires building interpersonal relationships between the firms’ managers, or what is sometimes referred to as relational capital.48 This is one lesson that can be drawn from a successful strategic alliance between Ford and Mazda. Ford and Mazda set up a framework of meetings within which their managers not only discuss matters pertaining to the alliance but also have time to get to know each other better. The belief is that the resulting friendships help build trust and facilitate harmonious relations between the two firms. Personal relationships also foster an informal management network between the firms. This network can then be used to help solve problems arising in more formal contexts (such as in joint committee meetings between personnel from the two firms).

Academics have argued that a major determinant of how much acquiring knowledge a company gains from an alliance is its ability to learn from its alliance partner.49 For example, in a five-year study of 15 strategic alliances between major multinationals, Gary Hamel, Yves Doz, and C. K. Prahalad focused on a number of alliances between Japanese companies and Western (European or American) partners.50 In every case in which a Japanese company emerged from an alliance stronger than its Western partner, the Japanese company had made a greater effort to learn. Few Western companies studied seemed to want to learn from their Japanese partners. They tended to regard the alliance purely as a cost-sharing or risk-sharing device, rather than as an opportunity to learn how a potential competitor does business.

Consider the alliance between General Motors and Toyota constituted in 1985 to build the Chevrolet Nova. This alliance was structured as a formal joint venture, called New United Motor Manufacturing Inc., and each party had a 50 percent equity stake. The venture owned an auto plant in Fremont, California. According to one Japanese manager, Toyota quickly achieved most of its objectives from the alliance: “We learned about U.S. supply and transportation. And we got the confidence to manage U.S. workers.”51 All that knowledge was then transferred to Georgetown, Kentucky, where Toyota opened its own plant in 1988. Possibly all GM got was a new product, the Chevrolet Nova. Some GM managers complained that the knowledge they gained through the alliance with Toyota has never been put to good use inside GM. They believe they should have been kept together as a team to educate GM’s engineers and workers about the Japanese system. Instead, they were dispersed to various GM subsidiaries.

To maximize the learning benefits of an alliance, a firm must try to learn from its partner and then apply the knowledge within its own organization. It has been suggested that all Page 366operating employees should be well briefed on the partner’s strengths and weaknesses and should understand how acquiring particular skills will bolster their firm’s competitive position. Hamel, Doz, and Prahalad note that this is already standard practice among Japanese companies. They made this observation:

images test PREP

Use LearnSmart to help retain what you have learned. Access your instructor’s Connect course to check out LearnSmart or go to learnsmartadvantage.com for help.

We accompanied a Japanese development engineer on a tour through a partner’s factory. This engineer dutifully took notes on plant layout, the number of production stages, the rate at which the line was running, and the number of employees. He recorded all this despite the fact that he had no manufacturing responsibility in his own company, and that the alliance did not encompass joint manufacturing. Such dedication greatly enhances learning.52

Key Terms

strategy

profitability

profit growth

value creation

operations

organization architecture

organizational structure

controls

incentives

processes

organizational culture

people

core competence

location economies

global web

experience curve

learning effects

economies of scale

universal needs

global standardization strategy

localization strategy

transnational strategy

international strategy

Summary

This chapter reviewed basic principles of strategy and the various ways in which firms can profit from global expansion, and it looked at the strategies that firms that compete globally can adopt. The chapter made the following points:

1. A strategy can be defined as the actions that managers take to attain the goals of the firm. For most firms, the preeminent goal is to maximize shareholder value. Maximizing shareholder value requires firms to focus on increasing their profitability and the growth rate of profits over time.

2. International expansion may enable a firm to earn greater returns by transferring the product offerings derived from its core competencies to markets where indigenous competitors lack those product offerings and competencies.

3. It may pay a firm to base each value creation activity it performs at that location where factor conditions are most conducive to the performance of that activity. We refer to this strategy as focusing on the attainment of location economies.

4. By rapidly building sales volume for a standardized product, international expansion can assist a firm in moving down the experience curve by realizing learning effects and economies of scale.

5. A multinational firm can create additional value by identifying valuable skills created within its foreign subsidiaries and leveraging those skills within its global network of operations.

6. The best strategy for a firm to pursue often depends on a consideration of the pressures for cost reductions and for local responsiveness.

7. Firms pursuing an international strategy transfer the products derived from core competencies to foreign markets, while undertaking some limited local customization.

8. Firms pursuing a localization strategy customize their product offering, marketing strategy, and business strategy to national conditions.

9. Firms pursuing a global standardization strategy focus on reaping the cost reductions that come from experience curve effects and location economies.

10. Many industries are now so competitive that firms must adopt a transnational strategy. This involves a simultaneous focus on reducing costs, transferring skills and products, and boosting local responsiveness. Implementing such a strategy may not be easy.

11. Strategic alliances are cooperative agreements between actual or potential competitors.

12. The advantages of alliances are that they facilitate entry into foreign markets, enable partners to share the fixed costs and risks associated with new products and processes, facilitate the transfer of complementary skills between companies, and help firms establish technical standards.

13. A disadvantage of a strategic alliance is that the firm risks giving away technological know-how and market access to its alliance partner in return for very little.

14. The disadvantages associated with alliances can be reduced if the firm selects partners carefully, paying close attention to the firm’s reputation and the structure of the alliance so as to avoid unintended transfers of know-how.

15. Keys to making alliances work seem to be building trust and informal communications networks between partners and taking proactive steps to learn from alliance partners.

Critical Thinking and Discussion Questions

1. In a world of zero transportation costs, no trade barriers, and nontrivial differences between nations with regard to factor conditions, firms must expand internationally if they are to survive. Discuss.

2. Plot the position of the following firms on Figure 12.8: Procter & Gamble, IBM, Apple, Coca-Cola, Dow Chemical, U.S. Steel, McDonald’s. In each case, justify your answer.

3. In what kind of industries does a localization strategy make sense? When does a global standardization strategy make most sense?

4. Reread the Management Focus on Procter & Gamble and then answer the following questions:

a. What strategy was Procter & Gamble pursuing when it first entered foreign markets in the period up until the 1980s?

b. Why do you think this strategy became less viable in the 1990s?

c. What strategy does P&G appear to be moving toward? What are the benefits of this strategy? What are the potential risks associated with it?

5. What do you see as the main organizational problems that are likely to be associated with implementation of a transnational strategy?

images Research Task http://globalEDGE.msu.edu

Use the globalEDGE website (globaledge.msu.edu) to complete the following exercises:

1. Several classifications and rankings of the world’s largest companies are prepared by a variety of sources. Find one such composite ranking system and identify the criteria that are used to rank the top global companies. Extract the list of the top 20 ranked companies, paying particular attention to their home countries.

2. The top management of your company, a manufacturer and marketer of smartphones, has decided to pursue international expansion opportunities in eastern Europe. To ensure success, management’s goal is to enter into countries with a high level of global connectedness. Identify the top three eastern European countries in which your company can market its current product line. Prepare an executive summary to support your recommendations.

images Ford’s Global Strategy closing case

When Ford CEO Alan Mulally arrived at the company in 2006 after a long career at Boeing, he was shocked to learn that the company produced one Ford Focus for Europe and a totally different one for the United States. “Can you imagine having one Boeing 737 for Europe and one 737 for the United States?” he said at the time. Due to this product strategy, Ford was unable to buy common parts for the vehicles, could not share development costs, and couldn’t use its European Focus plants to make cars for the United States, or vice versa. In a business where economies of scale are important, the result was high costs. Nor were these problems limited to the Ford Focus. The strategy of designing and building different cars for different regions was the standard approach at Ford.

Ford’s long-standing strategy of regional models was based upon the assumption that consumers in different regions had different tastes and preferences, which required considerable local customization. Americans, it was argued, loved their trucks and SUVs, while Europeans preferred smaller, fuel-efficient cars. Notwithstanding such differences, Mulally still could not understand why small car models like the Focus, or the Escape SUV, which were sold in different regions, were not built on the same platform and did not share common parts. In truth, the strategy probably had more to do with the autonomy of different regions within Ford’s organization—a fact that was deeply embedded in Ford’s history as one of the oldest multinational corporations.

When the global financial crisis rocked the world’s automobile industry in 2008–2009 and precipitated the steepest drop in sales since the Great Depression, Mulally decided that Ford had to change its long-standing practices in order to get its costs under control. Moreover, he felt that there was no way that Ford would be able to compete effectively in the large developing markets of China and India unless Ford leveraged its global scale to produce Page 368low-cost cars. The result was Mulally’s One Ford strategy, which aims to create a handful of car platforms that Ford can use everywhere in the world.

Under this strategy, new models—such as the 2013 Fiesta, Focus, and Escape—share a common design, are built on a common platform, use the same parts, and will be built in identical factories around the world. Ultimately, Ford hopes to have only five platforms to deliver sales of more than 6 million vehicles by 2016. In 2006, Ford had 15 platforms that accounted for sales of 6.6 million vehicles. By pursuing this strategy, Ford can share the costs of design and tooling, and it can attain much greater scale economies in the production of component parts. Ford has stated that it will take about one-third out of the $1 billion cost of developing a new car model and should significantly reduce its $50 billion annual budget for component parts. Moreover, because the different factories producing these cars are identical in all respects, useful knowledge acquired through experience in one factory can quickly be transferred to other factories, resulting in systemwide cost savings.

What Ford hopes is that this strategy will bring down costs sufficiently to enable Ford to make greater profit margins in developed markets and be able to achieve good profit margins at lower price points in hypercompetitive developing nations, such as China (now the world’s largest car market), where Ford currently trails its global rivals such as General Motors and Volkswagen. Indeed, the strategy is central to Mulally’s goal for growing Ford’s sales from 5.5 million in 2010 to 8 million by mid-decade.

Sources: M. Ramsey, “For SUV Marks New World Car Strategy,” The Wall Street Journal, November 16, 2011; B. Vlasic, “Ford Strategy Will Call for Stepping Up Expansion, Especially in Asia,” The New York Times, June 7, 2011; and “Global Manufacturing Strategy Gives Ford Competitive Advantage,” Ford Motor Company website, http://media.ford.com/article_display.cfm?article_id513633.

CASE DISCUSSION QUESTIONS

1. How would you characterize the strategy for competing internationally that Ford was pursuing prior to the arrival of Alan Mulally in 2006? What were the benefits of this strategy? What were the costs? Why was Ford pursuing this strategy?

2. What strategy is Mulally trying to get Ford to pursue with his One Ford initiative? What are the benefits of this strategy? Can you see any drawbacks?

3. Does the One Ford initiative imply that Ford will now ignore national and regional differences in demand?

Endnotes

1. More formally, ROIC = Net profit after tax/Capital, where capital includes the sum of the firm’s equity and debt. This way of calculating profitability is highly correlated with return on assets.

2. T. Copeland, T. Koller, and J. Murrin, Valuation: Measuring and Managing the Value of Companies (New York: John Wiley & Sons, 2000).

3. The concept of consumer surplus is an important one in economics. For a more detailed exposition, see D. Besanko, D. Dranove, and M. Shanley, Economics of Strategy (New York: John Wiley & Sons, 1996).

4. However, P = V only in the special case where the company has a perfect monopoly, and where it can charge each customer a unique price that reflects the value of the product to that customer (i.e., where perfect price discrimination is possible). More generally, except in the limiting case of perfect price discrimination, even a monopolist will see most consumers capture some of the value of a product in the form of a consumer surplus.

5. This point is central to the work of Michael Porter, Competitive Advantage (New York: Free Press, 1985). See also chap. 4 in P. Ghemawat, Commitment: The Dynamic of Strategy (New York: Free Press, 1991).

6. M. E. Porter, Competitive Strategy (New York: Free Press, 1980).

7. M. E. Porter, “What Is Strategy?” Harvard Business Review, On-point Enhanced Edition article, February 1, 2000.

8. Porter, Competitive Advantage.

9. D. Naidler, M. Gerstein, and R. Shaw, Organization Architecture (San Francisco: Jossey-Bass, 1992).

10. G. Morgan, Images of Organization (Beverly Hills, CA: Sage Publications, 1986).

11. Empirical evidence does seem to indicate that, on average, international expansion is linked to greater firm profitability. For some recent examples, see M. A. Hitt, R. E. Hoskisson, and H. Kim, “International Diversification, Effects on Innovation and Firm Performance,” Academy of Management Journal 40, no. 4 (1997), pp. 767–98; and S. Tallman and J. Li, “Effects of International Diversity and Product Diversity on the Performance of Multinational Firms,” Academy of Management Journal 39, no. 1 (1996), pp. 179–96.

12. This concept has been popularized by G. Hamel and C. K. Prahalad, Competing for the Future (Boston: Harvard Business School Press, 1994). The concept is grounded in the resource-based view of the firm; for a summary, see J. B. Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management 17 (1991), pp. 99–120; and K. R. Conner, “A Historical Comparison of Resource-Based Theory and Five Schools of Thought within Industrial Organization Economics: Do We Have a New Theory of the Firm?” Journal of Management 17 (1991), pp. 121–54.

13. J. P. Womack, D. T. Jones, and D. Roos, The Machine That Changed the World (New York: Rawson Associates, 1990).

14. M. E. Porter, The Competitive Advantage of Nations (New York: Free Press, 1990).

15. Example is based on C. S. Trager, “Enter the Mini-Multinational,” Northeast International Business, March 1989, pp. 13–14.

16. See R. B. Reich, The Work of Nations (New York: Alfred A. Knopf, 1991); and P. J. Buckley and N. Hashai, “A Global System View of Firm Boundaries,” Journal of International Business Studies, January 2004, pp. 33–50.

17. D. Barboza, “An Unknown Giant Flexes Its Muscles,” The New York Times, December 4, 2004, pp. B1, B3.

18. G. Hall and S. Howell, “The Experience Curve from an Economist’s Perspective,” Strategic Management Journal 6 (1985), pp. 197–212.

19. A. A. Alchain, “Reliability of Progress Curves in Airframe Production,” Econometrica 31 (1963), pp. 697–98.

Page 36920. Hall and Howell, “The Experience Curve from an Economist’s Perspective.”

21. For a full discussion of the source of scale economies, see D. Besanko, D. Dranove, and M. Shanley, Economics of Strategy (New York: John Wiley & Sons, 1996).

22. This estimate was provided by the Pharmaceutical Manufacturers Association.

23. See J. Birkinshaw and N. Hood, “Multinational Subsidiary Evolution: Capability and Charter Change in Foreign Owned Subsidiary Companies,” Academy of Management Review 23 (October 1998), pp. 773–95; A. K. Gupta and V. J. Govindarajan, “Knowledge Flows within Multinational Corporations,” Strategic Management Journal 21 (2000), pp. 473–96; V. J. Govindarajan and A. K. Gupta, The Quest for Global Dominance (San Francisco: Jossey Bass, 2001); T. S. Frost, J. M. Birkinshaw, and P. C. Ensign, “Centers of Excellence in Multinational Corporations,” Strategic Management Journal 23 (2002), pp. 997–1018; and U. Andersson, M. Forsgren, and U. Holm, “The Strategic Impact of External Networks,” Strategic Management Journal 23 (2002), pp. 979–96.

24. S. Leung, “Armchairs, TVs and Espresso: Is It McDonald’s?” The Wall Street Journal, August 30, 2002, pp. A1, A6; and E. Beardsley, “Why McDonald’s in France Doesn’t Feel Like Fast Food,” NPR, January 24, 2012.

25. C. K. Prahalad and Yves L. Doz, The Multinational Mission: Balancing Local Demands and Global Vision (New York: Free Press, 1987). Also see J. Birkinshaw, A. Morrison, and J. Hulland, “Structural and Competitive Determinants of a Global Integration Strategy,” Strategic Management Journal 16 (1995), pp. 637–55; and P. Ghemawat, Redefining Global Strategy (Boston: Harvard Business School Press, 2007).

26. J. E. Garten, “Wal-Mart Gives Globalization a Bad Name,” BusinessWeek, March 8, 2004, p. 24.

27. Prahalad and Doz, The Multinational Mission. Prahalad and Doz actually talk about local responsiveness rather than local customization.

28. T. Levitt, “The Globalization of Markets,” Harvard Business Review, May–June 1983, pp. 92–102.

29. W. W. Lewis, The Power of Productivity (Chicago: University of Chicago Press, 2004).

30. C. J. Chipello, “Local Presence Is Key to European Deals,” The Wall Street Journal, June 30, 1998, p. A15.

31. For an extended discussion see: G. S. Yip and G. Tomas M. Hult, Total Global Strategy (Boston: Pearson, 2012), and A. M. Rugman and A. Verbeke, “A Perspective on Regional and Global Strategies of Multinational Enterprises,” Journal of International Business Studies 35, no. 1 (2004)), pp. 3–18.

32. C. A. Bartlett and S. Ghoshal, Managing Across Borders: The Trans-national Solution (Boston: Harvard Business School Press, 1998).

33. C. A. Bartlett and S. Ghoshal, Managing Across Borders: The Transnational Solution (Boston: Harvard Business School Press, 1998).

34. Pankaj Ghemawat makes a similar argument, although he does not use the term transnational. See Ghemawat, Redefining Global Strategy.

35. T. Hout, M. E. Porter, and E. Rudden, “How Global Companies Win Out,” Harvard Business Review, September–October 1982, pp. 98–108.

36. See K. Ohmae, “The Global Logic of Strategic Alliances,” Harvard Business Review, March–April 1989, pp. 143–54; G. Hamel, Y. L. Doz, and C. K. Prahalad, “Collaborate with Your Competitors and Win!” Harvard Business Review, January–February 1989, pp. 133–39; W. Burgers, C. W. L. Hill, and W. C. Kim, “Alliances in the Global Auto Industry,” Strategic Management Journal 14 (1993), pp. 419–32; and P. Kale, H. Singh, and H. Perlmutter, “Learning and Protection of Proprietary Assets in Strategic Alliances: Building Relational Capital,” Strategic Management Journal 21 (2000), pp. 217–37.

37. L. T. Chang, “China Eases Foreign Film Rules,” The Wall Street Journal, October 15, 2004, p. B2.

38. B. L. Simonin, “Transfer of Marketing Know-How in International Strategic Alliances,” Journal of International Business Studies, 1999, pp. 463–91; and J. W. Spencer, “Firms’ Knowledge Sharing Strategies in the Global Innovation System,” Strategic Management Journal 24 (2003), pp. 217–33.

39. C. Souza, “Microsoft Teams with MIPS, Toshiba,” EBN, February 10, 2003, p. 4.

40. Kale, Singh, and Perlmutter, “Learning and Protection of Proprietary Assets.”

41. R. B. Reich and E. D. Mankin, “Joint Ventures with Japan Give Away Our Future,” Harvard Business Review, March–April 1986, pp. 78–90.

42. J. Bleeke and D. Ernst, “The Way to Win in Cross-Border Alliances,” Harvard Business Review, November–December 1991, pp. 127–35.

43. C. H. Deutsch, “The Venturesome Giant,” The New York Times, October 5, 2007, pp. C1, C8.

44. “Odd Couple: Jet Engines,” The Economist, May 5, 2007, pp. 79–80.

45. W. Roehl and J. F. Truitt, “Stormy Open Marriages Are Better,” Columbia Journal of World Business, Summer 1987, pp. 87–95.

46. B. Gomes-Casseres and K. McQuade, “Xerox and Fuji Xerox,” Cambridge, MA: Harvard Business School Case, February 15, 1991.

47. See T. Khanna, R. Gulati, and N. Nohria, “The Dynamics of Learning Alliances: Competition, Cooperation, and Relative Scope,” Strategic Management Journal 19 (1998), pp. 193–210; and Kale, Singh, and Perlmutter, “Learning and Protection of Proprietary Assets in Strategic Alliances.”

48. Kale, Singh, Perlmutter, “Learning and Protection of Proprietary Assets in Strategic Alliances.”

49. Hamel, Doz, and Prahalad, “Collaborate with Competitors”; Khanna, Gulati, and Nohria, “The Dynamics of Learning Alliances: Competition, Cooperation, and Relative Scope”; and E. W. K. Tang, “Acquiring Knowledge by Foreign Partners from International Joint Ventures in a Transition Economy: Learning by Doing and Learning Myopia,” Strategic Management Journal 23 (2002), pp. 835–54.

50. Hamel, Doz, and Prahalad, “Collaborate with Competitors.”

51. B. Wysocki, “Cross-Border Alliances Become Favorite Way to Crack New Markets,” The Wall Street Journal, March 4, 1990, p. A1.

52. Hamel, Doz, and Prahalad, “Collaborate with Competitors,” p. 138.

https://digitalbookshelf.argosy.edu/#/books/1259669432/cfi/6/44!/4/4/16/4@0:0

Entering Foreign Markets

Market Entry at Starbucks

opening case

Forty years ago, Starbucks was a single store in Seattle’s Pike Place Market selling premium-roasted coffee. Today, it is a global roaster and retailer of coffee with almost 20,000 stores, 40 percent of which are in 62 countries outside of the United States. Starbucks set out on its current course in the 1980s when the company’s director of marketing, Howard Schultz, came back from a trip to Italy enchanted with the Italian coffeehouse experience. Schultz, who later became CEO, persuaded the company’s owners to experiment with the coffeehouse format—and the Starbucks experience was born. The strategy was to sell the company’s own premium roasted coffee and freshly brewed espresso-style coffee beverages, along with a variety of pastries, coffee accessories, teas, and other products, in a tastefully designed coffeehouse setting. From the outset, the company focused on selling “a third place experience,” rather than just the coffee. The formula led to spectacular success in the United States, where Starbucks went from obscurity to one of the best-known brands in the country in a decade. Thanks to Starbucks, coffee stores became places for relaxation, chatting with friends, reading the newspaper, holding business meetings, or (more recently) browsing the web.

