INTERNATIONAL BUSINESS MANAGEMENT TEST [6 HOURS DURATION]

WEEK7SLIDESENTERINGFOREIGNMARKETS1.pptm

Home >Business & Finance homework help >Management homework help >INTERNATIONAL BUSINESS MANAGEMENT TEST [6 HOURS DURATION]

ENTERING FOREIGN MARKETS 1

© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Learning Objectives

To examine different choices of entry modes.

To explain the theoretical reasoning(theories and factors) behind selection of entry modes.

Multimedia Lecture Support Package to Accompany Basic Marketing

Lecture Script 6-2

Entry mode choices

A very important topic

Firms expanding internationally must decide:

Which entry mode to choose? And why?

Where to enter ? Location?

When to enter? Timing!

Entry mode

Sharma and Erramilli (2004, p. 2) define an entry mode as ‘‘a structural agreement that allows a firm to implement its product market strategy in a host country either by carrying out only the marketing operations (i.e., via export modes), or both production and marketing operations there by itself or in partnership with others (contractual modes, joint ventures, wholly owned operations)’’.

Entry mode

Pan and Tse (2000) divide entry modes into two categories: equity and non-equity.

Equity modes (e.g., joint ventures and wholly owned ventures such as greenfields, brownfields through acquisitions) require the exercise of higher levels of control from firm headquarters, due to their involving a relatively large commitment to investment (Pan & Tse, 2000).

Entry mode

Non-equity modes (e.g., contractual modes such as licensing, R&D contracts, turnkey projects and other alliances) require lower levels of control since these forms of entry are much less investment intensive (see also Anderson & Gatignon, 1986).

13-7

7-8

FOREIGN DIRECT INVESTMENT (FDI)

Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country

the firm becomes a multinational enterprise

FDI can be in the form of

greenfield investments - the establishment of a wholly new operation in a foreign country

acquisitions or mergers with existing firms in the foreign country

Foreign direct investment, or FDI, occurs when a firm invests directly in facilities to produce and/or market their products or services in a foreign country.

Once a firm undertakes FDI it becomes a multinational enterprise or MNE.

There are two main forms of FDI.

A greenfield investment involves establishing a wholly owned new operation in a foreign country.

This is the type of investment that both Nissan and Mercedes Benz have.

The second type of FDI is an acquisition or merger with an existing firm in the foreign country.

The flow of FDI refers to the amount of FDI undertaken over a given period of time.

Outflows of FDI are the flows of FDI out of a country, while inflows of FDI are the flows of FDI into a country.

The stock of FDI refers to the total accumulated value of foreign-owned assets at a given time.

FDI (Wholly Owned Subsidiaries)

Wholly owned subsidiaries: 100% ownership of the subsidiary

Firms establishing a wholly owned subsidiary can:

Set up a new operation in that country (Greenfield)

Acquire an established firm (Acquisition)

Merge with a firm (Merger)

(FDI) Joint Ventures

Joint ventures: the establishment of a firm that is jointly owned by two or more otherwise independent firms

Advantages:

A firm can benefit from a local partner's knowledge of the host country's competitive conditions, culture, language, political systems, and business systems

The costs and risks of opening a foreign market are shared with the partner

They can help firms avoid the risk of nationalization or other adverse government interference

FDI (Joint Ventures)

Disadvantages:

The firm risks giving control of its technology to its partner

The firm may not have the tight control over subsidiaries that it might need to realize experience curve or location economies

Shared ownership can lead to conflicts and battles for control if goals and objectives differ or change over time

(FDI) Wholly Owned Subsidiaries

Advantages:

They reduce the risk of losing control over core competencies

They allow for the tight control over operations in different countries that is necessary for engaging in global strategic coordination

They may be required if a firm is trying to realize location and experience curve economies

Disadvantages:

Firms bear the full costs and risks of setting up overseas operations

Selecting an Entry Mode

Theoretical underpinning

Dunning’s OLI (ownership, location and internalization advantage)

Transaction cost

Institutional theory

Dunning’s OLI

Ownership advantage (O): creates a monopolistic advantage to be used in markets abroad

Unique ownership advantage protected through ownership

e.g., Brand, technology, economies of scale, management know-how

If ownership advantage is high (technology, brand) the firm would prefer FDI so that it can have more control over its investments

Dunning’s OLI

- Location advantage (L): the FDI destination market must offer factors (land, capital, know-how, cost/quality of labor, economies of scale) that are advantageous for the firm to locate its investment there (link to trade theory)

If location advantage is high (large market size, low cost of labour) the firm would prefer FDI so that it can have more control over its investments thus more profits.

Dunning’s OLI

Internalisation advantage (I)

Dunning drew on internalization theory, which examined why firms would choose to own and control value-added activities rather than rely on the market (LICENSING ETC).