In 1995, with 700 stores across the United States, Starbucks began exploring foreign opportunities. The first target market was Japan. The company established a joint venture with a local retailer, Sazaby Inc. Each company held a 50 percent stake in the venture, Starbucks Coffee of Japan. Starbucks initially invested $10 million in this venture, its first foreign direct investment. The Starbucks format was then licensed to the venture, which was charged with taking over responsibility for growing Starbucks’ presence in Japan.

To make sure the Japanese operations replicated the “Starbucks experience” in North America, Starbucks transferred some employees to the Japanese operation. The licensing agreement required all Japanese store managers and employees to attend training classes similar to those given to U.S. employees. The agreement also required that stores adhere to the design parameters established in the United States. In 2001, the company introduced a stock option plan for all Japanese employees, making it the first Page 372company in Japan to do so. Skeptics doubted that Starbucks would be able to replicate its North American success overseas, but by the end of 2013 Starbucks’ had some 1,000 stores and a profitable business in Japan.

After Japan, the company embarked on an aggressive foreign investment program. In 1998, it purchased Seattle Coffee, a British coffee chain with 60 retail stores, for $84 million. An American couple, originally from Seattle, had started Seattle Coffee with the intention of establishing a Starbucks-like chain in Britain. In the late 1990s, Starbucks opened stores in Taiwan, Singapore, Thailand, New Zealand, South Korea, Malaysia, and—most significantly—China. In Asia, Starbucks’ most common strategy was to license its format to a local operator in return for initial licensing fees and royalties on store revenues. As in Japan, Starbucks insisted on an intensive employee-training program and strict specifications regarding the format and layout of the store.

By 2002, Starbucks was pursuing an aggressive expansion in mainland Europe. As its first entry point, Starbucks chose Switzerland. Drawing on its experience in Asia, the company entered into a joint venture with a Swiss company, Bon Appetit Group, Switzerland’s largest food service company. Bon Appetit was to hold a majority stake in the venture, and Starbucks would license its format to the Swiss company using a similar agreement to those it had used successfully in Asia. This was followed by a joint venture in other countries.

By 2014, Starbucks was emphasizing the rapid growth of its operations in China, where it now had 1,000 stores and plans to roll out another 500 in three years. The success of Starbucks in China has been attributed to a smart partnering strategy. China is not one homogeneous market; the culture of northern China is very different from that of the east, consumer spending power inland is not on par with that of the big coastal cities. To deal with this complexity, Starbucks entered into three different joint ventures. In the north, with Beijong Mei Da coffee, in the east with Taiwan based Uni-President, and in the south with Hong Kong based Maxim’s Caterers. Each partner bought different strengths and local expertise that helped the company to gain insights into the tastes and preferences of local Chinese customers, and to adapt accordingly. Starbucks now believes that China will become its second largest market after the United States by 2020. images

Sources: Starbucks 10K, various years; C. McLean, “Starbucks Set to Invade Coffee-Loving Continent,” Seattle Times, October 4, 2000, p. E1; J. Ordonez, “Starbucks to Start Major Expansion in Overseas Market,” The Wall Street Journal, October 27, 2000, p. B10; S. Homes and D. Bennett, “Planet Starbucks,” BusinessWeek, September 9, 2002, pp. 99–110; “Starbucks Outlines International Growth Strategy,” Business Wire, October 14, 2004; A. Yeh, “Starbucks Aims for New Tier in China,” Financial Times, February 14, 2006, p. 17; C. Matlack, “Will Global Growth Help Starbucks?” BusinessWeek, July 2, 2008; and H. H. Wang, “Five Things Starbucks Did to Get China Right,” Forbes, July 10, 2012.

images

Introduction

This chapter is concerned with two closely related topics: (1) the decision of which foreign markets to enter, when to enter them, and on what scale and (2) the choice of entry mode. Any firm contemplating foreign expansion must first struggle with the issue of which foreign markets to enter and the timing and scale of entry. The choice of which markets to enter should be driven by an assessment of relative long-run growth and profit potential. For example, enticed by its long-term growth potential, Starbucks entered China back in Page 3731999. The company now believes that China will ultimately become its second largest market after the United States, and accordingly, it has been investing heavily in that nation.

The choice of mode for entering a foreign market is another major issue with which international businesses must wrestle. The various modes for serving foreign markets are exporting, licensing or franchising to host-country firms, establishing joint ventures with a host-country firm, setting up a new wholly owned subsidiary in a host country to serve its market, and acquiring an established enterprise in the host nation to serve that market. Each of these options has advantages and disadvantages. The magnitude of the advantages and disadvantages associated with each entry mode is determined by a number of factors, including transport costs, trade barriers, political risks, economic risks, business risks, costs, and firm strategy. The optimal entry mode varies by situation, depending on these factors. Thus, whereas some firms may best serve a given market by exporting, other firms may better serve the market by setting up a new wholly owned subsidiary or by acquiring an established enterprise. Starbucks, for example, seems to have had a preference for entering into joint ventures with local partners and then licensing its format to the joint venture. Starbucks has done this in order to benefit from its joint-venture partners’ local expertise, which has helped the company to better configure its store format and menu to the tastes and preferences of local customers. In China, for example, its partners urged Starbucks to capitalize on the tea-drinking culture of the country by using popular local ingredients such as green tea. This helped to get consumers through the door, and once they frequented the stores, they quickly developed a taste for Starbucks coffee.

Basic Entry Decisions

A firm contemplating foreign expansion must make three basic decisions: which markets to enter, when to enter those markets, and on what scale.1

WHICH FOREIGN MARKETS? The 196 nation-states in the world do not all hold the same profit potential for a firm contemplating foreign expansion. Ultimately, the choice must be based on an assessment of a nation’s long-run profit potential. This potential is a function of several factors, many of which we have studied in earlier chapters. Chapters 2 and 3 looked in detail at the economic and political factors that influence the potential attractiveness of a foreign market. The attractiveness of a country as a potential market for an international business depends on balancing the benefits, costs, and risks associated with doing business in that country.

Chapters 2 and 3 also noted that the long-run economic benefits of doing business in a country are a function of factors such as the size of the market (in terms of demographics), the present wealth (purchasing power) of consumers in that market, and the likely future wealth of consumers, which depends upon economic growth rates. While some markets are very large when measured by number of consumers (e.g., China, India, and Indonesia), living standards and economic growth must also be evaluated. On this basis, China and India, while relatively poor, are growing so rapidly that they are attractive targets for inward investment. Alternatively, weak growth in Indonesia implies that this populous nation is a far less attractive target for inward investment. As we saw in Chapters 2 and 3, likely future economic growth rates appear to be a function of a free market system and a country’s capacity for growth (which may be greater in less developed nations). Also, the costs and risks associated with doing business in a foreign country are typically lower in economically advanced and politically stable democratic nations, and they are greater in less developed and politically unstable nations.

The discussion in Chapters 2 and 3 suggests that, other things being equal, the benefit– cost–risk trade-off is likely to be most favorable in politically stable developed and developing nations that have free market systems and where there is not a dramatic upsurge in either inflation rates or private-sector debt. The trade-off is likely to be least favorable in politically unstable developing nations that operate with a mixed or command economy or in developing nations where speculative financial bubbles have led to excess borrowing.

images LO 13-1

Explain the three basic decisions that firms contemplating foreign expansion must make: which markets to enter, when to enter those markets, and on what scale.

Page 374Another important factor is the value an international business can create in a foreign market. This depends on the suitability of its product offering to that market and the nature of indigenous competition.2 If the international business can offer a product that has not been widely available in that market and that satisfies an unmet need, the value of that product to consumers is likely to be much greater than if the international business simply offers the same type of product that indigenous competitors and other foreign entrants are already offering. Greater value translates into an ability to charge higher prices and/or to build sales volume more rapidly. By considering such factors, a firm can rank countries in terms of their attractiveness and long-run profit potential. Preference is then given to entering markets that rank highly. For example, Tesco, the large British grocery chain, has been aggressively expanding its foreign operations, primarily by focusing on emerging markets that lack strong indigenous competitors (see the accompanying Management Focus).

TIMING OF ENTRY Once attractive markets have been identified, it is important to consider the timing of entry. Entry is early when an international business enters a foreign market before other foreign firms and late when it enters after other international businesses have already established themselves. The advantages frequently associated with entering a market early are commonly known as first-mover advantages.3 One first-mover advantage is the ability to preempt rivals and capture demand by establishing a strong brand name. This desire has driven the rapid expansion by Tesco into developing nations (see the Management Focus). A second advantage is the ability to build sales volume in that country and ride down the experience curve ahead of rivals, giving the early entrant a cost advantage over later entrants. This cost advantage may enable the early entrant to cut prices below that of later entrants, thereby driving them out of the market. A third advantage is the ability of early entrants to create switching costs that tie customers into their products or services. Such switching costs make it difficult for later entrants to win business.

Timing of Entry

Entry is early when a firm enters a foreign market before other foreign firms and late when a firm enters after other international businesses have established themselves.

First-Mover Disadvantages

Disadvantages associated with entering a foreign market before other international businesses.

There can also be disadvantages associated with entering a foreign market before other international businesses. These are often referred to as first-mover disadvantages.4These disadvantages may give rise to pioneering costs—that is, costs that an early entrant has to bear that a later entrant can avoid. Pioneering costs arise when the business system in a foreign country is so different from that in a firm’s home market that the enterprise has to devote considerable effort, time, and expense to learning the rules of the game. Pioneering costs include the costs of business failure if the firm, due to its ignorance of the foreign environment, makes major mistakes. A certain liability is associated with being a foreigner, and this liability is greater for foreign firms that enter a national market early.5 Research seems to confirm that the probability of survival increases if an international business enters a national market after several other foreign firms have already done so.6 The late entrant may benefit by observing and learning from the mistakes made by early entrants.

First-Mover Advantages

Advantages accruing to the first to enter a market.

Pioneering Costs

Costs an early entrant bears that later entrants avoid, such as the time and effort in learning the rules, failure due to ignorance, and the liability of being a foreigner.

images Interactive Rankings

Entering foreign markets is the focus of Chapter 13. The selection of country markets to choose from is getting larger for many product categories as more countries see their populations’ growing purchasing power. With more than 200 countries in the world, the data are overwhelming, and even the starting point for analysis is not always an easy decision. The Interactive Rankings on globalEDGE can serve as a great pictorial view of the world on some 50 important variables in categories covering the economy, energy, government, health, infrastructure, labor, people, and trade and investment (globaledge.msu.edu/tools-and-data/interactive-rankings). Active data maps such as the Interactive Rankings maps are a good starting point for analysis to evaluate data for a specific country as well as the countries around in a region. This allows for a focus on entry into one market now and a strategy for expansion later on to nearby countries with similar characteristics. Which are the top three countries for Internet users?

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Tesco’s International Growth Strategy

Page 375Tesco is the largest grocery retailer in the United Kingdom, with a 25 percent share of the local market. In its home market, the company’s strengths are reputed to come from strong competencies in marketing and store site selection, logistics and inventory management, and its own label product offerings. By the early 1990s, these competencies had already given the company a leading position in the United Kingdom. The company was generating strong free cash flows, and senior management had to decide how to use that cash. One strategy they settled on was overseas expansion. As they looked at international markets, they soon concluded the best opportunities were not in established markets, such as those in North America and western Europe, where strong local competitors already existed, but in the emerging markets of eastern Europe and Asia, where there were few capable competitors but strong underlying growth trends.

Tesco’s first international foray was into Hungary in 1995, when it acquired an initial 51 percent stake in Global, a 43-store, state-owned grocery chain. By 2013, Tesco was the market leader in Hungary, with some 216 stores. In 1996, Tesco acquired 31 stores in Poland from Stavia; a year later it added 13 stores purchased from Kmart in the Czech Republic and Slovakia; and the following year it entered the Republic of Ireland.

Tesco’s Asian expansion began in 1998 in Thailand when it purchased 75 percent of Lotus, a local food retailer with 13 stores. Building on that base, Tesco had some 1,433 stores in Thailand by 2013. In 1999, the company entered South Korea when it partnered with Samsung to develop a chain of hypermarkets. This was followed by entry into Taiwan in 2000, Malaysia in 2002, and China in 2004. The move into China came after three years of careful research and discussions with potential partners. Like many other Western companies, Tesco was attracted to the Chinese market by its large size and rapid growth. In the end, Tesco settled on a 50/50 joint venture with Hymall, a hypermarket chain that is controlled by Ting Hsin, a Taiwanese group, that had been operating in China for six years. By 2013, Tesco had 131 stores in China. Ting Hsin is a well-capitalized enterprise in its own right, and it has matched Tesco’s investments, reducing the risks Tesco faces in China.

As a result of these moves, by 2013 Tesco generated sales of £20.8 billion outside of the United Kingdom (its UK annual revenues were £43.6 billion, excluding value-added taxes [VAT]). The addition of international stores has helped make Tesco the third-largest company in the global grocery market behind Walmart and Carrefour of France. Of the three, however, Tesco may be the most successful internationally. By 2013, all of its foreign ventures—except for a small U.S. operation that it is in the process of divesting—were making money.

hinese customers enter a Tesco supermarket in Xiamen. Tesco’s expansion into China has proven to be very successful.

In explaining the company’s success, Tesco’s managers have detailed a number of important factors. First, the company devotes considerable attention to transferring its core capabilities in retailing to its new ventures. At the same time, it does not send in an army of expatriate managers to run local operations, preferring to hire local managers and support them with a few operational experts from the United Kingdom. Second, the company believes that its partnering strategy in Asia has been a great asset. Tesco has teamed up with good companies that have a deep understanding of the markets in which they are participating but that lack Tesco’s financial strength and retailing capabilities. Consequently, both Tesco and its partners have brought useful assets to the venture, increasing the probability of success. As the venture becomes established, Tesco has typically increased its ownership stake in its partner. By 2010, Tesco owned 99 percent of Homeplus, its South Korean hypermarket chain. When the venture was established, Tesco owned 51 percent. Third, the company has focused on markets with good growth potential but that lack strong indigenous competitors, which provides Tesco with ripe ground for expansion.

Sources: P. N. Child, “Taking Tesco Global,” The McKenzie Quarterly 3 (2002); H. Keers, “Global Tesco Sets Out Its Stall in China,” Daily Telegraph, July 15, 2004, p. 31; K. Burgess, “Tesco Spends Pounds 140m on Chinese Partnership,” Financial Times, July 15, 2004, p. 22; J. McTaggart, “Industry Awaits Tesco Invasion,” Progressive Grocer, March 1, 2006, pp. 8–10; Tesco’s annual reports, archived at www.tesco.com; “Tesco Set to Push Ahead in the United States,” The Wall Street Journal, October 6, 2010, p. 19; and P. Sonne, “Five Years and $1.6 Billion Later, Tesco Decides to Quit US,” The Wall Street Journal, December 6, 2012.

Pioneering costs also include the costs of promoting and establishing a product offering, including the costs of educating customers. These can be significant when the product being promoted is unfamiliar to local consumers. In contrast, later entrants may be able to ride on an early entrant’s investments in learning and customer education by watching how the early entrant proceeded in the market, by avoiding costly mistakes made by the early entrant, and by exploiting the market potential created by the early entrant’s investments in customer education. For example, KFC introduced the Chinese to American-style fast food, but a later entrant, McDonald’s, has capitalized on the market in China.

Page 376Is First-Mover Advantage Always a Good Thing?

Timing of entry into a foreign market is one of the most critical aspects of going international. Popularized by Marvin Lieberman and David Montgomery in 1988, first-mover advantage was an idea that resonated with every company. But, 10 years later, in 1998, Lieberman and Montgomery actually backed off their own idea that taking advantage of being the first mover was always a good strategy. At this time, it was too late: Venture capitalists, companies, people, and many scholars had already latched on to the positive things about being first in a new foreign market and stressed this approach over any other timing of entry. Now we are some 15 years into the twenty-first century, and the realization is that first-mover advantages also come with pioneering costs. If you had a choice of being the first-mover into a new emerging foreign market (e.g., Turkey) and being the fifth company entering that market with your product, what would you choose and why?

Sources: M. B. Lieberman and D. B. Montgomery, “First-Mover Advantages,” Strategic Management Journal 9, no. S1 (1988), pp. 41–58;and M. B. Lieberman and D. B. Montgomery, “First-Mover (Dis)Advantages: Retrospective and Link with the Resource-Based View,” Strategic Management Journal 19, no. 12 (1998), pp. 1111–25.

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An early entrant may be put at a severe disadvantage, relative to a later entrant, if regulations change in a way that diminishes the value of an early entrant’s investments. This is a serious risk in many developing nations where the rules that govern business practices are still evolving. Early entrants can find themselves at a disadvantage if a subsequent change in regulations invalidates prior assumptions about the best business model for operating in that country.

SCALE OF ENTRY AND STRATEGIC COMMITMENTS Another issue that an international business needs to consider when contemplating market entry is the scale of entry. Entering a market on a large scale involves the commitment of significant resources. Entering a market on a large scale implies rapid entry. Consider the entry of the Dutch insurance company ING into the U.S. insurance market in 1999. ING had to spend several billion dollars to acquire its U.S. operations. Not all firms have the resources necessary to enter on a large scale, and even some large firms prefer to enter foreign markets on a small scale and then build slowly as they become more familiar with the market.

The consequences of entering on a significant scale— entering rapidly—are associated with the value of the resulting strategic commitments.7 A strategic commitment has a long-term impact and is difficult to reverse. Deciding to enter a foreign market on a significant scale is a major strategic commitment. Strategic commitments, such as rapid, large-scale market entry, can have an important influence on the nature of competition in a market. For example, by entering the U.S. financial services market on a significant scale, ING signaled its commitment to the market. This will have several effects. On the positive side, it will make it easier for the company to attract customers and distributors (such as insurance agents). The scale of entry gives both customers and distributors reasons for believing that ING will remain in the market for the long run. The scale of entry may also give other foreign institutions considering entry into the United States pause; now they will have to compete not only against indigenous institutions in the United States, but also against an aggressive and successful European institution. On the negative side, by committing itself heavily to one country, the United States, ING may have fewer resources available to support expansion in other desirable markets, such as Japan. The commitment to the United States limits the company’s strategic flexibility.

As suggested by the ING example, significant strategic commitments are neither unambiguously good nor bad. Rather, they tend to change the competitive playing field and unleash a number of changes, some of which may be desirable and some of which will not be. It is important for a firm to think through the implications of large-scale entry into a market and act accordingly. Of particular relevance is trying to identify how actual and potential competitors might react to large-scale entry into a market. Also, the large-scale entrant is more likely than the small-scale entrant to be able to capture first-mover advantages associated with demand preemption, scale economies, and switching costs.

The value of the commitments that flow from rapid large-scale entry into a foreign market must be balanced against the resulting risks and lack of flexibility associated with significant commitments. But strategic inflexibility can also have value. A famous example from military history illustrates the value of inflexibility. When Hernán Cortés landed in Mexico, he ordered his men to burn all but one of his ships. Cortés reasoned that by eliminating their only method of retreat, his men had no choice but to fight hard to win against the Aztecs—and ultimately they did.8

Page 377Balanced against the value and risks of the commitments associated with large-scale entry are the benefits of a small-scale entry. Small-scale entry allows a firm to learn about a foreign market while limiting the firm’s exposure to that market. Small-scale entry is a way to gather information about a foreign market before deciding whether to enter on a significant scale and how best to enter. By giving the firm time to collect information, small-scale entry reduces the risks associated with a subsequent large-scale entry. But the lack of commitment associated with small-scale entry may make it more difficult for the small-scale entrant to build market share and to capture first-mover or early-mover advantages. The risk-averse firm that enters a foreign market on a small scale may limit its potential losses, but it may also miss the chance to capture first-mover advantages.

MARKET ENTRY SUMMARY There are no “right” decisions here, just decisions that are associated with different levels of risk and reward. Entering a large developing nation such as China or India before most other international businesses in the firm’s industry, and entering on a large scale, will be associated with high levels of risk. In such cases, the liability of being foreign is increased by the absence of prior foreign entrants whose experience can be a useful guide. At the same time, the potential long-term rewards associated with such a strategy are great. The early large-scale entrant into a major developing nation may be able to capture significant first-mover advantages that will bolster its long-run position in that market.9 In contrast, entering developed nations such as Australia or Canada after other international businesses in the firm’s industry, and entering on a small scale to first learn more about those markets, will be associated with much lower levels of risk. However, the potential long-term rewards are also likely to be lower because the firm is essentially forgoing the opportunity to capture first-mover advantages and because the lack of commitment signaled by small-scale entry may limit its future growth potential.

This section has been written largely from the perspective of a business based in a developed country considering entry into foreign markets. Christopher Bartlett and Sumantra Ghoshal have pointed out the ability that businesses based in developing nations have to enter foreign markets and become global players.10 Although such firms tend to be late entrants into foreign markets, and although their resources may be limited, Bartlett and Ghoshal argue that such late movers can still succeed against well-established global competitors by pursuing appropriate strategies. In particular, Bartlett and Ghoshal argue that companies based in developing nations should use the entry of foreign multinationals as an opportunity to learn from these competitors by benchmarking their operations and performance against them. Furthermore, they suggest the local company may be able to find ways to differentiate itself from a foreign multinational, for example, by focusing on market niches that the multinational ignores or is unable to serve effectively if it has a standardized global product offering. Having improved its performance through learning and differentiated its product offering, the firm from a developing nation may then be able to pursue its own international expansion strategy. Even though the firm may be a late entrant into many countries, by benchmarking and then differentiating itself from early movers in global markets, the firm from the developing nation may still be able to build a strong international business presence. A good example of how this can work is given in the accompanying Management Focus, which looks at how Jollibee, a Philippines-based fast-food chain, has started to build a global presence in a market dominated by U.S. multinationals such as McDonald’s and KFC.

Entry Modes

Once a firm decides to enter a foreign market, the question arises as to the best mode of entry. Firms can use six different modes to enter foreign markets: exporting, turnkey projects, licensing, franchising, establishing joint ventures with a host-country firm, or setting up a new wholly owned subsidiary in the host country. Each entry mode has advantages and disadvantages. Managers need to consider these carefully when deciding which to use.11

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Compare and contrast the different modes that firms use to enter foreign markets.

management FOCUS

The Jollibee Phenomenon—A Philippine Multinational

Jollibee is one of the Philippines’ phenomenal business success stories. Jollibee, which stands for “Jolly Bee,” began operations in 1975 as a two-branch ice cream parlor. It later expanded its menu to include hot sandwiches and other meals. Encouraged by early success, Jollibee Foods Corporation was incorporated in 1978, with a network that had grown to seven outlets. In 1981, when Jollibee had 11 stores, McDonald’s began to open stores in Manila. Many observers thought Jollibee would have difficulty competing against McDonald’s. However, Jollibee saw this as an opportunity to learn from a very successful global competitor. Jollibee benchmarked its performance against that of McDonald’s and started to adopt operational systems similar to those used at McDonald’s to control its quality, cost, and service at the store level. This helped Jollibee to improve its performance.

As it came to better understand McDonald’s business model, Jollibee began to look for a weakness in McDonald’s global strategy. Jollibee executives concluded that McDonald’s fare was too standardized for many locals and that the local firm could gain share by tailoring its menu to local tastes. Jollibee’s hamburgers were set apart by a secret mix of spices blended into the ground beef to make the burgers sweeter than those produced by McDonald’s, appealing more to Philippine tastes. It also offered local fare, including various rice dishes, pineapple burgers, and banana langka and peach mango pies for desserts. By pursuing this strategy, Jollibee maintained a leadership position over the global giant. By 2012, Jollibee had more than 740 stores in the Philippines, a market share of more than 60 percent, and revenues in excess of $600 million. McDonald’s, in contrast, had about 250 stores.

In the mid-1980s, Jollibee had gained enough confidence to expand internationally. Its initial ventures were into neighboring Asian countries such as Indonesia, where it pursued the strategy of localizing the menu to better match local tastes, thereby differentiating itself from McDonald’s. In 1987, Jollibee entered the Middle East, where a large contingent of expatriate Filipino workers provided a ready-made market for the company. The strategy of focusing on expatriates worked so well that in the late 1990s Jollibee decided to enter another foreign market where there was a large Filipino population— the United States. Between 1999 and 2012, Jollibee opened 25 stores in the United States, 20 of which are in California. Even though many believe the U.S. fast-food market is saturated, the stores have performed well. While the initial clientele was strongly biased toward the expatriate Filipino community, where Jollibee’s brand awareness is high, non-Filipinos increasingly are coming to the restaurant. In the San Francisco store, which has been open the longest, more than half the customers are now non-Filipino. Today, Jollibee has 75 international stores that operate under the Jollibee name and a potentially bright future as a niche player in a market that has historically been dominated by U.S. multinationals.

Sources: “Jollibee Battles Burger Giants in US Market,” Philippine Daily Inquirer, July 13, 2000; M. Ballon, “Jollibee Struggling to Expand in U.S.,” Los Angeles Times, September 16, 2002, p. C1; J. Hookway, “Burgers and Beer,” Far Eastern Economic Review, December 2003, pp. 72–74; S. E. Lockyer, “Coming to America,” Nation’s Restaurant News, February 14, 2005, pp. 33–35; Erik de la Cruz, “Jollibee to Open 120 New Stores This Year, Plans India,” Inquirer Money, July 5, 2006 (www.business.inquirer.net); and www.jollibee.com.ph .

EXPORTING Many manufacturing firms begin their global expansion as exporters and only later switch to another mode for serving a foreign market. We take a close look at the mechanics of exporting in Chapter 16. Here, we focus on the advantages and disadvantages of exporting as an entry mode.

Advantages Exporting has two distinct advantages. First, it avoids the often substantial costs of establishing manufacturing operations in the host country. Second, exporting may help a firm achieve experience curve and location economies (see Chapter 12). Page 379By manufacturing the product in a centralized location and exporting it to other national markets, the firm may realize substantial scale economies from its global sales volume. This is how many Japanese automakers made inroads into the U.S. market.

Exporting

Sale of products produced in one country to residents of another country.

Disadvantages Exporting has a number of drawbacks. First, exporting from the firm’s home base may not be appropriate if lower-cost locations for manufacturing the product can be found abroad (i.e., if the firm can realize location economies by moving production elsewhere). Thus, particularly for firms pursuing global or transnational strategies, it may be preferable to manufacture where the mix of factor conditions is most favorable from a value creation perspective and to export to the rest of the world from that location. This is not so much an argument against exporting as an argument against exporting from the firm’s home country. Many U.S. electronics firms have moved some of their manufacturing to the Far East because of the availability of low-cost, highly skilled labor there. They then export from that location to the rest of the world, including the United States.

A second drawback to exporting is that high transport costs can make exporting uneconomical, particularly for bulk products. One way of getting around this is to manufacture bulk products regionally. This strategy enables the firm to realize some economies from large-scale production and at the same time to limit its transport costs. For example, many multinational chemical firms manufacture their products regionally, serving several countries from one facility.

Another drawback is that tariff barriers can make exporting uneconomical. Similarly, the threat of tariff barriers by the host-country government can make it very risky. A fourth drawback to exporting arises when a firm delegates its marketing, sales, and service in each country where it does business to another company. This is a common approach for manufacturing firms that are just beginning to expand internationally. The other company may be a local agent, or it may be another multinational with extensive international distribution operations. Local agents often carry the products of competing firms and so have divided loyalties. In such cases, the local agent may not do as good a job as the firm would if it managed its marketing itself. Similar problems can occur when another multinational takes on distribution.

The way around such problems is to set up wholly owned subsidiaries in foreign nations to handle local marketing, sales, and service. By doing this, the firm can exercise tight control over marketing and sales in the country while reaping the cost advantages of manufacturing the product in a single location, or a few choice locations.

TURNKEY PROJECTS Firms that specialize in the design, construction, and start-up of turnkey plants are common in some industries. In a turnkey project, the contractor agrees to handle every detail of the project for a foreign client, including the training of operating personnel. At completion of the contract, the foreign client is handed the “key” to a plant that is ready for full operation—hence, the term turnkey. This is a means of exporting process technology to other countries. Turnkey projects are most common in the chemical, pharmaceutical, petroleum-refining, and metal-refining industries, all of which use complex, expensive production technologies.

Turnkey Project

A project in which a firm agrees to set up an operating plant for a foreign client and hand over the “key” when the plant is fully operational.

Advantages The know-how required to assemble and run a technologically complex process, such as refining petroleum or steel, is a valuable asset. Turnkey projects are a way of earning great economic returns from that asset. The strategy is particularly useful where FDI is limited by host-government regulations. For example, the governments of many oil-rich countries have set out to build their own petroleum-refining industries, so they restrict FDI in their oil-refining sectors. But because many of these countries lack petroleum-refining technology, they gain it by entering into turnkey projects with foreign firms that have the technology. Such deals are often attractive to the selling firm because, without them, they would have no way to earn a return on their valuable know-how in that country. A turnkey strategy can also be less risky than conventional FDI. In a country with unstable political and economic environments, a longer-term investment might expose the firm to Page 380unacceptable political and/or economic risks (e.g., the risk of nationalization or of economic collapse).

Disadvantages Three main drawbacks are associated with a turnkey strategy. First, the firm that enters into a turnkey deal will have no long-term interest in the foreign country. This can be a disadvantage if that country subsequently proves to be a major market for the output of the process that has been exported. One way around this is to take a minority equity interest in the operation. Second, the firm that enters into a turnkey project with a foreign enterprise may inadvertently create a competitor. For example, many of the Western firms that sold oil-refining technology to firms in Saudi Arabia, Kuwait, and other Gulf states now find themselves competing with these firms in the world oil market. Third, if the firm’s process technology is a source of competitive advantage, then selling this technology through a turnkey project is also selling competitive advantage to potential and/or actual competitors.

LICENSING A licensing agreement is an arrangement whereby a licensor grants the rights to intangible property to another entity (the licensee) for a specified period, and in return, the licensor receives a royalty fee from the licensee.12 Intangible property includes patents, inventions, formulas, processes, designs, copyrights, and trademarks. For example, to enter the Japanese market, Xerox, inventor of the photocopier, established a joint venture with Fuji Photo that is known as Fuji Xerox. Xerox then licensed its xerographic know-how to Fuji Xerox. In return, Fuji Xerox paid Xerox a royalty fee equal to 5 percent of the net sales revenue that Fuji Xerox earned from the sales of photocopiers based on Xerox’s patented know-how. In the Fuji Xerox case, the license was originally granted for 10 years, and it has been renegotiated and extended several times since. The licensing agreement between Xerox and Fuji Xerox also limited Fuji Xerox’s direct sales to the Asian Pacific region (although Fuji Xerox does supply Xerox with photocopiers that are sold in North America under the Xerox label).13

Advantages In the typical international licensing deal, the licensee puts up most of the capital necessary to get the overseas operation going. Thus, a primary advantage of licensing is that the firm does not have to bear the development costs and risks associated with opening a foreign market. Licensing is very attractive for firms lacking the capital to develop operations overseas. In addition, licensing can be attractive when a firm is unwilling to commit substantial financial resources to an unfamiliar or politically volatile foreign market. Licensing is also often used when a firm wishes to participate in a foreign market but is prohibited from doing so by barriers to investment. This was one of the original reasons for the formation of the Fuji Xerox joint venture. Xerox wanted to participate in the Japanese market but was prohibited from setting up a wholly owned subsidiary by the Japanese government. So Xerox set up the joint venture with Fuji and then licensed its know-how to the joint venture.

Licensing Agreement

Arrangement in which a licensor grants the rights to intangible property to the licensee for a specified period and receives a royalty fee in return.

Finally, licensing is frequently used when a firm possesses some intangible property that might have business applications, but it does not want to develop those applications itself. For example, Bell Laboratories at AT& T originally invented the transistor circuit in the 1950s, but AT& T decided it did not want to produce transistors, so it licensed the technology to a number of other companies, such as Texas Instruments. Similarly, Coca-Cola has licensed its famous trademark to clothing manufacturers, which have incorporated the design into clothing.

Disadvantages Licensing has three serious drawbacks. First, it does not give a firm the tight control over manufacturing, marketing, and strategy that is required for realizing experience curve and location economies. Licensing typically involves each licensee setting up its own production operations. This severely limits the firm’s ability to realize experience curve and location economies by producing its product in a centralized location. When these economies are important, licensing may not be the best way to expand overseas.

Models walk the catwalk at Coca-Cola’s clothing show in Rio de Janeiro, Brazil. Coca-Cola has licensed its famous trademark to clothing manufacturers.

Second, competing in a global market may require a firm to coordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another. By its very nature, licensing limits a firm’s ability to do this. A licensee is unlikely to allow a multinational firm to use its profits (beyond those due in the form of royalty payments) to support a different licensee operating in another country.

A third problem with licensing is one that we encountered in Chapter 8 when we reviewed the economic theory of FDI. This is the risk associated with licensing technological know-how to foreign companies. Technological know-how constitutes the basis of many multinational firms’ competitive advantage. Most firms wish to maintain control over how their know-how is used, and a firm can quickly lose control over its technology by licensing it. Many firms have made the mistake of thinking they could maintain control over their know-how within the framework of a licensing agreement. RCA Corporation, for example, once licensed its color TV technology to Japanese firms including Matsushita and Sony. The Japanese firms quickly assimilated the technology, improved on it, and used it to enter the U.S. market, taking substantial market share away from RCA.

There are ways of reducing this risk. One way is by entering into a cross-licensing agreement with a foreign firm. Under a cross-licensing agreement, a firm might license some valuable intangible property to a foreign partner, but in addition to a royalty payment, the firm might also request that the foreign partner license some of its valuable knowhow to the firm. Such agreements are believed to reduce the risks associated with licensing technological know-how because the licensee realizes that if it violates the licensing contract (by using the knowledge obtained to compete directly with the licensor), the licensor can do the same to it. Cross-licensing agreements enable firms to hold each other hostage, which reduces the probability that they will behave Page 382opportunistically toward each other.14 Such cross-licensing agreements are increasingly common in high-technology industries.

Exporting or Licensing?

In Chapter 13, we discuss as series of advantages and disadvantages of exporting and licensing (as well as turnkey projects, franchising, joint ventures, and wholly owned subsidiaries as other entry mode choices). Exporting refers to the sale of products produced in one country to residents of another country. Licensing refers to an arrangement in which a licensor grants the rights to intangible property to the licensee for a specified period and receives a royalty fee in return. Both of these modes of entry into a foreign market have unique advantages and disadvantages. Oftentimes, selecting exporting or licensing depends on myriad factors—one being the global mindset of the business owner. Assume you have a choice to enter three emerging markets—Bolivia, Chile, and Peru, neighboring countries in South America. You have a great product, with lots of technological innovation and a lightweight packaging. Would you opt for exporting or licensing, and why?

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Another way of reducing the risk associated with licensing is to follow the Fuji Xerox model and link an agreement to license know-how with the formation of a joint venture in which the licensor and licensee take important equity stakes. Such an approach aligns the interests of licensor and licensee because both have a stake in ensuring that the venture is successful. Thus, the risk that Fuji Photo might appropriate Xerox’s technological knowhow, and then compete directly against Xerox in the global photocopier market, was reduced by the establishment of a joint venture in which both Xerox and Fuji Photo had an important stake.

FRANCHISING Franchising is similar to licensing, although franchising tends to involve longer-term commitments than licensing. Franchising is basically a specialized form of licensing in which the franchiser not only sells intangible property (normally a trademark) to the franchisee, but also insists that the franchisee agree to abide by strict rules as to how it does business. The franchiser will also often assist the franchisee to run the business on an ongoing basis. As with licensing, the franchiser typically receives a royalty payment, which amounts to some percentage of the franchisee’s revenues. Whereas licensing is pursued primarily by manufacturing firms, franchising is employed primarily by service firms.15 McDonald’s is a good example of a firm that has grown by using a franchising strategy. McDonald’s strict rules as to how franchisees should operate a restaurant extend to control over the menu, cooking methods, staffing policies, and design and location. McDonald’s also organizes the supply chain for its franchisees and provides management training and financial assistance.16

Advantages The advantages of franchising as an entry mode are very similar to those of licensing. The firm is relieved of many of the costs and risks of opening a foreign market on its own. Instead, the franchisee typically assumes those costs and risks. This creates a good incentive for the franchisee to build a profitable operation as quickly as possible. Thus, using a franchising strategy, a service firm can build a global presence quickly and at a relatively low cost and risk, as McDonald’s has.

Disadvantages The disadvantages of franchising are less pronounced than in the case of licensing. Because franchising is often used by service companies, there is no reason to consider the need for coordination of manufacturing to achieve experience curve and location economies. But franchising may inhibit the firm’s ability to take profits out of one country to support competitive attacks in another. A more significant disadvantage of franchising is quality control. The foundation of franchising arrangements is that the firm’s brand name conveys a message to consumers about the quality of the firm’s product. Thus, a business traveler checking in at a Four Seasons hotel in Hong Kong can reasonably expect the same quality of room, food, and service that she would receive in New York. The Four Seasons name is supposed to guarantee consistent product quality. This presents a problem in that foreign franchisees may not be as concerned about quality as they are supposed to be, and the result of poor quality can extend beyond lost sales in a particular foreign market to a decline in the firm’s worldwide reputation. For example, if the business traveler has a bad experience at the Four Seasons in Hong Kong, she may never go to another Four Seasons hotel and may urge her colleagues to do likewise. The geographical distance of the firm Page 383from its foreign franchisees can make poor quality difficult to detect. In addition, the sheer numbers of franchisees—in the case of McDonald’s, tens of thousands—can make quality control difficult. Due to these factors, quality problems may persist.

Franchising

A specialized form of licensing in which the franchiser sells intangible property to the franchisee and insists on rules to conduct the business.

So, You Think You Want to Own a Franchise?

Franchising is a specialized form of licensing in which the franchiser not only sells intangible property to the franchisee, but also insists that the franchisee agree to abide by strict rules as to how it does business. Some of the advantages of franchising include branding, advertising, reputation, and headquarters/ company support for development of the infrastructure needed to operate the franchise business. Some of the disadvantages of franchising include restrictions on territory and pricing, not being completely independent, franchise fee and ongoing royalty payments, and dependence on other franchise owners for nurturing the brand. Well-known worldwide franchise systems include Subway, 7-Eleven, Pizza Hut, and McDonald’s, for example. Assume you are interested in being an international entrepreneur. Would franchising be your choice of starting a business?

Source: T. Hult, D. Closs, and D. Frayer, Global Supply Chain Management: Leveraging Processes, Measurements, and Tools for Strategic Corporate Advantage (New York: McGraw-Hill Education, 2014).

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One way around this disadvantage is to set up a subsidiary in each country in which the firm expands. The subsidiary might be wholly owned by the company or a joint venture with a foreign company. The subsidiary assumes the rights and obligations to establish franchises throughout the particular country or region. McDonald’s, for example, establishes a master franchisee in many countries. Typically, this master franchisee is a joint venture between McDonald’s and a local firm. The proximity and the smaller number of franchises to oversee reduce the quality control challenge. In addition, because the subsidiary (or master franchisee) is at least partly owned by the firm, the firm can place its own managers in the subsidiary to help ensure that it is doing a good job of monitoring the franchises. This organizational arrangement has proven very satisfactory for McDonald’s, KFC, and others.

JOINT VENTURES A joint venture entails establishing a firm that is jointly owned by two or more otherwise independent firms. Fuji Xerox, for example, was set up as a joint venture between Xerox and Fuji Photo. Establishing a joint venture with a foreign firm has long been a popular mode for entering a new market. The most typical joint venture is a 50/50 venture, in which there are two parties, each of which holds a 50 percent ownership stake and contributes a team of managers to share operating control. This was the case with the Fuji–Xerox joint venture until 2001; it is now a 25/75 venture with Xerox holding 25 percent. GM’s successful joint venture in China with its Chinese partner, SAIC, was a 50/50 venture until 2010, which it became a 51/49 venture, with SAIC holding the 51 percent stake. Some firms, however, have sought joint ventures in which they have a majority share and thus tighter control.17

Joint Venture

Establishing a firm that is jointly owned by two or more otherwise independent firms.

Advantages Joint ventures have a number of advantages. First, a firm benefits from a local partner’s knowledge of the host country’s competitive conditions, culture, language, political systems, and business. Thus, for many U.S. firms, joint ventures have involved the U.S. company providing technological know-how and products and the local partner providing the marketing expertise and the local knowledge necessary for competing in that country. Second, when the development costs and/or risks of opening a foreign market are high, a firm might gain by sharing these costs and or risks with a local partner. Third, in many countries, political considerations make joint ventures the only feasible entry mode. Research suggests joint ventures with local partners face a low risk of being subject to nationalization or other forms of adverse government interference.18 This appears to be because local equity partners, who may have some influence on host-government policy, have a vested interest in speaking out against nationalization or government interference.

Disadvantages Despite these advantages, there are major disadvantages with joint ventures. First, as with licensing, a firm that enters into a joint venture risks giving control of its technology to its partner. Thus, a proposed joint venture in 2002 between Boeing and Mitsubishi Heavy Industries to build a new wide-body jet (the 787) raised fears that Boeing might unwittingly give away its commercial airline technology to the Japanese. However, joint-venture agreements can be constructed to minimize this risk. One option is to hold majority ownership in the venture. This allows the dominant partner to exercise greater control over its technology. But it can be difficult to find a foreign partner who is willing to settle for minority ownership. Another option is to “wall off” from a partner technology that is central to the core competence of the firm, while sharing other technology.

A second disadvantage is that a joint venture does not give a firm the tight control over subsidiaries that it might need to realize experience curve or location economies. Nor does it give a firm the tight control over a foreign subsidiary that it might need for engaging in coordinated global attacks against its rivals. Consider the entry of Texas Instruments (TI) into the Japanese semiconductor market. When TI established semiconductor facilities in Japan, it did so for the dual purpose of checking Japanese manufacturers’ market share and limiting their cash available for invading TI’s global market. In other words, TI was engaging in global Page 384strategic coordination. To implement this strategy, TI’s subsidiary in Japan had to be prepared to take instructions from corporate headquarters regarding competitive strategy. The strategy also required the Japanese subsidiary to run at a loss if necessary. Few if any potential joint-venture partners would have been willing to accept such conditions because it would have necessitated a willingness to accept a negative return on investment. Indeed, many joint ventures establish a degree of autonomy that would make such direct control over strategic decisions all but impossible to establish.19 Thus, to implement this strategy, TI set up a wholly owned subsidiary in Japan.

A third disadvantage with joint ventures is that the shared ownership arrangement can lead to conflicts and battles for control between the investing firms if their goals and objectives change or if they take different views as to what the strategy should be. This was apparently not a problem with the Fuji Xerox joint venture. According to Yotaro Kobayashi, the former chairman of Fuji Xerox, a primary reason is that both Xerox and Fuji Photo adopted an arm’s-length relationship with Fuji Xerox, giving the venture’s management considerable freedom to determine its own strategy.20 However, much research indicates that conflicts of interest over strategy and goals often arise in joint ventures. These conflicts tend to be greater when the venture is between firms of different nationalities, and they often end in the dissolution of the venture.21 Such conflicts tend to be triggered by shifts in the relative bargaining power of venture partners. For example, in the case of ventures between a foreign firm and a local firm, as a foreign partner’s knowledge about local market conditions increases, it depends less on the expertise of a local partner. This increases the bargaining power of the foreign partner and ultimately leads to conflicts over control of the venture’s strategy and goals.22 Some firms have sought to limit such problems 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 percent of the stock. Establishing a wholly owned subsidiary in a foreign market can be done two ways. The firm either can set up a new operation in that country, often referred to as a greenfield venture, or it can acquire an established firm in that host nation and use that firm to promote its products.23 For example, ING’s strategy for entering the U.S. insurance market was to acquire established U.S. enterprises, rather than try to build an operation from the ground floor.

Wholly Owned Subsidiary

A subsidiary in which the firm owns 100 percent of the stock.

Advantages There are several clear advantages of wholly owned subsidiaries. First, when a firm’s competitive advantage is based on technological competence, a wholly owned subsidiary will often be the preferred entry mode because it reduces the risk of losing control over that competence. (See Chapter 8 for more details.) Many high-tech firms prefer this entry mode for overseas expansion (e.g., firms in the semiconductor, electronics, and pharmaceutical industries). Second, a wholly owned subsidiary gives a firm tight control over operations in different countries. This is necessary for engaging in global strategic coordination (i.e., using profits from one country to support competitive attacks in another).

Third, a wholly owned subsidiary may be required if a firm is trying to realize location and experience curve economies (as firms pursuing global and transnational strategies try to do). As we saw in Chapter 12, when cost pressures are intense, it may pay a firm to configure its value chain in such a way that the value added at each stage is maximized. Thus, a national subsidiary may specialize in manufacturing only part of the product line or certain components of the end product, exchanging parts and products with other subsidiaries in the firm’s global system. Establishing such a global production system requires a high degree of control over the operations of each affiliate. The various operations must be prepared to accept centrally determined decisions as to how they will produce, how much they will produce, and how their output will be priced for transfer to the next operation. Because licensees or joint-venture partners are unlikely to accept such a subservient role, establishing wholly owned subsidiaries may be necessary. Finally, establishing a wholly owned subsidiary gives the firm a 100 percent share in the profits generated in a foreign market.

Page 385Disadvantage Establishing a wholly owned subsidiary is generally the most costly method of serving a foreign market from a capital investment standpoint. Firms doing this must bear the full capital costs and risks of setting up overseas operations. The risks associated with learning to do business in a new culture are less if the firm acquires an established host-country enterprise. However, acquisitions raise additional problems, including those associated with trying to marry divergent corporate cultures. These problems may more than offset any benefits derived by acquiring an established operation. Because the choice between greenfield ventures and acquisitions is such an important one, we shall discuss it in more detail later in the chapter.

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Selecting an Entry Mode

As the preceding discussion demonstrated, all the entry modes have advantages and disadvantages, as summarized in Table 13.1. Thus, trade-offs are inevitable when selecting an entry mode. For example, when considering entry into an unfamiliar country with a track record for discriminating against foreign-owned enterprises when awarding government contracts, a firm might favor a joint venture with a local enterprise. Its rationale might be that the local partner will help it establish operations in an unfamiliar environment and will help the company win government contracts. However, if the firm’s core competence is based on proprietary technology, entering a joint venture might risk losing control of that technology to the joint-venture partner, in which case the strategy may seem unattractive Despite the existence of such trade-offs, it is possible to make some generalizations about the optimal choice of entry mode.24

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Identify the factors that influence a firm’s choice of entry mode.

13.1 TABLE Advantages and Disadvantages of Entry Modes. Page 386

CORE COMPETENCIES AND ENTRY MODE We saw in Chapter 12 that firms often expand internationally to earn greater returns from their core competencies, transferring the skills and products derived from their core competencies to foreign markets where indigenous competitors lack those skills. The optimal entry mode for these firms depends to some degree on the nature of their core competencies. A distinction can be drawn between firms whose core competency is in technological know-how and those whose core competency is in management know-how.

Technological Know-How As was observed in Chapter 8, if a firm’s competitive advantage (its core competence) is based on control over proprietary technological knowhow, licensing and joint-venture arrangements should be avoided if possible to minimize the risk of losing control over that technology. Thus, if a high-tech firm sets up operations in a foreign country to profit from a core competency in technological know-how, it will probably do so through a wholly owned subsidiary. This rule should not be viewed as hard and fast, however. Sometimes a licensing or joint-venture arrangement can be structured to reduce the risk of licensees or joint-venture partners expropriating technological know-how. Another exception exists when a firm perceives its technological advantage to be only transitory, such as when it expects rapid imitation of its core technology by competitors. In such cases, the firm might want to license its technology as rapidly as possible to foreign firms to gain global acceptance for its technology before the imitation occurs.25 Such a strategy has some advantages. By licensing its technology to competitors, the firm may deter them from developing their own, possibly superior, technology. Further, by licensing its technology, the firm may establish its technology as the dominant design in the industry. This may ensure a steady stream of royalty payments. However, the attractions of licensing are frequently outweighed by the risks of losing control over technology, and if this is a risk, licensing should be avoided.

Management Know-How The competitive advantage of many service firms is based on management know-how (e.g., McDonald’s, Starbucks). For such firms, the risk of losing control over the management skills to franchisees or joint-venture partners is not that great. These firms’ valuable asset is their brand name, and brand names are generally well protected by international laws pertaining to trademarks. Given this, many of the issues arising in the case of technological know-how are of less concern here. As a result, many service firms favor a combination of franchising and subsidiaries to control the franchises within particular countries or regions. The subsidiaries may be wholly owned or joint ventures, but most service firms have found that joint ventures with local partners work best for the controlling subsidiaries. A joint venture is often politically more acceptable and brings a degree of local knowledge to the subsidiary.

PRESSURES FOR COST REDUCTIONS AND ENTRY MODE The greater the pressures for cost reductions are, the more likely a firm will want to pursue some combination of exporting and wholly owned subsidiaries. By manufacturing in those locations where factor conditions are optimal and then exporting to the rest of the world, a firm may be able to realize substantial location and experience curve economies. The firm might then want to export the finished product to marketing subsidiaries based in various countries. These subsidiaries will typically be wholly owned and have the responsibility for overseeing distribution in their particular countries. Setting up wholly owned marketing subsidiaries is preferable to joint-venture arrangements and to using foreign marketing agents because it gives the firm tight control that might be required for coordinating a globally dispersed value chain. It also gives the firm the ability to use the profits generated in one market to improve its competitive position in another market. In other words, firms pursuing global standardization or transnational strategies tend to prefer establishing wholly owned subsidiaries.

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Recognize the pros and cons of acquisitions versus greenfield ventures as an entry strategy.

Greenfield Venture or Acquisition?

Page 387A firm can establish a wholly owned subsidiary in a country by building a subsidiary from the ground up, the so-called greenfield strategy, or by acquiring an enterprise in the target market.26 The volume of cross-border acquisitions has been growing at a rapid rate for two decades. Over most of the past two decades, between 40 and 80 percent of all FDI inflows have been in the form of mergers and acquisitions.27

PROS AND CONS OF ACQUISITIONS Acquisitions have three major points in their favor. First, they are quick to execute. By acquiring an established enterprise, a firm can rapidly build its presence in the target foreign market. When the German automobile company Daimler-Benz decided it needed a bigger presence in the U.S. automobile market, it did not increase that presence by building new factories to serve the United States, a process that would have taken years. Instead, it acquired the no. 3 U.S. automobile company, Chrysler, and merged the two operations to form DaimlerChrysler (Daimler spun off Chrysler into a private equity firm in 2007). When the Spanish telecommunications service provider Telefónica wanted to build a service presence in Latin America, it did so through a series of acquisitions, purchasing telecommunications companies in Brazil and Argentina. In these cases, the firms made acquisitions because they knew that was the quickest way to establish a sizable presence in the target market.

Second, in many cases firms make acquisitions to preempt their competitors. The need for preemption is particularly great in markets that are rapidly globalizing, such as telecommunications, where a combination of deregulation within nations and liberalization of regulations governing cross-border foreign direct investment has made it much easier for enterprises to enter foreign markets through acquisitions. Such markets may see concentrated waves of acquisitions as firms race each other to attain global scale. In the telecommunications industry, for example, regulatory changes triggered what can be called a feeding frenzy, with firms entering each other’s markets via acquisitions to establish a global presence. These included the $56 billion acquisition of AirTouch Communications in the United States by the British company Vodafone, which was the largest acquisition ever; the $13 billion acquisition of One 2 One in Britain by the German company Deutsche Telekom; and the $6.4 billion acquisition of Excel Communications in the United States by Teleglobe of Canada, all of which occurred in 1998 and 1999.28 A similar wave of cross-border acquisitions occurred in the global automobile industry over the same time period, with Daimler acquiring Chrysler, Ford acquiring Volvo, and Renault acquiring Nissan.

Third, managers may believe acquisitions to be less risky than greenfield ventures. When a firm makes an acquisition, it buys a set of assets that are producing a known revenue and profit stream. In contrast, the revenue and profit stream that a greenfield venture might generate is uncertain because it does not yet exist. When a firm makes an acquisition in a foreign market, it not only acquires a set of tangible assets, such as factories, logistics systems, customer service systems, and so on, but it also acquires valuable intangible assets including a local brand name and managers’ knowledge of the business environment in that nation. Such knowledge can reduce the risk of mistakes caused by ignorance of the national culture.

Despite the arguments for making acquisitions, acquisitions often produce disappointing results.29 For example, a study by Mercer Management Consulting looked at 150 acquisitions worth more than $500 million each.30 The Mercer study concluded that 50 percent of these acquisitions eroded shareholder value, while another 33 percent created only marginal returns. Only 17 percent were judged to be successful. Similarly, a study by KPMG, an accounting and management consulting company, looked at 700 large acquisitions. The study found that while some 30 percent of these actually created value for the acquiring company, 31 percent destroyed value, and the remainder had little impact.31 A similar study by McKinsey & Company estimated that some 70 percent of mergers and acquisitions failed to achieve expected revenue synergies.32 In a seminal study of the post-acquisition performance of acquired companies, David Ravenscraft and Mike Scherer concluded that on average the Page 388profits and market shares of acquired companies declined following acquisition.33 They also noted that a smaller but substantial subset of those companies experienced traumatic difficulties, which ultimately led to their being sold by the acquiring company. Ravenscraft and Scherer’s evidence suggests that many acquisitions destroy rather than create value. While most research has looked at domestic acquisitions, the findings probably also apply to cross-border acquisitions.34

Why Do Acquisitions Fail? Acquisitions fail for several reasons. First, the acquiring firms often overpay for the assets of the acquired firm. The price of the target firm can get bid up if more than one firm is interested in its purchase, as is often the case. In addition, the management of the acquiring firm is often too optimistic about the value that can be created via an acquisition and is thus willing to pay a significant premium over a target firm’s market capitalization. This is called the “hubris hypothesis” of why acquisitions fail. The hubris hypothesis postulates that top managers typically overestimate their ability to create value from an acquisition, primarily because rising to the top of a corporation has given them an exaggerated sense of their own capabilities.35 For example, Daimler acquired Chrysler in 1998 for $40 billion, a premium of 40 percent over the market value of Chrysler before the takeover bid. Daimler paid this much because it thought it could use Chrysler to help it grow market share in the United States. At the time, Daimler’s management issued bold announcements about the “synergies” that would be created from combining the operations of the two companies. However, within a year of the acquisition, Daimler’s German management was faced with a crisis at Chrysler, which was suddenly losing money due to weak sales in the United States. In retrospect, Daimler’s management had been far too optimistic about the potential for future demand in the U.S. auto market and about the opportunities for creating value from “synergies.” Daimler acquired Chrysler at the end of a multiyear boom in U.S. auto sales and paid a large premium over Chrysler’s market value just before demand slumped (and in 2007, in an admission of failure, Daimler sold its Chrysler unit to a private equity firm).36

Second, many acquisitions fail because there is a clash between the cultures of the acquiring and acquired firms. After an acquisition, many acquired companies experience high management turnover, possibly because their employees do not like the acquiring company’s way of doing things.37 This happened at DaimlerChrysler; many senior managers left Chrysler in the first year after the merger. Apparently, Chrysler executives disliked the dominance in decision making by Daimler’s German managers, while the Germans resented that Chrysler’s American managers were paid two to three times as much as their German counterparts. These cultural differences created tensions, which ultimately exhibited themselves in high management turnover at Chrysler.38 The loss of management talent and expertise can materially harm the performance of the acquired unit.39 This may be particularly problematic in an international business, where management of the acquired unit may have valuable local knowledge that can be difficult to replace.

Third, many acquisitions fail because attempts to realize gains by integrating the operations of the acquired and acquiring entities often run into roadblocks and take much longer than forecast. Differences in management philosophy and company culture can slow the integration of operations. Differences in national culture may exacerbate these problems. Bureaucratic haggling between managers also complicates the process. Again, this reportedly occurred at DaimlerChrysler, where grand plans to integrate the operations of the two companies were bogged down by endless committee meetings and by simple logistical considerations such as the six-hour time difference between Detroit and Germany. By the time an integration plan had been worked out, Chrysler was losing money, and Daimler’s German managers suddenly had a crisis on their hands.

Finally, many acquisitions fail due to inadequate pre-acquisition screening.40 Many firms decide to acquire other firms without thoroughly analyzing the potential benefits and costs. They often move with undue haste to execute the acquisition, perhaps because they fear another competitor may preempt them. After the acquisition, however, many acquiring firms discover that instead of buying a well-run business, they have purchased a troubled organization. This may be a particular problem in cross-border acquisitions because the acquiring firm may not fully understand the target firm’s national culture and business system. For example, in 2011 Hewlett-Packard acquired the British information technology company Autonomy for $11 billion. A year later, the company admitted that Autonomy was both less profitable and smaller than it had realized and wrote down the value of Autonomy by $8.8 billion. HP subsequently claimed that senior managers at Autonomy were engaged in systematic accounting fraud and had overstated the revenues of their business in order to close a sale to HP. Be this as it may, HP’s failure to see problems prior to the acquisition raises serious questions about its diligence processes.41

Reducing the Risks of Failure These problems can all be overcome if the firm is careful about its acquisition strategy.42 Screening of the foreign enterprise to be acquired, including a detailed auditing of operations, financial position, and management culture, can help to make sure the firm (1) does not pay too much for the acquired unit, (2) does not uncover any nasty surprises after the acquisition, and (3) acquires a firm whose organization culture is not antagonistic to that of the acquiring enterprise. It is also important for the acquirer to allay any concerns that management in the acquired enterprise might have. The objective should be to reduce unwanted management attrition after the acquisition. Finally, managers must move rapidly after an acquisition to put an integration plan in place and to act on that plan. Some people in both the acquiring and acquired units will try to slow or stop any integration efforts, particularly when losses of employment or management power are involved, and managers should have a plan for dealing with such impediments before they arise.

PROS AND CONS OF GREENFIELD VENTURES The big advantage of establishing a greenfield venture in a foreign country is that it gives the firm a much greater ability to build the kind of subsidiary company that it wants. For example, it is much easier to build an organization culture from scratch than it is to change the culture of an acquired unit. Similarly, it is much easier to establish a set of operating routines in a new subsidiary than it is to convert the operating routines of an acquired unit. This is a very important advantage for many international businesses, where transferring products, competencies, skills, and know-how from the established operations of the firm to the new subsidiary are principal ways of creating value. For example, when Lincoln Electric, the U.S. manufacturer of arc welding equipment, first ventured overseas in the mid-1980s, it did so by acquisitions, purchasing arc welding equipment companies in Europe. However, Lincoln’s competitive advantage in the United States was based on a strong organizational culture and a unique set of incentives that encouraged its employees to do everything possible to increase productivity. Lincoln found through bitter experience that it was almost impossible to transfer its organizational culture and incentives to acquired firms, which had their own distinct organizational cultures and incentives. As a result, the firm switched its entry strategy in the mid-1990s and began to enter foreign countries by establishing greenfield ventures, building operations from the ground up. While this strategy takes more time to execute, Lincoln has found that it yields greater long-run returns than the acquisition strategy.

Set against this significant advantage are the disadvantages of establishing a greenfield venture. Greenfield ventures are slower to establish. They are also risky. As with any new venture, a degree of uncertainty is associated with future revenue and profit prospects. However, if the firm has Page 390already been successful in other foreign markets and understands what it takes to do business in other countries, these risks may not be that great. For example, having already gained great knowledge about operating internationally, the risk to McDonald’s of entering yet another country is probably not that great. Also, greenfield ventures are less risky than acquisitions in the sense that there is less potential for unpleasant surprises. A final disadvantage is the possibility of being preempted by more aggressive global competitors who enter via acquisitions and build a big market presence that limits the market potential for the greenfield venture.

How Risky Would Indonesia Be for a New Greenfield Investment?

Business is all about risk, the right risks. Choosing which risks to accept and which to avoid is at the heart of international business. These risks increase and become more interesting with entry into foreign markets. David Conklin discusses the idea of managing risk through planned uncertainty. By “planned uncertainty,” he means an awareness of contingencies, with possible what-if scenarios developed in advance. The key idea here is that through an ongoing monitoring of the various risk areas, decision makers can have much of the data they may need to address a number of possible outcomes. Of course, we have to know what uncertainty to plan for, and we don’t know what we don’t know. Planning for everything is impossible, but what Conklin suggests is that planned uncertainty is a way of thinking. Given that we don’t know the future, this way of thinking may be helpful in career development and other parts of our lives. Who ever said business wasn’t like surfing? So, as just one country example, how big do you think the risk is by entering Indonesia with a new greenfield investment?

Source: D. Conklin, “Analyzing and Managing Country Risks,” Ivey Business Journal: Improving the Practice of Management, January/February, 1992. Also, see “Indices” for countries on globalEDGE.msu.edu (e.g., for Indonesia, globaledge.msu.edu/countries/indonesia/indices).

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GREENFIELD VENTURE OR ACQUISITION? The choice between acquisitions and greenfield ventures is not an easy one. Both modes have their advantages and disadvantages. In general, the choice will depend on the circumstances confronting the firm. If the firm is seeking to enter a market where there are already well-established incumbent enterprises, and where global competitors are also interested in establishing a presence, it may pay the firm to enter via an acquisition. In such circumstances, a greenfield venture may be too slow to establish a sizable presence. However, if the firm is going to make an acquisition, its management should be cognizant of the risks associated with acquisitions that were discussed earlier and consider these when determining which firms to purchase. It may be better to enter by the slower route of a greenfield venture than to make a bad acquisition.

If the firm is considering entering a country where there are no incumbent competitors to be acquired, then a greenfield venture may be the only mode. Even when incumbents exist, if the competitive advantage of the firm is based on the transfer of organizationally embedded competencies, skills, routines, and culture, it may still be preferable to enter via a greenfield venture. Things such as skills and organizational culture, which are based on significant knowledge that is difficult to articulate and codify, are much easier to embed in a new venture than they are in an acquired entity, where the firm may have to overcome the established routines and culture of the acquired firm. Thus, as our earlier examples suggest, firms such as McDonald’s and Lincoln Electric prefer to enter foreign markets by establishing greenfield ventures.

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Key Terms

timing of entry

first-mover advantages

first-mover disadvantages

pioneering costs

exporting

turnkey project

licensing agreement

franchising

joint venture

wholly owned subsidiary

Summary

The chapter made the following points:

1. Basic entry decisions include identifying which markets to enter, when to enter those markets, and on what scale.

2. The most attractive foreign markets tend to be found in politically stable developed and developing nations that have free market systems and where there is no dramatic upsurge in either inflation rates or private-sector debt.

3. There are several advantages associated with entering a national market early, before other international businesses have established themselves. These advantages must be balanced against the pioneering costs that early entrants often have to bear, including the greater risk of business failure.

4. Large-scale entry into a national market constitutes a major strategic commitment that is likely to change the nature of competition in that market and limit the entrant’s future strategic flexibility. Although making major strategic commitments can yield many benefits, there are also risks associated with such a strategy.

Page 3915. There are six modes of entering a foreign market: exporting, creating turnkey projects, licensing, franchising, establishing joint ventures, and setting up a wholly owned subsidiary.

6. Exporting has the advantages of facilitating the realization of experience curve economies and of avoiding the costs of setting up manufacturing operations in another country. Disadvantages include high transport costs, trade barriers, and problems with local marketing agents.

7. Turnkey projects allow firms to export their process know-how to countries where FDI might be prohibited, thereby enabling the firm to earn a greater return from this asset. The disadvantage is that the firm may inadvertently create efficient global competitors in the process.

8. The main advantage of licensing is that the licensee bears the costs and risks of opening a foreign market. Disadvantages include the risk of losing technological know-how to the licensee and a lack of tight control over licensees.

9. The main advantage of franchising is that the franchisee bears the costs and risks of opening a foreign market. Disadvantages center on problems of quality control of distant franchisees.

10. Joint ventures have the advantages of sharing the costs and risks of opening a foreign market and of gaining local knowledge and political influence. Disadvantages include the risk of losing control over technology and a lack of tight control.

11. The advantages of wholly owned subsidiaries include tight control over technological know-how. The main disadvantage is that the firm must bear all the costs and risks of opening a foreign market.

12. The optimal choice of entry mode depends on the firm’s strategy. When technological know-how constitutes a firm’s core competence, wholly owned subsidiaries are preferred because they best control technology. When management know-how constitutes a firm’s core competence, foreign franchises controlled by joint ventures seem to be optimal. When the firm is pursuing a global standardization or transnational strategy, the need for tight control over operations to realize location and experience curve economies suggests wholly owned subsidiaries are the best entry mode.

13. When establishing a wholly owned subsidiary in a country, a firm must decide whether to do so by a greenfield venture strategy or by acquiring an established enterprise in the target market.

14. Acquisitions are quick to execute, may enable a firm to preempt its global competitors, and involve buying a known revenue and profit stream. Acquisitions may fail when the acquiring firm overpays for the target, when the cultures of the acquiring and acquired firms clash, when there is a high level of management attrition after the acquisition, and when there is a failure to integrate the operations of the acquiring and acquired firm.

15. The advantage of a greenfield venture in a foreign country is that it gives the firm a much greater ability to build the kind of subsidiary company that it wants. For example, it is much easier to build an organization culture from scratch than it is to change the culture of an acquired unit.

Critical Thinking and Discussion Questions

1. Review the Management Focus on Tesco. Then answer the following questions:

a. Why did Tesco’s initial international expansion strategy focus on developing nations?

b. How does Tesco create value in its international operations?

c. In Asia, Tesco has a history of entering into joint-venture agreements with local partners. What are the benefits of doing this for Tesco? What are the risks? How are those risks mitigated?

d. In March 2006, Tesco announced it would enter the United States. This represented a departure from its historic strategy of focusing on developing nations. Why do you think Tesco made this decision? How is the U.S. market different from others Tesco has entered? What are the risks here?

2. Licensing proprietary technology to foreign competitors is the best way to give up a firm’s competitive advantage. Discuss.

3. Discuss how the need for control over foreign operations varies with firms’ strategies and core competencies. What are the implications for the choice of entry mode?

4. A small Canadian firm that has developed valuable new medical products using its unique biotechnology knowhow is trying to decide how best to serve the European Union market. Its choices are given on the next page. The cost of investment in manufacturing facilities will be a major one for the Canadian firm, but it is not outside its reach. If these are the firm’s only options, which one would you advise it to choose? Why?

• Manufacture the products at home and let foreign sales agents handle marketing.

• Manufacture the products at home and set up a wholly owned subsidiary in Europe to handle marketing.

• Enter into an alliance with a large European pharmaceutical firm. The products would be manufactured in Europe by the 50/50 joint venture and marketed by the European firm.

images Research Task http://globalEDGE.msu.edu

Use the globalEDGE website (globaledge.msu.edu) to complete the following exercises:

1. A vital element in a successful international market entry strategy is an appropriate fit of skills and capabilities between partners. As such, the Entrepreneur magazine annually publishes a ranking of the “Top Global Franchises.” Provide a list of the top 10 companies that pursue franchising as a mode of international expansion. Study one of these companies in detail, and provide a description of its business model, its international expansion pattern, desirable qualifications in possible franchisees, and the support and training typically provided by the franchiser. Are there areas where improvement can be made for the company to maintain competitiveness? Provide sufficient justification for your position.

2. The U.S. Commercial Service prepares reports known as the “Country Commercial Guide” for countries of interest to U.S. investors. Utilize the Country Commercial Guide for Russia to gather information on this country’s energy and mining industry. Considering that your company has plans to enter Russia in the foreseeable future, select the most appropriate entry method. Be sure to support your decision with the information collected.

images JCB in India closing case

JCB, the venerable British manufacturer of construction equipment, has long been a relatively small player in a global market that is dominated by the likes of Caterpillar and Komatsu, but there is one exception to this: India. While the company is present in 150 countries, of the 69,100 machines it sold globally in 2012, around a third were in India. For JCB, India is truly the jewel in the crown.

The story of JCB in India dates back to 1979 when the company entered into a joint venture with Escorts, an Indian engineering conglomerate, to manufacture backhoe loaders for sale in India. Escorts held a majority 60 percent stake in the venture, and JCB 40 percent. The joint venture was a first for JCB, which historically had exported as much as two-thirds of its production from Britain to a wide range of nations. However, high tariff barriers made direct exports to India difficult.

JCB would probably have preferred to go it alone in India, but government regulations at the time required foreign investors to create joint ventures with local companies. JCB believed the Indian construction market was ripe for growth and could become very large. The company’s managers believed that it was better to get a foothold in the nation, thereby gaining an advantage over global competitors, rather than wait until the growth potential was realized.

By the end of the 1990s the joint venture was selling some 2,000 backhoes in India and had an 80 percent share of the Indian market. After years of deregulation, the Indian economy was booming. However, JCB felt that the joint venture limited its ability to expand. For one thing, much of JCB’s global success was based upon the utilization of leading-edge manufacturing technologies and relentless product innovation, but the company was very hesitant about transferring this know-how to a venture where it did not have a majority stake and therefore lacked control. The last thing JCB wanted was for these valuable technologies to leak out of the joint venture into Escorts, which was one of the largest manufacturers of tractors in India and might conceivably become a direct competitor in Page 393the future. Moreover, JCB was unwilling to make the investment in India required to take the joint venture to the next level unless it could capture more of the long-run returns.

Tradition meets the new as a camel-drawn cart moves past a backhoe awaiting transportation outside a JCB factory in Faridabad, India.

In 1999, JCB took advantages of changes in government regulations to renegotiate the terms of the venture with Escorts, purchasing 20 percent of its partner’s equity to give JCB majority control. In 2003, JCB took this to its logical end when it responded to further relaxation of government regulations on foreign investment to purchase all of Escorts’ remaining equity, transforming the joint venture into a wholly owned subsidiary.

Having gained full control, in early 2005 JCB increased its investment in India, announcing it would build a second factory in Pune that it would use to serve the Indian market. In 2007, in what represented a bold bet on future demand in the Indian market in the face of a global economic slowdown, JCB embarked on a major overhaul and expansion of its original India factory in Ballabgarh. To sell the additional Indian output, JCB rapidly expanded its dealer network, doubling the number of outlets in six years to reach 400 by 2011. The company also localized production for more than 80 percent of the parts used in its best-selling backhoe loader. This was done both to keep costs low and to make sure dealers had immediate access to spare parts. The strategy worked; between 2001 and 2012 JCB’s Indian revenues increased tenfold, and the company is now the leading manufacturer of backhoes in the country.

Sources: P. Marsh, “Partnerships Feel the Indian Heat, ” Financial Times, June 22, 2006, p. 11; P. Marsh, “JCB Targets Asia to Spread Production,” Financial Times, March 16, 2005, p. 26; D. Jones, “Profits Jump at JCB,” Daily Post, June 20, 2006, p. 21; R. Bentley, “Still Optimistic about Asia,” Asian Business Review, October 1, 1999, p. 1; “JCB Launches India-Specific Heavy Duty Crane,” The Hindu, October 18, 2008; P. M. Thomas, “JCB Hits Pay Dirt in India,” Forbes.com, December 6, 2011; and J. Moulds, “JCB Unearths Record Sales and Profits,” The Guardian, April 17, 2012.

CASE DISCUSSION QUESTIONS

1. Why do you think that India was an attractive market for JCB?

2. Historically, JCB entered foreign markets through exports. Why do you think JCB generally favored exports?

3. In India, JCB decided to enter via a joint venture. What was the articulated rational for this? In what other ways might the joint venture strategy have benefited JCB?

4. What were the risks associated with the joint venture strategy? How did JCB deal with these risks?

5. What are the benefits to JCB of localizing significant production in India? What are the disadvantages? Do the benefits outweigh the disadvantages?

Endnotes

1. For interesting empirical studies that deal with the issues of timing and resource commitments, see T. Isobe, S. Makino, and D. B. Montgomery, “Resource Commitment, Entry Timing, and Market Performance of Foreign Direct Investments in Emerging Economies,” Academy of Management Journal 43, no. 3 (2000), pp. 468–84; and Y. Pan and P. S. K. Chi, “Financial Performance and Survival of Multinational Corporations in China,” Strategic Management Journal 20, no. 4 (1999), pp. 359–74. A complementary theoretical perspective on this issue can be found in V. Govindarjan and A. K. Gupta, The Quest for Global Dominance (San Francisco: Jossey-Bass, 2001). Also see F. Vermeulen and H. Barkeme, “Pace, Rhythm and Scope: Process Dependence in Building a Profitable Multinational Corporation,” Strategic Management Journal 23 (2002), pp. 637–54.

2. This can be reconceptualized as the resource base of the entrant, relative to indigenous competitors. For work that focuses on this issue, see W. C. Bogner, H. Thomas, and J. McGee, “A Longitudinal Study of the Competitive Positions and Entry Paths of European Firms in the U.S. Pharmaceutical Market,” Strategic Management Journal 17 (1996), pp. 85–107; D. Collis, “A Resource-Based Analysis of Global Competition,” Strategic Management Journal 12 (1991), pp. 49–68; and S. Tallman, “Strategic Management Models and Resource-Based Strategies among MNEs in a Host Market,” Strategic Management Journal 12 (1991), pp. 69–82.

3. For a discussion of first-mover advantages, see M. Lieberman and D. Montgomery, “First-Mover Advantages,” Strategic Management Journal 9 (Summer Special Issue, 1988), pp. 41–58.

4. J. M. Shaver, W. Mitchell, and B. Yeung, “The Effect of Own Firm and Other Firm Experience on Foreign Direct Investment Survival in the United States, 1987–92,” Strategic Management Journal 18 (1997), pp. 811–24.

5. S. Zaheer and E. Mosakowski, “The Dynamics of the Liability of Foreignness: A Global Study of Survival in the Financial Services Industry,” Strategic Management Journal 18 (1997), pp. 439–64.

6. Shaver, Mitchell, and Yeung, “The Effect of Own Firm and Other Firm Experience on Foreign Direct Investment Survival in the United States.”

7. P. Ghemawat, Commitment: The Dynamics of Strategy (New York: Free Press, 1991).

8. R. Luecke, Scuttle Your Ships before Advancing (Oxford: Oxford University Press, 1994).

9. Isobe, Makino, and Montgomery, “Resource Commitment, Entry Timing, and Market Performance”; Pan and Chi, “Financial Performance and Survival of Multinational Corporations in China”; and Govindarjan and Gupta, The Quest for Global Dominance.

10. Christopher Bartlett and Sumantra Ghoshal, “Going Global: Lessons from Late Movers,” Harvard Business Review, March– April 2000, pp. 132–45.

11. This section draws on numerous studies, including C. W. L. Hill, P. Hwang, and W. C. Kim, “An Eclectic Theory of the Choice of International Entry Mode,” Strategic Management Journal 11 (1990), pp. 117–28; C. W. L. Hill and W. C. Kim, “Searching for a Dynamic Theory of the Multinational Page 394Enterprise: A Transaction Cost Model,” Strategic Management Journal 9 (Special Issue on Strategy Content, 1988), pp. 93–104; E. Anderson and H. Gatignon, “Modes of Foreign Entry: A Transaction Cost Analysis and Propositions,” Journal of International Business Studies 17 (1986), pp. 1–26; F. R. Root, Entry Strategies for International Markets (Lexington, MA: D. C. Heath, 1980); A. Madhok, “Cost, Value and Foreign Market Entry: The Transaction and the Firm,” Strategic Management Journal 18 (1997), pp. 39–61; K. D. Brouthers and L. B. Brouthers, “Acquisition or Greenfield Start-Up?” Strategic Management Journal 21, no. 1 (2000), pp. 89–97; X. Martin and R. Salmon, “Knowledge Transfer Capacity and Its Implications for the Theory of the Multinational Enterprise,” Journal of International Business Studies, July 2003, p. 356; and A. Verbeke, “The Evolutionary View of the MNE and the Future of Internalization Theory,” Journal of International Business Studies, November 2003, pp. 498–515.

12. For a general discussion of licensing, see F. J. Contractor, “The Role of Licensing in International Strategy,” Columbia Journal of World Business, Winter 1982, pp. 73–83.

13. See E. Terazono and C. Lorenz, “An Angry Young Warrior,” Financial Times, September 19, 1994, p. 11; and K. McQuade and B. Gomes-Casseres, “Xerox and Fuji-Xerox,” Harvard Business School Case No. 9-391-156. Harvard University Press in Cambridge, MA.

14. O. E. Williamson, The Economic Institutions of Capitalism (New York: Free Press, 1985).

15. J. H. Dunning and M. McQueen, “The Eclectic Theory of International Production: A Case Study of the International Hotel Industry,” Managerial and Decision Economics 2 (1981), pp. 197–210.

16. Andrew E. Serwer, “McDonald’s Conquers the World,” Fortune, October 17, 1994, pp. 103–16.

17. For an excellent review of the basic theoretical literature of joint ventures, see B. Kogut, “Joint Ventures: Theoretical and Empirical Perspectives,” Strategic Management Journal 9 (1988), pp. 319–32. More recent studies include T. Chi, “Option to Acquire or Divest a Joint Venture,” Strategic Management Journal 21, no. 6 (2000), pp. 665–88; H. Merchant and D. Schendel, “How Do International Joint Ventures Create Shareholder Value?” Strategic Management Journal 21, no. 7 (2000), pp. 723–37; H. K. Steensma and M. A. Lyles, “Explaining IJV Survival in a Transitional Economy though Social Exchange and Knowledge Based Perspectives,” Strategic Management Journal 21, no. 8 (2000), pp. 831–51; and J. F. Hennart and M. Zeng, “Cross Cultural Differences and Joint Venture Longevity,” Journal of International Business Studies, December 2002, pp. 699–717.

18. D. G. Bradley, “Managing against Expropriation,” Harvard Business Review, July–August 1977, pp. 78–90.

19. J. A. Robins, S. Tallman, and K. Fladmoe-Lindquist, “Autonomy and Dependence of International Cooperative Ventures,” Strategic Management Journal, October 2002, pp. 881–902.

20. Speech given by Tony Kobayashi at the University of Washington Business School, October 1992.

21. A. C. Inkpen and P. W. Beamish, “Knowledge, Bargaining Power, and the Instability of International Joint Ventures,” Academy of Management Review 22 (1997), pp. 177–202; and S. H. Park and G. R. Ungson, “The Effect of National Culture, Organizational Complementarity, and Economic Motivation on Joint Venture Dissolution,” Academy of Management Journal 40 (1997), pp. 279–307.

22. Inkpen and Beamish, “Knowledge, Bargaining Power, and the Instability of International Joint Ventures.”

23. See Brouthers and Brouthers, “Acquisition or Greenfield Start-Up?”; and J. F. Hennart and Y. R. Park, “Greenfield versus Acquisition: The Strategy of Japanese Investors in the United States,” Management Science, 1993, pp. 1054–70.

24. This section draws on Hill, Hwang, and Kim, “An Eclectic Theory of the Choice of International Entry Mode.”

25. C. W. L. Hill, “Strategies for Exploiting Technological Innovations: When and When Not to License,” Organization Science 3 (1992), pp. 428–41.

26. See Brouthers and Brouthers, “Acquisition or Greenfield Start-Up?”; and J. Anand and A. Delios, “Absolute and Relative Resources as Determinants of International Acquisitions,” Strategic Management Journal, February 2002, pp. 119–34.

27. United Nations, World Investment Report, 2010 (New York and Geneva: United Nations, 2010).

28. Ibid.

29. For evidence on acquisitions and performance, see R. E. Caves, “Mergers, Takeovers, and Economic Efficiency,” International Journal of Industrial Organization 7 (1989), pp. 151–74; M. C. Jensen and R. S. Ruback, “The Market for Corporate Control: The Scientific Evidence,” Journal of Financial Economics 11 (1983), pp. 5–50; R. Roll, “Empirical Evidence on Takeover Activity and Shareholder Wealth,” in Knights, Raiders and Targets, ed. J. C. Coffee, L. Lowenstein, and S. Rose (Oxford: Oxford University Press, 1989); A. Schleifer and R. W. Vishny, “Takeovers in the 60s and 80s: Evidence and Implications,” Strategic Management Journal 12 (Winter 1991 Special Issue), pp. 51–60; T. H. Brush, “Predicted Changes in Operational Synergy and Post-Acquisition Performance of Acquired Businesses,” Strategic Management Journal 17 (1996), pp. 1–24; and A. Seth, K. P. Song, and R. R. Pettit, “Value Creation and Destruction in Cross-Border Acquisitions,” Strategic Management Journal 23 (October 2002), pp. 921–40.

30. J. Warner, J. Templeman, and R. Horn, “The Case against Mergers,” BusinessWeek, October 30, 1995, pp. 122–34.

31. “Few Takeovers Pay Off for Big Buyers,” Investor’s Business Daily, May 25, 2001, p. 1.

32. S. A. Christofferson, R. S. McNish, and D. L. Sias, “Where Mergers Go Wrong,” The McKinsey Quarterly 2 (2004), pp. 92–110.

33. D. J. Ravenscraft and F. M. Scherer, Mergers, Selloffs, and Economic Efficiency (Washington, DC: Brookings Institution, 1987).

Page 39534. See P. Ghemawat and F. Ghadar, “The Dubious Logic of Global Mega-Mergers,” Harvard Business Review, July–August 2000, pp. 65–72.

35. R. Roll, “The Hubris Hypothesis of Corporate Takeovers,” Journal of Business 59 (1986), pp. 197–216.

36. “Marital Problems,” The Economist, October 14, 2000.

37. See J. P. Walsh, “Top Management Turnover Following Mergers and Acquisitions,” Strategic Management Journal 9 (1988), pp. 173–83.

38. B. Vlasic and B. A. Stertz, Taken for a Ride: How Daimler-Benz Drove Off with Chrysler (New York: HarperCollins, 2000).

39. See A. A. Cannella and D. C. Hambrick, “Executive Departure and Acquisition Performance,” Strategic Management Journal 14 (1993), pp. 137–52.

40. P. Haspeslagh and D. Jemison, Managing Acquisitions (New York: Free Press, 1991).

41. V. Aggarwal, “HP Was Aware of Autonomy’s Loss Making Hardware Sales,” Reuters, February 18, 2014.

42. P. Haspeslagh and D. Jemison, Managing Acquisitions (New York: Free Press, 1991).

Exporting, Importing, and Countertrade

Growing Through Exports

opening case

It is a little know fact that small firms comprise the majority of U.S. exporters. Business with fewer than 500 employees made up 97 percent of all U.S. exporters in 2012 according the U.S. Census Bureau. These small businesses generated $460 billion in foreign sales in 2012, an increase of $10 billion over 2011. In total, companies with less than 500 employees accounted for 34 percent of all U.S. exports by value in 2012. Despite this, there is still significant room for growth. Only about 5 percent of small businesses actually export.

One company that has illustrated the power of exporting for a small business is Sono-Tek Corp, a developer of ultrasonic spray coating technology in Milton, New York. Sono-Tek’s primary overseas customers include contract manufacturers for electronic and medical equipment firms. Some $6 million of Sono-Tek’s annual revenues now come from exports to customers in Europe, Southeast Asia, and Latin America. Sono-Tek’s CEO, Chris Coccio, believes that without exporting the company would be one-third of its current size.

Another New York company, Vision Quest Lighting, has had a similar experience. Vision Quest Lighting, which has around 30 employees, makes decorative lighting for retail chains, including Limited Brands, Ann Taylor, and Abercrombie and Fitch. As these brands expanded their international presence, Vision Quest Lighting grew with them. According to the company’s management, its international exposure helped the company to survive in the recessionary years of 2008–2009 when demand in the United States was very soft. Looking forward, Vision Quest Lighting sees great growth opportunities in China, where it has recently established a factory to produce products for the local market.

Both of these companies have found exporting to be challenging. Sono-Tek’s Chris Coccio notes that his biggest worries include recruiting foreign staff that understand the local market, the costs of business travel, problems associated with communicating with far-flung clients, and getting paid. He is not alone in this last worry. According to the Small Business Exporters Association, getting paid can be a major headache. In a recent survey conducted by the Association, 41 percent of respondents indicated that they worried about getting paid. The association urges small exporters to work with banks and to make sure Page 398that they get letters of credit from foreign importers before shipping goods or performing services.

At Vision Quest Lighting, management notes that being successfully requires a bilingual agent or foreign employee who understands the business system, lives in country, and can help the foreign company to navigate its way through a culturally challenging environment. There is no substitute, according to the company, for someone with his or her feet on the ground who understands the local business culture. In Vision Quests’ case, for example, their business in China did not start to take off until they hired a local Chinese employee. images

Sources: R. Colvin, “The Cost of Expanding Overseas,” The Wall Street Journal, February 26, 2014; John Grossman, “New Path for Trade: Selling in China,” The New York Times, January 23, 2013; and N. Levy, “LI Lighting Firm Learns the Ropes in China,” Newsday, October 20, 2013.

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Introduction

The previous chapter reviewed exporting from a strategic perspective. We considered exporting as just one of a range of strategic options for profiting from international expansion. This chapter is more concerned with the nuts and bolts of exporting (and importing). It looks at how to export. As the opening case makes clear, exporting is not just for large enterprises; many small firms such as Sono-Tek and Vision Quest Lighting have benefited significantly from the moneymaking opportunities of exporting.

The volume of export activity in the world economy has increased as exporting has become easier. The gradual decline in trade barriers under the umbrella of GATT and now the WTO (see Chapter 7) along with regional economic agreements such as the European Union and the North American Free Trade Agreement (see Chapter 9) have significantly increased export opportunities. At the same time, modern communication and transportation technologies have alleviated the logistical problems associated with exporting. Over the last two decades firms have increasingly used the Internet, toll-free phone numbers, and international air express services to reduce the costs of exporting. Consequently, it is not unusual to find thriving exporters among small companies.

Nevertheless, exporting remains a challenge for many firms. Smaller enterprises can find the process intimidating. The firm wishing to export must identify foreign market opportunities, avoid a host of unanticipated problems that are often associated with doing business in a foreign market, familiarize itself with the mechanics of export and import financing, learn where it can get financing and export credit insurance, and learn how it should deal with foreign exchange risk. The process can be made more problematic by currencies that are not freely convertible. Arranging payment for exports to countries with weak currencies can be a problem. Countertrade allows payment for exports to be made through goods and services rather than money. This chapter discusses all these issues with the exception of foreign exchange risk, which was covered in Chapter 10. The chapter opens by considering the promise and pitfalls of exporting.

images LO 14-1

Explain the promises and risks associated with exporting.

The Promise and Pitfalls of Exporting

The great promise of exporting is that large revenue and profit opportunities are to be found in foreign markets for most firms in most industries. This was true for both Sono-Tek Corp. and Vision Quest Lighting in the opening case. The international market is normally so much larger than the firm’s domestic market that exporting is nearly always a way to increase the revenue and profit base of a company. By expanding the size of the market, exporting can enable a firm to achieve economies of scale, thereby lowering its unit costs. Firms that do not export often lose out on significant opportunities for growth and cost reduction.1

Page 399images Export Tutorials

Exporting, importing, and countertrade are the focus areas of Chapter 14. The exporting entry mode choice, also discussed in Chapter 13, is the most often used way to conduct cross-border trade for companies. The vast majority of small and medium-sized enterprises, for example, use exporting as their way to expand to international markets. But that begs the question of whether the company is ready to export and whether the product the company plans to export is ready to be exported. The “Export Tutorials” section of globalEDGE (http://globaledge.msu.edu/reference-desk/export-tutorials) includes CORE as a diagnostic tool to assess “company readiness to export.” The Export Tutorial section also has a lengthy set of questions and answers to the most common exporting-related questions in the categories of government regulations, financial considerations, sales and marketing, and logistics. For example, one question deals with whether a company needs a license to export. Assume you are based in the United States. How can you identify the relevant commodity jurisdiction for a product?

Consider the case of Marlin Steel Wire Products, a Baltimore manufacturer of wire baskets and fabricated metal items with revenues of about $5 million. Among its products are baskets to hold dedicated parts for aircraft engines and automobiles. Its engineers design custom wire baskets for the assembly lines of companies such as Boeing and Toyota. It has a reputation for producing high-quality products for these niche markets. Like many small businesses, Marlin did not have a history of exporting. However, in the mid-2000s, Marlin dipped its toe in the export market, shipping small numbers of products to Mexico and Canada. Marlin CEO Drew Greenblatt soon realized that export sales could be the key to growth. In 2008, when the global financial crisis hit and America slid into a serious recession, Marlin was exporting only 5 percent of its orders to foreign markets. Greenblatt’s strategy for dealing with weak demand from the United States was to aggressively expand international sales. By 2010, exports accounted for 17 percent of sales, and the company had set a goal of exporting half its output.2

Despite examples such as SteelMaster and Marlin, studies have shown that while many large firms tend to be proactive about seeking opportunities for profitable exporting— systematically scanning foreign markets to see where the opportunities lie for leveraging their technology, products, and marketing skills in foreign countries—many mediumsize and small firms are very reactive.3 Typically, such reactive firms do not even consider exporting until their domestic market is saturated and the emergence of excess productive capacity at home forces them to look for growth opportunities in foreign markets. Also, many small and medium-size firms tend to wait for the world to come to them, rather than going out into the world to seek opportunities. Even when the world does come to them, they may not respond. An example is MMO Music Group, which makes sing-along tapes for karaoke machines. Foreign sales accounted for about 15 percent of MMO’s revenues of $8 million, but the firm’s CEO admits this figure would probably have been much higher had he paid attention to building international sales. Unanswered e-mails and phone messages from Asia and Europe often piled up while he was trying to manage the burgeoning domestic side of the business. By the time MMO did turn its attention to foreign markets, competitors had stepped into the breach, and MMO found it tough going to build export volume.4

For Which Product Is Autarky a Good Choice for Countries?

The word autarky refers to the quality and belief that a country should be self-sufficient and avoid trade and/or external assistance with other nations. Many economists regard autarky as an idealistic, but impractical, goal of countries. Basically, it sounds like a nice idea to be self-sufficient and practice autarky. In reality, throughout history countries have tried to achieve autarky but soon discovered they could not produce the wide range of products and services customers in their population want and need. These countries also found out that manufacturing products at competitive prices over the long term became a daunting task. In fact, those countries found themselves worse off economically than nations that engaged in international trade. So, a word to the wise; unless your country can efficiently produce everything it needs, the country needs to engage in international trade. A more logical and achievable possibility is to perhaps focus on being self-sufficient in certain areas, for certain products or services. Which product or service do you think a country should strive to be self-sufficient in?

Source: J. Heathcote, “Financial Autarky and International Business Cycles,” Journal of Monetary Economics 49, no. 3 (2002), pp. 601-627.

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MMO’s experience is common, and it suggests a need for firms to become more proactive about seeking export opportunities. One reason more firms are not proactive is that they are unfamiliar with foreign market opportunities; they simply do not know how big the opportunities actually are or where they might lie. Simple ignorance of the potential opportunities is a huge barrier to exporting.5 Also, many would-be exporters, particularly smaller firms, are often intimidated by the complexities and mechanics of exporting to countries where business practices, language, culture, legal systems, and currency are very different from the home market.6 This combination of unfamiliarity and intimidation probably explains why exporters still account for only a tiny percentage of U.S. firms, less than 5 percent of firms with fewer than 500 employees, according to the Small Business Administration.7

To make matters worse, many neophyte exporters run into significant problems when first trying to do business abroad, and this sours them on future exporting ventures. Common pitfalls include poor market analysis, a poor understanding of competitive conditions in the foreign market, a failure to customize the product offering to the needs of foreign customers, a lack of an effective distribution program, a poorly executed promotional campaign, and problems securing financing.8 Novice exporters tend to underestimate the time and expertise needed to cultivate business in foreign countries.9 Few realize the amount of management resources that have to be dedicated to this activity. Many foreign customers require face-to-face negotiations on their home turf. An exporter may have to spend months learning about a country’s trade regulations, business practices, and more before a deal can be closed. The accompanying Management Focus, which documents the experience of FCX Systems in China, suggests that it may take years before foreigners are comfortable enough to purchase in significant quantities.

management FOCUS

FCX Systems

Founded with the help of a $20,000 loan from the Small Business Administration, FCX Systems is an exporting success story. FCX makes power converters for the aerospace industry. These devices convert common electric utility frequencies into the higher frequencies used in aircraft systems and are primarily used to provide power to aircraft while they are on the ground. Today, the West Virginia enterprise generates more than half its annual sales from exports to more than 75 countries. FCX’s prowess in opening foreign markets has earned the company several awards for export excellence, including a presidential award for achieving extraordinary growth in export sales.

FCX initially got into exporting because it found that foreigners were often more receptive to the company’s products than potential American customers. According to Don Gallion, president of FCX, “In the overseas market, they were looking for a good technical product, preferably made in the U.S., but they weren’t asking questions about ‘How long have you been in business? Are you still going to be here tomorrow?’ They were just anxious to get the product.”

In 1989, shortly after it had been founded, FCX signed on with an international distribution company to help with exporting, but Gallion became disillusioned with that company, and in 1994 FCX started to handle the exporting process on its own. At the time, exports represented 12 percent of sales, but by 1997 they had jumped to more than 50 percent of the total, where they have stayed since.

In explaining the company’s export success, Gallion cites a number of factors. One was the extensive assistance that FCX has received over the years from a number of federal and state agencies, including the U.S. Department of Commerce and the Development Office of West Virginia. These agencies demystified the process of exporting and provided good contacts for FCX. Finding a good local representative to help work through local regulations and customs is another critical factor, according to Gallion, who says, “A good rep will keep you out of trouble when it comes to customs and what you should and shouldn’t do.” Persistence is also very important, says Gallion, particularly when trying to break into markets where personal relationships are crucial, such as China.

China has been an interesting story for FCX. The company has been booking $2 million to $3 million in sales to China, but it took years to get to this point. China had been on Gallion’s radar screen since the early 1990s, primarily because of the country’s rapid modernization and its plans to build or remodel almost 200 airports. This constituted a potentially large market opportunity for FCX, particularly compared with the United States, where perhaps only three new airports would be built during the same period. Despite the scale of the opportunity, progress was very slow. The company had to identify airports and airline projects, government agencies, customers, and decision makers, as well as work through different languages—and make friends. According to Gallion, “Only after they consider you a friend will they buy a product. They believe a friend would never cheat you.” To make friends in China, Gallion estimates he had to make more than 100 trips to China, but now that the network has been established, it is starting to pay dividends.

Sources: J. Sparshott, “Businesses Must Export to Compete,” The Washington Times, September 1, 2004, p. C8; “Entrepreneur of the Year 2001: Donald Gallion, FCX Systems,” The State Journal, June 18, 2001, p. S10; and T. Pierro, “Exporting Powers Growth of FCX Systems,” The State Journal, April 6, 1998, p. 1.

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Page 401Exporters often face voluminous paperwork, complex formalities, and many potential delays and errors. According to a UN report on trade and development, a typical international trade transaction may involve 30 parties, 60 original documents, and 360 document copies, all of which have to be checked, transmitted, reentered into various information systems, processed, and filed. The United Nations has calculated that the time involved in preparing documentation, along with the costs of common errors in paperwork, often amounts to 10 percent of the final value of goods exported.10

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Improving Export Performance

Inexperienced exporters have a number of ways to gain information about foreign market opportunities and avoid common pitfalls that tend to discourage and frustrate novice exporters.11 In this section, we look at information sources for exporters to increase their knowledge of foreign market opportunities, we consider the pros and cons of using export management companies (EMCs) to assist in the export process, and we review various exporting strategies that can increase the probability of successful exporting. We begin, however, with a look at how several nations try to help domestic firms export.

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Identify the steps managers can take to improve their firm’s export performance.

AN INTERNATIONAL COMPARISON One big impediment to exporting is the simple lack of knowledge of the opportunities available. Often, there are many markets for a firm’s product, but because they are in countries separated from the firm’s home base by culture, language, distance, and time, the firm does not know of them. Identifying export opportunities is made even more complex because more than 200 countries with widely differing cultures compose the world of potential opportunities. Faced with such complexity and diversity, firms sometimes hesitate to seek export opportunities.

Identify information sources and government programs that exist to help exporters.

The way to overcome ignorance is to collect information. In Germany—one of the world’s most successful exporting nations—trade associations, government agencies, and commercial banks gather information, helping small firms identify export opportunities. A similar function is provided by the Japanese Ministry of International Trade and Industry (MITI), which is always on the lookout for export opportunities. In addition, many Japanese firms are affiliated in some way with the sogo shosha, Japan’s great trading houses. The sogo shosha have offices all over the world, and they proactively, continuously seek export opportunities for their affiliated companies large and small.12

MITI

Japan’s Ministry of International Trade and Industry.

Sogo Shosha

Japanese trading companies; a key part of the keiretsu, the large Japanese industrial groups.

German and Japanese firms can draw on the large reservoirs of experience, skills, information, and other resources of their respective export-oriented institutions. Unlike their German and Japanese competitors, many U.S. firms are relatively blind when they seek export opportunities; they are information-disadvantaged. In part, this reflects historical differences. Both Germany and Japan have long made their living as trading nations, whereas until recently the United States has been a relatively self-contained continental economy in which international trade played a minor role. This is changing; both imports and exports now play a greater role in the U.S. economy than they did 20 years ago. However, the United States has not yet evolved an institutional structure for promoting exports similar to that of either Germany or Japan.

INFORMATION SOURCES Despite institutional disadvantages, U.S. firms can increase their awareness of export opportunities. The most comprehensive source of information is the U.S. Department of Commerce and its district offices all over the country. Within that department are two organizations dedicated to providing businesses with intelligence and assistance for attacking foreign markets: the International Trade Administration and the U.S. Commercial Service.

Those agencies provide the potential exporter with a “best prospects” list, which gives the names and addresses of potential distributors in foreign markets along with businesses they are in, the products they handle, and their contact person. In addition, the Department of Page 402Commerce has assembled a “comparison shopping service” for 14 countries that are major markets for U.S. exports. For a small fee, a firm can receive a customized market research survey on a product of its choice. This survey provides information on marketability, the competition, comparative prices, distribution channels, and names of potential sales representatives. Each study is conducted on-site by an officer of the Department of Commerce.

The Department of Commerce also organizes trade events that help potential exporters make foreign contacts and explore export opportunities. The department organizes exhibitions at international trade fairs, which are held regularly in major cities worldwide. The department also has a matchmaker program, in which department representatives accompany groups of U.S. businesspeople abroad to meet with qualified agents, distributors, and customers.

Another government organization, the Small Business Administration (SBA), can help potential exporters (see the accompanying Management Focus for examples of the SBA’s work). The SBA employs 76 district international trade officers and 10 regional international trade officers throughout the United States as well as a 10-person international trade staff in Washington, D.C. Through its Service Corps of Retired Executives (SCORE) program, the SBA also oversees some 11,500 volunteers with international trade experience to provide one-on-one counseling to active and new-to-export businesses. The SBA also coordinates the Export Legal Assistance Network (ELAN), a nationwide group of international trade attorneys who provide free initial consultations to small businesses on export-related matters.

Is Chinese Exporting the Next Edge for the Country?

With hundreds of television sets stacked high, Changhong Electronics’ warehouse in Shunde resembles many other storage depots in southern China, but their destinations reveal an important shift in global trade patterns. While Changhong’s smaller sets are headed for Europe, its 50-inch plasma screens, which dominate the warehouse, will be shipped to South Africa. Fast growth in developing countries and sluggish Western economies are prompting these companies to abandon their obsession with the United States and Europe and to try and capitalize on rapidly growing markets in Asia, Africa, and Latin America. The so-called China price—a vastly lower price because of low labor costs and the low cost of capital for large government-owned companies— now applies to industrial goods, not just consumer goods. Experts believe that cheap Chinese exports could provide a boost to investment in the developing world, just as they once did to consumption in the developed world. Can China boost investment in the developing world and also boost its own economy?

Source: R. Jacob, “Chinese Exporters Seek New Markets,” Financial Times, June 12, 2012.

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In addition to the Department of Commerce and SBA, nearly every state and many large cities maintain active trade commissions whose purpose is to promote exports. Most of these provide business counseling, information gathering, technical assistance, and financing. Unfortunately, many have fallen victim to budget cuts or to turf battles for political and financial support with other export agencies.

A number of private organizations are also beginning to provide more assistance to would-be exporters. Commercial banks and major accounting firms are more willing to assist small firms in starting export operations than they were a decade ago. In addition, large multinationals that have been successful in the global arena are typically willing to discuss opportunities overseas with the owners or managers of small firms.13

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Identify the steps managers can take to improve their firm’s export performance.

UTILIZING EXPORT MANAGEMENT COMPANIES One way for first-time exporters to identify the opportunities associated with exporting and to avoid many of the associated pitfalls is to hire an export management company (EMC). EMCs are export specialists that act as the export marketing department or international department for their client firms. EMCs normally accept two types of export assignments. They start exporting operations for a firm with the understanding that the firm will take over operations after they are well established. In another type, start-up services are performed with the understanding that the EMC will have continuing responsibility for selling the firm’s products. Many EMCs specialize in serving firms in particular industries and in particular areas of the world. Thus, one EMC may specialize in selling agricultural products in the Asian market, while another may focus on exporting electronics products to eastern Europe.

Export Management Company (EMC)

Export specialists who act as an export marketing department for client firms.

In theory, the advantage of EMCs is that they are experienced specialists that can help the neophyte exporter identify opportunities and avoid common pitfalls. A good EMC Page 403will have a network of contacts in potential markets, have multilingual employees, have a good knowledge of different business mores, and be fully conversant with the ins and outs of the exporting process and with local business regulations. However, the quality of EMCs varies.14 While some perform their functions very well, others appear to add little value to the exporting company. Therefore, an exporter should review carefully a number of EMCs and check references. One drawback of relying on EMCs is that the company can fail to develop its own exporting capabilities.

management FOCUS

Exporting with a Little Government Help

Exporting can seem like a daunting prospect, but the reality is that in the United States, as in many other countries, many small enterprises have built profitable export businesses. For example, Landmark Systems of Virginia had virtually no domestic sales before it entered the European market. Landmark had developed a software program for IBM mainframe computers and located an independent distributor in Europe to represent its product. In the first year, 80 percent of sales were attributed to exporting. In the second year, sales jumped from $100,000 to $1.4 million—with 70 percent attributable to exports. Landmark is not alone; government data suggest that in the United States, more than 97 percent of the 240,000 firms that export are small or medium-size businesses that employ fewer than 500 people. Their share of total U.S. exports has grown steadily and is around 30 percent today.

To help jump-start the exporting process, many small companies have drawn on the expertise of government agencies, financial institutions, and export management companies. Consider the case of Novi Inc., a California-based business. Company President Michael Stoff tells how he utilized the services of the U.S. Small Business Administration (SBA) Office of International Trade to start exporting:

“When I began my business venture, Novi Inc., I knew that my Tune-Tote (a stereo system for bicycles) had the potential to be successful in international markets. Although I had no prior experience in this area, I began researching and collecting information on international markets. I was willing to learn, and by targeting key sources for information and guidance, I was able to penetrate international markets in a short period of time. One vital source I used from the beginning was the SBA. Through SBA I was directed to a program that dealt specifically with business development—the Service Corps of Retired Executives (SCORE). I was assigned an adviser who had run his own import/export business for 30 years. The services of SCORE are provided on a continual basis and are free.”

“As I began to pursue exporting, my first step was a thorough marketing evaluation. I targeted trade shows with a good presence of international buyers. I also went to DOC [Department of Commerce] for counseling and information about the rules and regulations of exporting. I advertised my product in Commercial News USA, distributed through United States embassies to buyers worldwide. I utilized DOC’s World Traders Data Reports to get background information on potential foreign buyers. As a result, I received 60–70 inquiries about Tune-Tote from around the world. Once I completed my research and evaluation of potential buyers, I decided which ones would be most suitable to market my product internationally. Then I decided to grant exclusive distributorship. In order to effectively communicate with my international customers, I invested in a fax. I chose a U.S. bank to handle international transactions. The bank also provided guidance on methods of payment and how best to receive and transmit money. This is essential know-how for anyone wanting to be successful in foreign markets.”

In just one year of exporting, export sales at Novi topped $1 million and increased 40 percent in the second year of operations. Today, Novi Inc. is a large distributor of wireless intercom systems that exports to more than 10 countries.

Sources: Small Business Administration Office of International Trade, “Guide to Exporting,” www.sba.gov/oit/info/Guide-ToExporting/index.html; U.S. Department of Commerce, “A Profile of U.S. Exporting Companies, 2000–2001,” February 2003, report available at www.census.gov/foreign-trade/aip/index.html#profile; and The 2007 National Exporting Strategy (Washington, DC: U.S. International Trade Commission, 2007).

EXPORT STRATEGY In addition to using EMCs, a firm can reduce the risks associated with exporting if it is careful about its choice of export strategy.15 A few guidelines can help firms improve their odds of success. For example, one of the most successful exporting firms in the world, 3M (originally, Minnesota Mining & Manufacturing Company), has built its export success on three main principles—enter on a small scale to reduce risks, add additional product lines once the exporting operations start to become successful, and hire locals to promote the firm’s products (3M’s export strategy is profiled in the accompanying Management Focus). Another successful exporter, Red Spot Paint & Varnish Company, emphasizes the importance of cultivating personal relationships when trying to build an export business.

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Identify the steps managers can take to improve their firm’s export performance.

The probability of exporting successfully can be increased dramatically by taking a handful of simple strategic steps. First, particularly for the novice exporter, it helps to hire an Page 404EMC or at least an experienced export consultant to identify opportunities and navigate the paperwork and regulations so often involved in exporting. Second, it often makes sense to initially focus on one market or a handful of markets. Learn what is required to succeed in those markets before moving to other markets. The firm that enters many markets at once runs the risk of spreading its limited management resources too thin. The result of such a shotgun approach to exporting may be a failure to become established in any one market. Third, as with 3M, it often makes sense to enter a foreign market on a small scale to reduce the costs of any subsequent failure. Most important, entering on a small scale provides the time and opportunity to learn about the foreign country before making significant capital commitments to that market. Fourth, the exporter needs to recognize the time and managerial commitment involved in building export sales and should hire additional personnel to oversee this activity. Fifth, in many countries, it is important to devote a lot of attention to building strong and enduring relationships with local distributors and/or customers. Sixth, as 3M often does, it is important to hire local personnel to help the firm establish itself in a foreign market. Local people are likely to have a much greater sense of how to do business in a given country than a manager from an exporting firm who has previously never set foot in that country. Seventh, several studies have suggested the firm needs to be proactive about seeking export opportunities.16 Armchair exporting does not work! The world will not normally beat a pathway to your door. Finally, it is important for the exporter to retain the option of local production. Once exports reach a sufficient volume to justify cost-efficient local production, the exporting firm should consider establishing production facilities in the foreign market. Such localization helps foster good relations with the foreign country and can lead to greater market acceptance. Exporting is often not an end in itself, but merely a step on the road toward establishment of foreign production (again, 3M provides an example of this philosophy).

management FOCUS

Export Strategy at 3M

3M, which makes more than 40,000 products including tape, sandpaper, medical products, and the ever-present Post-it notes, is one of the world’s great multinational operations. Today, more than 60 percent of the firm’s revenues are generated outside the United States. Although the bulk of these revenues came from foreign-based operations, 3M remains a major exporter with more than $2 billion in exports. The company often uses its exports to establish an initial presence in a foreign market, only building foreign production facilities once sales volume rises to a level that justifies local production.

The export strategy is built around simple principles. One is known as “FIDO,” which stands for first in (to a new market) defeats others. The essence of FIDO is to gain an advantage over other exporters by getting into a market first and learning about that country and how to sell there before others do. A second principle is “make a little, sell a little,” which is the idea of entering on a small scale with a very modest investment and pushing one basic product, such as reflective sheeting for traffic signs in Russia or scouring pads in Hungary. Once 3M believes it has learned enough about the market to reduce the risk of failure to reasonable levels, it adds additional products.

A third principle at 3M is to hire local employees to sell the firm’s products. The company normally sets up a local sales subsidiary to handle its export activities in a country. It then staffs this subsidiary with local hires because it believes they are likely to have a much better idea than American expatriates of how to sell in their own country. Because of the implementation of this principle, fewer than 200 of 3M’s 40,000-plus foreign employees are U.S. expatriates.

Another common practice at 3M is to formulate global strategic plans for the export and eventual overseas production of its products. Within the context of these plans, 3M gives local managers considerable autonomy to find the best way to sell the product within their country. Thus, when 3M first exported its Post-it notes, it planned to “sample the daylights” out of the product, but it also told local managers to find the best way of doing this. Local managers hired office cleaning crews to pass out samples in Great Britain and Germany; in Italy, office products distributors were used to pass out free samples; while in Malaysia, local managers employed young women to go from office to office handing out samples of the product. In typical 3M fashion, when the volume of Post-it notes was sufficient to justify it, exports from the United States were replaced by local production. Thus, after several years, 3M found it worthwhile to set up production facilities in France to produce Post-it notes for the European market.

Sources: R. L. Rose, “Success Abroad,” The Wall Street Journal, March 29, 1991, p. A1; T. Eiben, “US Exporters Keep On Rolling,” Fortune, June 14, 1994, pp. 128–31; 3M Company, A Century on Innovation, 3M, 2002; and 2005 10K form archived at 3M’s website at www.3m.com.

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Page 40514.1 FIGURE

Preference of the U.S. Exporter

Export and Import Financing

Mechanisms for financing exports and imports have evolved over the centuries in response to a problem that can be particularly acute in international trade: the lack of trust that exists when one must put faith in a stranger. In this section, we examine the financial devices that have evolved to cope with this problem in the context of international trade: the letter of credit, the draft (or bill of exchange), and the bill of lading. Then we trace the 14 steps of a typical export-import transaction.17

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Recognize the basic steps involved in export financing.

LACK OF TRUST Firms engaged in international trade have to trust someone they may have never seen, who lives in a different country, who speaks a different language, who abides by (or does not abide by) a different legal system, and who could be very difficult to track down if he or she defaults on an obligation. Consider a U.S. firm exporting to a distributor in France. The U.S. businessman might be concerned that if he ships the products to France before he receives payment from the French businesswoman, she might take delivery of the products and not pay him. Conversely, the French importer might worry that if she pays for the products before they are shipped, the U.S. firm might keep the money and never ship the products or might ship defective products. Neither party to the exchange completely trusts the other. This lack of trust is exacerbated by the distance between the two parties—in space, language, and culture—and by the problems of using an underdeveloped international legal system to enforce contractual obligations.

Due to the (quite reasonable) lack of trust between the two parties, each has his or her own preferences as to how the transaction should be configured. To make sure he is paid, the manager of the U.S. firm would prefer the French distributor to pay for the products before he ships them (see Figure 14.1). Alternatively, to ensure she receives the products, the French distributor would prefer not to pay for them until they arrive (see Figure 14.2). Thus, each party has a different set of preferences. Unless there is some way of establishing trust between the parties, the transaction might never occur.

How Trusting Can You Be?

In Chapter 14, we discuss the fact that firms that are engaged in international trade have to trust someone they may have never seen, who lives in a different country, who speaks a different language, who abides by (or does not abide by) a different legal system, and who could be very difficult to track down if he or she defaults on an obligation. Basically, there is a lot of potential for unknown issues to arise and for complications to happen given the lack of established trust between trading partners. With more than 200 countries in the world, lots of cultural values and beliefs, and many potential avenues to run into complications, how much trust would you place on a relationship that (1) involved an organization from a country like yours (e.g., Swedish people doing business with Danish people) or (2) involved an organization from a country very different from yours (e.g., a Canadian doing business with someone from Turkey)?

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The problem is solved by using a third party trusted by both—normally a reputable bank—to act as an intermediary. What happens can be summarized as follows (see Figure 14.3). First, the French importer obtains the bank’s promise to pay on her behalf, knowing the U.S. exporter will trust the bank. This promise is known as a letter of credit. Having seen the letter of credit, the U.S. exporter now ships the products to France. Title to the products is given to the bank in the form of a document called a bill of lading. In return, the U.S. exporter tells the bank to pay for the products, which the bank does. The document for requesting this Page 406payment is referred to as a draft. The bank, having paid for the products, now passes the title on to the French importer, whom the bank trusts. At that time or later, depending on their agreement, the importer reimburses the bank. In the remainder of this section, we examine how this system works in more detail.

14.2 FIGURE

Preference of the French Importer

14.3 FIGURE

The Use of a Third Party

LETTER OF CREDIT A letter of credit, abbreviated as L/C, stands at the center of international commercial transactions. Issued by a bank at the request of an importer, the letter of credit states that the bank will pay a specified sum of money to a beneficiary, normally the exporter, on presentation of particular, specified documents.

Letter of Credit

Issued by a bank, indicating that the bank will make payments under specific circumstances.

Consider again the example of the U.S. exporter and the French importer. The French importer applies to her local bank, say, the Bank of Paris, for the issuance of a letter of credit. The Bank of Paris then undertakes a credit check of the importer. If the Bank of Paris is satisfied with her creditworthiness, it will issue a letter of credit. However, the Bank of Paris might require a cash deposit or some other form of collateral from her first. In addition, the Bank of Paris will charge the importer a fee for this service. Typically this amounts to between 0.5 and 2 percent of the value of the letter of credit, depending on the importer’s creditworthiness and the size of the transaction. (As a rule, the larger the transaction, the lower the percentage.)

Assume the Bank of Paris is satisfied with the French importer’s creditworthiness and agrees to issue a letter of credit. The letter states that the Bank of Paris will pay the U.S. exporter for the merchandise as long as it is shipped in accordance with specified instructions and conditions. At this point, the letter of credit becomes a financial contract between the Bank of Paris and the U.S. exporter. The Bank of Paris then sends the letter of credit to the U.S. exporter’s bank, say, the Bank of New York. The Bank of New York tells the exporter that it has received a letter of credit and that he can ship the merchandise. After the exporter has shipped the merchandise, he draws a draft against Page 407the Bank of Paris in accordance with the terms of the letter of credit, attaches the required documents, and presents the draft to his own bank, the Bank of New York, for payment. The Bank of New York then forwards the letter of credit and associated documents to the Bank of Paris. If all the terms and conditions contained in the letter of credit have been complied with, the Bank of Paris will honor the draft and will send payment to the Bank of New York. When the Bank of New York receives the funds, it will pay the U.S. exporter.

As for the Bank of Paris, once it has transferred the funds to the Bank of New York, it will collect payment from the French importer. Alternatively, the Bank of Paris may allow the importer some time to resell the merchandise before requiring payment. This is not unusual, particularly when the importer is a distributor and not the final consumer of the merchandise, since it helps the importer’s cash flow. The Bank of Paris will treat such an extension of the payment period as a loan to the importer and will charge an appropriate rate of interest.

The great advantage of this system is that both the French importer and the U.S. exporter are likely to trust reputable banks, even if they do not trust each other. Once the U.S. exporter has seen a letter of credit, he knows that he is guaranteed payment and will ship the merchandise. Also, an exporter may find that having a letter of credit will facilitate obtaining pre-export financing. For example, having seen the letter of credit, the Bank of New York might be willing to lend the exporter funds to process and prepare the merchandise for shipping to France. This loan may not have to be repaid until the exporter has received his payment for the merchandise. As for the French importer, she does not have to pay for the merchandise until the documents have arrived and unless all conditions stated in the letter of credit have been satisfied. The drawback for the importer is the fee she must pay the Bank of Paris for the letter of credit. In addition, because the letter of credit is a financial liability against her, it may reduce her ability to borrow funds for other purposes.

DRAFT A draft, sometimes referred to as a bill of exchange, is the instrument normally used in international commerce to effect payment. A draft is simply an order written by an exporter instructing an importer, or an importer’s agent, to pay a specified amount of money at a specified time. In the example of the U.S. exporter and the French importer, the exporter writes a draft that instructs the Bank of Paris, the French importer’s agent, to pay for the merchandise shipped to France. The person or business initiating the draft is known as the maker (in this case, the U.S. exporter). The party to whom the draft is presented is known as the drawee (in this case, the Bank of Paris).

Bill of Exchange

An order written by an exporter instructing an importer, or an importer’s agent, to pay a specified amount of money at a specified time.

Draft

An order written by an exporter telling an importer what and when to pay.

International practice is to use drafts to settle trade transactions. This differs from domestic practice in which a seller usually ships merchandise on an open account, followed by a commercial invoice that specifies the amount due and the terms of payment. In domestic transactions, the buyer can often obtain possession of the merchandise without signing a formal document acknowledging his or her obligation to pay. In contrast, due to the lack of trust in international transactions, payment or a formal promise to pay is required before the buyer can obtain the merchandise.

Drafts fall into two categories, sight drafts and time drafts. A sight draft is payable on presentation to the drawee. A time draft allows for a delay in payment—normally 30, 60, 90, or 120 days. It is presented to the drawee, who signifies acceptance of it by writing or stamping a notice of acceptance on its face. Once accepted, the time draft becomes a promise to pay by the accepting party. When a time draft is drawn on and accepted by a bank, it is called a banker’s acceptance. When it is drawn on and accepted by a business firm, it is called a trade acceptance.

Sight Draft

A draft payable on presentation to the drawee.

Time Draft

A promise to pay by the accepting party at some future date.

Time drafts are negotiable instruments; that is, once the draft is stamped with an acceptance, the maker can sell the draft to an investor at a discount from its face value. Imagine the agreement between the U.S. exporter and the French importer calls for the exporter to present the Bank of Paris (through the Bank of New York) with a time draft requiring payment Page 408120 days after presentation. The Bank of Paris stamps the time draft with an acceptance. Imagine further that the draft is for $100,000.

The exporter can either hold onto the accepted time draft and receive $100,000 in 120 days or sell it to an investor, say, the Bank of New York, for a discount from the face value. If the prevailing discount rate is 7 percent, the exporter could receive $97,700 by selling it immediately (7 percent per year discount rate for 120 days for $100,000 equals $2,300, and $100,000 − $2,300 = $97,700). The Bank of New York would then collect the full $100,000 from the Bank of Paris in 120 days. The exporter might sell the accepted time draft immediately if he needed the funds to finance merchandise in transit and/or to cover cash flow shortfalls.

BILL OF LANDING The third key document for financing international trade is the bill of lading. The bill of lading is issued to the exporter by the common carrier transporting the merchandise. It serves three purposes: it is a receipt, a contract, and a document of title. As a receipt, the bill of lading indicates that the carrier has received the merchandise described on the face of the document. As a contract, it specifies that the carrier is obligated to provide a transportation service in return for a certain charge. As a document of title, it can be used to obtain payment or a written promise of payment before the merchandise is released to the importer. The bill of lading can also function as collateral against which funds may be advanced to the exporter by its local bank before or during shipment and before final payment by the importer.

Bill of Lading

A document issued to an exporter by a common carrier transporting merchandise. It serves as a receipt, a contract, and a document of title.

A TYPICAL INTERNATIONAL TRADE TRANSACTION Now that we have reviewed the elements of an international trade transaction, let us see how the process works in a typical case, sticking with the example of the U.S. exporter and the French importer. The typical transaction involves 14 steps (see Figure 14.4).

1. The French importer places an order with the U.S. exporter and asks the American if he would be willing to ship under a letter of credit.

14.4 FIGURE

A Typical International Trade Transaction

Page 4092. The U.S. exporter agrees to ship under a letter of credit and specifies relevant information such as prices and delivery terms.

3. The French importer applies to the Bank of Paris for a letter of credit to be issued in favor of the U.S. exporter for the merchandise the importer wishes to buy.

4. The Bank of Paris issues a letter of credit in the French importer’s favor and sends it to the U.S. exporter’s bank, the Bank of New York.

5. The Bank of New York advises the exporter of the opening of a letter of credit in his favor.

6. The U.S. exporter ships the goods to the French importer on a common carrier. An official of the carrier gives the exporter a bill of lading.

7. The U.S. exporter presents a 90-day time draft drawn on the Bank of Paris in accordance with its letter of credit and the bill of lading to the Bank of New York. The exporter endorses the bill of lading so title to the goods is transferred to the Bank of New York.

8. The Bank of New York sends the draft and bill of lading to the Bank of Paris. The Bank of Paris accepts the draft, taking possession of the documents and promising to pay the now-accepted draft in 90 days.

9. The Bank of Paris returns the accepted draft to the Bank of New York.

10. The Bank of New York tells the U.S. exporter that it has received the accepted bank draft, which is payable in 90 days.

11. The exporter sells the draft to the Bank of New York at a discount from its face value and receives the discounted cash value of the draft in return.

12. The Bank of Paris notifies the French importer of the arrival of the documents. She agrees to pay the Bank of Paris in 90 days. The Bank of Paris releases the documents so the importer can take possession of the shipment.

13. In 90 days, the Bank of Paris receives the importer’s payment, so it has funds to pay the maturing draft.

14. In 90 days, the holder of the matured acceptance (in this case, the Bank of New York) presents it to the Bank of Paris for payment. The Bank of Paris pays.

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Export Assistance

Prospective U.S. exporters can draw on two forms of government-backed assistance to help finance their export programs. They can get financing aid from the Export-Import Bank and export credit insurance from the Foreign Credit Insurance Association (similar programs are available in most countries).

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Identify information sources and government programs that exist to help exporters.

EXPORT-IMPORT BANK Export-Import Bank (Ex-Im Bank) is an independent agency of the U.S. government. Its mission is to provide financing aid that will facilitate exports, imports, and the exchange of commodities between the United States and other countries. In 2010, its financing activities were expanded from $4 billion to $6 billion following a push by the Obama administration to try to create some 2 million new jobs through exports. The Ex-Im Bank pursues its mission with various loan and loan-guarantee programs. The agency guarantees repayment of medium- and long-term loans U.S. commercial banks make to foreign borrowers for purchasing U.S. exports. The Ex-Im Bank guarantee makes the commercial banks more willing to lend cash to foreign enterprises.

Export–Import Bank (Ex-Im Bank)

Agency of the U.S. government whose mission is to provide aid in financing and facilitate exports and imports.

Ex-Im Bank also has a direct lending operation under which it lends dollars to foreign borrowers for use in purchasing U.S. exports. In some cases, it grants loans that commercial banks would not if it sees a potential benefit to the United States in doing so. The foreign borrowers use the loans to pay U.S. suppliers and repay the loan to Ex-Im Bank with interest.

Fred Hochber, chairman and president of the U.S. Export-Import Bank, speaks during their annual conference.

EXPORT CREDIT INSURANCE For reasons outlined earlier, exporters clearly prefer to get letters of credit from importers. However, sometimes an exporter who insists on a letter of credit will lose an order to one who does not require a letter of credit. Thus, when the importer is in a strong bargaining position and able to play competing suppliers against each other, an exporter may have to forgo a letter of credit.18 The lack of a letter of credit exposes the exporter to the risk that the foreign importer will default on payment. The exporter can insure against this possibility by buying export credit insurance. If the customer defaults, the insurance firm will cover a major portion of the loss.

In the United States, export credit insurance is provided by the Foreign Credit Insurance Association (FCIA), an association of private commercial institutions operating under the guidance of the Export-Import Bank. The FCIA provides coverage against commercial risks and political risks. Losses due to commercial risk result from the buyer’s insolvency or payment default. Political losses arise from actions of governments that are beyond the control of either buyer or seller. Marlin, the small Baltimore manufacturer of wire baskets discussed earlier, credits export credit insurance with giving the company the confidence to push ahead with export sales. For a premium of roughly half a percent of the price of a sale, Marlin has been able to insure itself against the possibility of nonpayment by a foreign buyer.19

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images LO 14-5

Describe how countertrade can be used to facilitate exporting.

Countertrade

Countertrade is an alternative means of structuring an international sale when conventional means of payment are difficult, costly, or nonexistent. We first encountered countertrade in Chapter 10’s discussion of currency convertibility. A government may restrict the convertibility of its currency to preserve its foreign exchange reserves so they can be used to service international debt commitments and purchase crucial imports.20 This is problematic for exporters. Nonconvertibility implies that the exporter may not be paid in his or her home currency, and few exporters would desire payment in a currency that is not convertible. Countertrade is a common solution.21 Countertrade denotes a range of barterlike agreements; its principle is to trade goods and services for other goods and services when they cannot be traded for money. Some examples of countertrade are:

Countertrade

The trade of goods and services for other goods and services.

Page 411• An Italian company that manufactures power-generating equipment, ABB SAE Sadelmi SpA, was awarded a 720 million baht ($17.7 million) contract by the Electricity Generating Authority of Thailand. The contract specified that the company had to accept 218 million baht ($5.4 million) of Thai farm products as part of the payment.

• Saudi Arabia agreed to buy ten 747 jets from Boeing with payment in crude oil, discounted at 10 percent below posted world oil prices.

• General Electric won a contract for a $150 million electric generator project in Romania by agreeing to market $150 million of Romanian products in markets to which Romania did not have access.

• The Venezuelan government negotiated a contract with Caterpillar under which Venezuela would trade 350,000 tons of iron ore for Caterpillar earthmoving equipment.

• Albania offered such items as spring water, tomato juice, and chrome ore in exchange for a $60 million fertilizer and methanol complex.

• Philip Morris ships cigarettes to Russia, for which it receives chemicals that can be used to make fertilizer. Philip Morris ships the chemicals to China, and in return, China ships glassware to North America for retail sale by Philip Morris.22

Is Countertrade an Appropriate Way of Trading Today?

Countertrades can take many forms, and there are several examples of how it works internationally. For instance, the Malaysian government recently bought 20 diesel electric locomotives from General Electric. Officials of the government said that GE will be paid with palm oil supplied by a plantation company. The company will supply about 200,000 metric tons of palm oil over a period of 30 months. No money changed hands, and no third parties were involved. As another example, in order to save foreign exchange reserves, the Philippine government offered some creditors tinned tuna to repay part of a state $4 billion debt. In other examples, General Motors Corporation sold $12 million worth of locomotive and diesel engines to Yugoslavia and took cash and $4 million in Yugoslavian cutting tools as payment. Plus, McDonnell Douglas agreed to a compensation deal with Thailand for eight top-of-the-line F/A–18 strike aircraft. Thailand agreed to pay $578 million of the total cost in cash, and McDonnell Douglas agreed to accept $93 million in a mixed bag of goods, including Thai rubber, ceramics, furniture, frozen chicken, and canned fruit. To some, these types of trading contracts are strange and to some they are normal, especially if we go back in time. But what about today? Should the global marketplace engage in these types of non-monetary trades?

Source: S. Rama, “Types of Counter Trade,” 2011, www.citeman.com/13236-types-of-counter-trade.html.

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THE POPULARITY OF COUNTERTRADE In the modern era, countertrade arose in the 1960s as a way for the Soviet Union and the communist states of eastern Europe, whose currencies were generally nonconvertible, to purchase imports. During the 1980s, the technique grew in popularity among many developing nations that lacked the foreign exchange reserves required to purchase necessary imports. Today, reflecting their own shortages of foreign exchange reserves, some successor states to the former Soviet Union and the eastern European communist nations periodically engage in countertrade to purchase their imports. Estimates of the percentage of world trade covered by some sort of countertrade agreement range from highs of 8 and 10 percent by value to lows of around 2 percent.23 The precise figure is unknown, but it is probably at the low end of these estimates, given the increasing liquidity of international financial markets and wider currency convertibility. However, a short-term spike in the volume of countertrade can follow periodic financial crises. For example, countertrade activity increased notably after the Asian financial crisis of 1997. That crisis left many Asian nations with little hard currency to finance international trade. In the tight monetary regime that followed the crisis in 1997, many Asian firms found it very difficult to get access to export credit to finance their own international trade. Thus, they turned to the only option available to them—countertrade.

Given that countertrade is a means of financing international trade, albeit a relatively minor one, prospective exporters may have to engage in this technique from time to time to gain access to certain international markets. The governments of developing nations sometimes insist on a certain amount of countertrade.24

TYPES OF COUNTERTRADE With its roots in the simple trading of goods and services for other goods and services, countertrade has evolved into a diverse set of Page 412activities that can be categorized as five distinct types of trading arrangements: barter, counterpurchase, offset, switch trading, and compensation or buyback.25 Many countertrade deals involve not just one arrangement, but elements of two or more.

Barter Barter is the direct exchange of goods and/or services between two parties without a cash transaction. Although barter is the simplest arrangement, it is not common. Its problems are twofold. First, if goods are not exchanged simultaneously, one party ends up financing the other for a period. Second, firms engaged in barter run the risk of having to accept goods they do not want, cannot use, or have difficulty reselling at a reasonable price. For these reasons, barter is viewed as the most restrictive countertrade arrangement. It is primarily used for one-time-only deals in transactions with trading partners who are not creditworthy or trustworthy.

Barter

The direct exchange of goods or services between two parties without a cash transaction.

Counterpurchase Counterpurchase is a reciprocal buying agreement. It occurs when a firm agrees to purchase a certain amount of materials back from a country to which a sale is made. Suppose a U.S. firm sells some products to China. China pays the U.S. firm in dollars, but in exchange, the U.S. firm agrees to spend some of its proceeds from the sale on textiles produced by China. Thus, although China must draw on its foreign exchange reserves to pay the U.S. firm, it knows it will receive some of those dollars back because of the counterpurchase agreement. In one counterpurchase agreement, Rolls-Royce sold jet parts to Finland. As part of the deal, Rolls-Royce agreed to use some of the proceeds from the sale to purchase Finnish-manufactured TV sets that it would then sell in Great Britain.

Counterpurchase

A reciprocal buying agreement.

Offset An offset is similar to a counterpurchase insofar as one party agrees to purchase goods and services with a specified percentage of the proceeds from the original sale. The difference is that this party can fulfill the obligation with any firm in the country to which the sale is being made. From an exporter’s perspective, this is more attractive than a straight counterpurchase agreement because it gives the exporter greater flexibility to choose the goods that it wishes to purchase.

Offset

Agreement to purchase goods and services with a specified percentage of proceeds from an original sale in that country from any firm in the country.

Switch Trading The term switch trading refers to the use of a specialized third-party trading house in a countertrade arrangement. When a firm enters a counterpurchase or offset agreement with a country, it often ends up with what are called counterpurchase credits, which can be used to purchase goods from that country. Switch trading occurs when a third-party trading house buys the firm’s counterpurchase credits and sells them to another firm that can better use them. For example, a U.S. firm concludes a counterpurchase agreement with Poland for which it receives some number of counterpurchase credits for purchasing Polish goods. The U.S. firm cannot use and does not want any Polish goods, however, so it sells the credits to a third-party trading house at a discount. The trading house finds a firm that can use the credits and sells them at a profit.

Switch Trading

Use of a specialized third-party trading house in a countertrade arrangement.

In one example of switch trading, Poland and Greece had a counterpurchase agreement that called for Poland to buy the same U.S.-dollar value of goods from Greece that it sold to Greece. However, Poland could not find enough Greek goods that it required, so it ended up with a dollar-denominated counterpurchase balance in Greece that it was unwilling to use. A switch trader bought the right to 250,000 counterpurchase dollars from Poland for $225,000 and sold them to a European sultana (grape) merchant for $235,000, who used them to purchase sultanas from Greece.

Compensation or Buybacks A buyback occurs when a firm builds a plant in a country—or supplies technology, equipment, training, or other services to the country—and agrees to take a certain percentage of the plant’s output as partial payment for the contract. For example, Occidental Petroleum negotiated a deal with Russia under which Occidental would build several ammonia plants in Russia and as partial payment receive ammonia over a 20-year period.

Buyback

Agreement to accept a percentage of a plant’s output as payment for contract to build a plant.

Page 413PROS AND CONS OF COUNTERTRADE Counter-trade’s main attraction is that it can give a firm a way to finance an export deal when other means are not available. Given the problems that many developing nations have in raising the foreign exchange necessary to pay for imports, countertrade may be the only option available when doing business in these countries. Even when countertrade is not the only option for structuring an export transaction, many countries prefer countertrade to cash deals. Thus, if a firm is unwilling to enter a countertrade agreement, it may lose an export opportunity to a competitor that is willing to make a countertrade agreement.

A subsea oil and gas tree is lowered into a testing pool at a GE plant in Montrose, UK. Large, diverse, global companies like GE can benefit from countertrade agreements.

In addition, a countertrade agreement may be required by the government of a country to which a firm is exporting goods or services. Boeing often has to accept to counterpurchase agreements to capture orders for its commercial jet aircraft. For example, in exchange for gaining an order from Air India, Boeing may be required to purchase certain component parts, such as aircraft doors, from an Indian company. Taking this one step further, Boeing can use its willingness to enter into a counterpurchase agreement as a way of winning orders in the face of intense competition from its global rival, Airbus. Thus, countertrade can become a strategic marketing weapon.

However, the drawbacks of countertrade agreements are substantial. Other things being equal, firms would normally prefer to be paid in hard currency. Countertrade contracts may involve the exchange of unusable or poor-quality goods that the firm cannot dispose of profitably. For example, a few years ago, one U.S. firm got burned when 50 percent of the television sets it received in a countertrade agreement with Hungary were defective and could not be sold. In addition, even if the goods it receives are of high quality, the firm still needs to dispose of them profitably. To do this, countertrade requires the firm to invest in an in-house trading department dedicated to arranging and managing countertrade deals. This can be expensive and time-consuming.

Given these drawbacks, countertrade is most attractive to large, diverse multinational enterprises that can use their worldwide network of contacts to dispose of goods acquired in countertrading. The masters of countertrade are Japan’s giant trading firms, the sogo shosha, which use their vast networks of affiliated companies to profitably dispose of goods acquired through countertrade agreements. The trading firm of Mitsui & Company, for example, has about 120 affiliated companies in almost every sector of the manufacturing and service industries. If one of Mitsui’s affiliates receives goods in a countertrade agreement that it cannot consume, Mitsui & Company will normally be able to find another affiliate that can profitably use them. Firms affiliated with one of Japan’s sogo shosha often have a competitive advantage in countries where countertrade agreements are preferred.

Western firms that are large, diverse, and have a global reach (e.g., General Electric, Philip Morris, and 3M) have similar profit advantages from countertrade agreements. Indeed, 3M has established its own trading company—3M Global Trading Inc.—to develop and manage the company’s international countertrade programs. Unless there is no alternative, small and medium-size exporters should probably try to avoid countertrade deals because they lack the worldwide network of operations that may be required to profitably utilize or dispose of goods acquired through them.26

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Key Terms

MITI

sogo shosha

export management company (EMC)

letter of credit

bill of exchange

Page 414draft

sight draft

time draft

bill of lading

Export–Import Bank (Ex-Im Bank)

countertrade

barter

counterpurchase

offset

switch trading

buyback

Summary

This chapter examined the steps that firms must take to establish themselves as exporters. The chapter made the following points:

1. One big impediment to exporting is ignorance of foreign market opportunities.

2. Neophyte exporters often become discouraged or frustrated with the exporting process because they encounter many problems, delays, and pitfalls.

3. The way to overcome ignorance is to gather information. In the United States, a number of institutions, the most important of which is the Department of Commerce, can help firms gather information in the matchmaking process. Export management companies can also help identify export opportunities.

4. Many of the pitfalls associated with exporting can be avoided if a company hires an experienced export management company, or export consultant, and if it adopts the appropriate export strategy.

5. Firms engaged in international trade must do business with people they cannot trust and people who may be difficult to track down if they default on an obligation. Due to the lack of trust, each party to an international transaction has a different set of preferences regarding the configuration of the transaction.

6. The problems arising from lack of trust between exporters and importers can be solved by using a third party that is trusted by both, normally a reputable bank.

7. A letter of credit is issued by a bank at the request of an importer. It states that the bank promises to pay a beneficiary, normally the exporter, on presentation of documents specified in the letter.

8. A draft is the instrument normally used in international commerce to effect payment. It is an order written by an exporter instructing an importer, or an importer’s agent, to pay a specified amount of money at a specified time.

9. Drafts are either sight drafts or time drafts. Time drafts are negotiable instruments.

10. A bill of lading is issued to the exporter by the common carrier transporting the merchandise. It serves as a receipt, a contract, and a document of title.

11. U.S. exporters can draw on two types of government-backed assistance to help finance their exports: loans from the Export-Import Bank and export credit insurance from the FCIA.

12. Countertrade includes a range of barterlike agreements. It is primarily used when a firm exports to a country whose currency is not freely convertible and may lack the foreign exchange reserves required to purchase the imports.

13. The main attraction of countertrade is that it gives a firm a way to finance an export deal when other means are not available. A firm that insists on being paid in hard currency may be at a competitive disadvantage vis-à-vis one that is willing to engage in countertrade.

14. The main disadvantage of countertrade is that the firm may receive unusable or poor-quality goods that cannot be disposed of profitably.

Critical Thinking and Discussion Questions

Critical Thinking and Discussion Questions

1. A firm based in Washington State wants to export a shipload of finished lumber to the Philippines. The would-be importer cannot get sufficient credit from domestic sources to pay for the shipment but insists that the finished lumber can quickly be resold in the Philippines for a profit. Outline the steps the exporter should take to effect this export to the Philippines.

2. You are the assistant to the CEO of a small textile firm that manufactures quality, premium-priced, stylish clothing. The CEO has decided to see what the opportunities are for exporting and has asked you for advice as to the steps the company should take. What advice would you give the CEO?

Page 4153. An alternative to using a letter of credit is export credit insurance. What are the advantages and disadvantages of using export credit insurance rather than a letter of credit for exporting (a) a luxury yacht from California to Canada and (b) machine tools from New York to Ukraine?

4. How do you explain the use of countertrade? Under what scenarios might its use increase further by 2020? Under what scenarios might its use decline?

5. How might a company make strategic use of countertrade schemes as a marketing weapon to generate export revenues? What are the risks associated with pursuing such a strategy?

images Research Task http://globalEDGE.msu.edu

Use the globalEDGE website (globaledge.msu.edu) to complete the following exercises:

1. One way that exporters analyze conditions in emerging markets is through the use of macroeconomic indicators. The Market Potential Index (MPI) is a yearly study conducted by the Michigan State University Center for International Business Education and Research (MSU-CIBER) to compare the market potential of emerging markets for U.S. exporters. Provide a description of the dimensions used in the index. Which of the dimensions would have greater importance for a company that markets wireless devices? What about a company that sells clothing?

2. You work in the sales department of a company that manufactures and sells medical implants. A Brazilian company contacted your department and expressed interest in purchasing a large quantity of your products. The Brazilian company requested an FOB price quote. One of your colleagues mentioned to you that FOB is part of a collection of international shipping terms called “Incoterms,” but that was all he knew. Find the Export Tutorials on the globalEDGE site, and find a more detailed explanation of Incoterms. For an FOB quote, what line items will you need to include in your price quote, in addition to the price your company will charge for the products?

images MD International closing case

Al Merritt founded MD International in 1987. A former salesman for a medical equipment company, Merritt saw an opportunity to act as an export intermediary for medical equipment manufacturers in the United States. He chose to focus on Latin America and the Caribbean, a region that he already had experience in. Also, trade barriers were starting to fall throughout the region as Latin American governments embraced a more liberal economic ideology, creating an opening for entrepreneurs such as Merritt. Local governments were also expanding their spending on health care, creating an opportunity that Merritt was poised to exploit.

Merritt located his company in south Florida to be close to his market. Since then, the company has grown to become the largest intermediary exporting medical devices to the region. Today, the company sells the products of more than 30 medical manufacturers to some 600 regional distributors. While many medical equipment manufacturers don’t sell directly to the region because of the sizable marketing costs, MD can afford to because it goes into those markets with a broad portfolio of products.

The company’s success is in part due to its deep-rooted knowledge and understanding of the Latin American market. MD works very closely with teams of doctors, biomedical engineers, microbiologists, and marketing managers across Latin America to understand their needs and what the company can do for them. The sale of products to customers is typically only the beginning of a relationship. MD International also provides training to medical personnel in the use of devices and offers extensive after-sale service and support.

Along the way to becoming a successful exporter, MD International has leaned heavily upon export assistance programs established by the U.S. government. For example, a shipment to Venezuela was held up by the Venezuelan customs seeking proof that the medical devices were not intended for military use. Within two days, staff at the U.S. Export Assistance Center in Miami arranged for the U.S. embassy in Venezuela to have a letter written and delivered to the customs officials, assuring them that the products had no military applications, and the shipment was released. Merritt has also worked extensively with the Export–Import Bank to gain financing for its exports (the company needs to finance the inventory that it exports).

Despite these advantages, it has not all been easy going for MD International. Latin American economies have often been highly cyclical, and MD International has ridden those cycles with them. In the early 2000s, for example, after several years of solid growth, an economic crisis in both Page 416Argentina and Brazil, coupled with a slowdown in Mexico, resulted in losses for the year and forced Merritt to lay off one-third of his staff and cut the pay of others, which included a 50 percent pay cut for himself. Things started to improve by the mid-2000s, and a weak dollar at the time also helped to boost export sales. However, the global financial crisis of 2008–2009 ushered in another tough period. MD International not only survived the downturn, but came out stronger as weaker competitors fall by the wayside.

CASE DISCUSSION QUESTIONS

1. How does an intermediary such as MD International create value for the manufacturers that use it to sell medical equipment in foreign markets? Why do they want to use MD International rather than export directly themselves?

2. Why did MD International focus on Latin America? What are the benefits of this regional approach? What are the potential drawbacks?

3. What would it take for MD International to start exporting to other regions, such as Asia or Europe? Given this, would you advise Al Merritt to continue his regional focus going forward or to add other regions?

4. How important has government assistance been to MD International? Do you think helping firms such as MD International represents a good use of taxpayer money?

Sources: J. Bussey, “Where Have All the Exporters Gone?” Miami Herald, September 30, 2005, p. C1; M. Chandler, “Dade Firm Seeks to Remake Health Care,” Miami Herald, June 15, 2000; and C. Cultice, “Exports with a Heart,” U.S. Department of Commerce, export success stories, at www.export.gov.

Endnotes

1. R. A. Pope, “Why Small Firms Export: Another Look,” Journal of Small Business Management 40 (2002), pp. 17–26.

2. M. C. White, “Marlin Steel Wire Products,” Slate Magazine, November 10, 2010.

3. S. T. Cavusgil, “Global Dimensions of Marketing,” in Marketing, ed. P. E. Murphy and B. M. Enis (Glenview, IL: Scott, Foresman, 1985), pp. 577–99.

4. S. M. Mehta, “Enterprise: Small Companies Look to Cultivate Foreign Business,” The Wall Street Journal, July 7, 1994, p. B2.

5. P. A. Julien and C. Ramagelahy, “Competitive Strategy and Performance of Exporting SMEs,” Entrepreneurship Theory and Practice, 2003, pp. 227–94.

6. W. J. Burpitt and D. A. Rondinelli, “Small Firms’ Motivations for Exporting: To Earn and Learn?” Journal of Small Business Management, October 2000, pp. 1–14; and J. D. Mittelstaedt, G. N. Harben, and W. A. Ward, “How Small Is Too Small?” Journal of Small Business Management 41 (2003), pp. 68–85.

7. Small Business Administration, “The State of Small Business 1999–2000: Report to the President,” 2001; and D. Ransom, “Obama’s Math: More Exports Equals More Jobs,” The Wall Street Journal, February 6, 2010.

8. A. O. Ogbuehi and T. A. Longfellow, “Perceptions of U.S. Manufacturing Companies Concerning Exporting,” Journal of Small Business Management, October 1994, pp. 37–59; and U.S. Small Business Administration, “Guide to Exporting,” www.sba.gov/oit/info/Guide-to-Exporting/index.html.

9. R. W. Haigh, “Thinking of Exporting?” Columbia Journal of World Business 29 (December 1994), pp. 66–86.

10. F. Williams, “The Quest for More Efficient Commerce,” Financial Times, October 13, 1994, p. 7.

11. See Burpitt and Rondinelli, “Small Firms’ Motivations for Exporting”; and C. S. Katsikeas, L. C. Leonidou, and N. A. Morgan, “Firm Level Export Performance Assessment,” Academy of Marketing Science 28 (2000), pp. 493–511.

12. M. Y. Yoshino and T. B. Lifson, The Invisible Link (Cambridge, MA: MIT Press, 1986).

13. L. W. Tuller, Going Global (Homewood, IL: Business One– Irwin, 1991).

14. Haigh, “Thinking of Exporting?”

15. M. A. Raymond, J. Kim, and A. T. Shao. “Export Strategy and Performance,” Journal of Global Marketing 15 (2001), pp. 5–29; and P. S. Aulakh, M. Kotabe, and H. Teegen, “Export Strategies and Performance of Firms from Emerging Economies,” Academy of Management Journal 43 (2000), pp. 342–61.

16. J. Francis and C. Collins-Dodd, “The Impact of Firms’ Export Orientation on the Export Performance of High-Tech Small and Medium Sized Enterprises,” Journal of International Marketing 8, no. 3 (2000), pp. 84–103.

17. J. Koch, “Integration of U.S. Small Businesses into the Export Trade Sector Using Available Financial Tools and Resources,” Business Credit 109, no. 10 (2007), pp. 64–68.

18. For a review of the conditions under which a buyer has power over a supplier, see M. E. Porter, Competitive Strategy (New York: Free Press, 1980).

19. White, “Marlin Steel Wire Products.”

20. Exchange Agreements and Exchange Restrictions (Washington, DC: International Monetary Fund, 1989).

21. It’s also sometimes argued that countertrade is a way of reducing the risks inherent in a traditional money-for-goods transaction, particularly with entities from emerging economies. See C. J. Choi, S. H. Lee, and J. B. Kim, “A Note of Countertrade: Contractual Uncertainty and Transactional Governance in Emerging Economies,” Journal of International Business Studies 30, no. 1 (1999), pp. 189–202.

22. J. R. Carter and J. Gagne, “The Do’s and Don’ts of International Countertrade,” Sloan Management Review, Spring 1988, Page 417pp. 31–37; and W. Maneerungsee, “Countertrade: Farm Goods Swapped for Italian Electricity,” Bangkok Post, July 23, 1998.

23. Estimate from the American Countertrade Association at www.countertrade.org/index.htm. See also D. West, “Countertrade,” Business Credit 104, no. 4 (2001), pp. 64–67; and B. Meyer, “The Original Meaning of Trade Meets the Future of Barter,” World Trade 13 (January 2000), pp. 46–50.

24. Carter and Gagne, “The Do’s and Don’ts of International Countertrade.”

25. For details, see Carter and Gagne, “Do’s and Don’ts of International Countertrade”; J. F. Hennart, “Some Empirical Dimensions of Countertrade,” Journal of International Business Studies, 1990, pp. 240–60; and West, “Countertrade.”

26. D. J. Lecraw, “The Management of Counter-Trade: Factors Influencing Success,” Journal of International Business Studies, Spring 1989, pp. 41–59.

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