The greater the firm perceives its O advantages to be, the greater its incentive to internalize their use thus use more control based entry mode - FDI

Transaction cost theory

A firm may encounter increased costs in finding or negotiating a market based agreement either (1) because of the difficulties of estimating and including all contingencies in the agreement, or (2) because of the inability to receive a fair price due to problems with information asymmetry (Taylor et al., 1998; Williamson, 1985).

Furthermore, monitoring and enforcing market contracts may be difficult due to distance, communication problems or the lack of measurable outputs (Hill, 1990; Williamson, 1985).

Transaction cost theory

So, if transaction cost is high (cost of monitoring licensee and franchisee and also their opportunistic behavior) firms will prefer to internalize its operation (not externalize) and use FDI.

So Dunning’s internalization theory is grounded on transaction cost theory

In the case of McDonald, the owners have a business model where they can control the franchisee and thus issue of high transaction cost will not arise. So Franchising is preferred.

Dunning’s OLI

IN THE CASE OF MCDONALD

Why McDonald prefer to use franchising (a form of licensing) to expand its business and not FDI?

Answer

Franchising allow them to exploit its ownership advantage (brand, recipe etc) so no need to internalize.

Not practical to use FDI.

Institutional theory and entry mode choice

Institutions here refer to formal regulations (written rules) and informal regulations (unwritten rules of the game –norms, traditions, culture)

Institutional theory and entry mode choice

In some countries, institutional structure may provide barriers to entry such as legal restrictions on ownership (Delios & Beamish, 1999; Gatignon & Anderson, 1988; Gomes-Casseres, 1990; North, 1990).

Firms entering countries with few legal restrictions on mode of entry tend to use wholly owned modes while firms entering countries with many legal restrictions on mode of entry tend to use joint venture modes.

Institutional theory and entry mode choice

Brouthers and Brouthers (2000: 91) suggest that the “cultural context helps to define profit potential and/or the risks associated with a specific market entry.”

Firms tend to be selective and prefer to enter more attractive, less risky markets (i.e., culturally similar countries with stable economic, social and political conditions).

Strategically, firms enter these markets with wholly owned modes in order to obtain a high return (Erramilli & Rao, 1993; Kim & Hwang, 1992).

Institutional theory and entry mode choice

However, firms tend to prefer joint venture modes when entering countries characterized by high investment risk.

Investment risk can impact both the need for local knowledge and the exposure of assets.

Beamish and Banks (1987) suggest that as investment risks increase, firms tend to seek local knowledge through joint ventures with local firms.

How Can Firms Enter Foreign Markets?

https://www.youtube.com/watch?v=D8-PkFgw2Yk

Factors influencing entry mode choice

Internal factors (firm size, international experience, product complexity, product differentiation advantage)

External factors (socio cultural distance, demand uncertainty, market size and growth, trade barrier, intensity of competition, number of relevant intermediaries)

Transaction related factors (tacit nature of know how, opportunistic behaviour)

Desired mode characteristic (risk averse, control, flexibility)

How Can Firms Enter Foreign Markets?

Factors influencing entry mode choice

Internal factors (firm size, international experience, product complexity, product differentiation advantage)

Firm size – The bigger the firm the more you may want to control your ownership advantage (brand, trademark, market share, knowledge) so you opt for FDI (more control)

International experience – the more experience you have the more knowledge you have thus you prefer FDI (why use licensing)

The more complex your products thus the more control you want coz you have no confidence that others can do it for you –prefer FDI

The more differentiated your product, the more profits you can make thus prefer to use FDI

Some of these factors are part of ownership advantage (Dunning’s O)

How Can Firms Enter Foreign Markets?

Factors influencing entry mode choice

2. External factors (socio cultural distance, demand uncertainty, market size and growth, trade barrier, intensity of competition, number of relevant intermediaries)

Many of these factors are Institutional factors and locational factors

If cultural distance is high the firm will prefer a JV (partial control entry mode) or Licensing (or franchising)

Demand undertainty means high economic risk so prefer to use less risky entry mode (maybe exporting or licensing)

If market size and growth is high prefer to use FDI (maximise profit)

If competition is intense economic risk increases so prefer less risky entry mode (exporting)

How Can Firms Enter Foreign Markets?

Factors influencing entry mode choice

3. Transaction related factors (tacit nature of know how, opportunistic behaviour)

Related to transaction cost theory

The more tacit the know how the more difficult to transfer (teach) to licensee or franchisee. So the cost of transferring this knowledge can be very high thus firms prefer FDI (more control)

How Can Firms Enter Foreign Markets?

4. Desired mode characteristic (risk averse, control, flexibility)

The more risk averse the owner of the business, lower control modes of entry are preferred (FDI entails more investment)

The owner do not want to let go his ownership advantage (prefer more control)

Owner is not flexible. The decision maker uses the same entry mode for all foreign markets.

Greenfield or Acquisition?

Question: Should a firm establish a wholly owned subsidiary in a country by:

Building a subsidiary from the ground up: greenfield strategy

Acquiring an established enterprise in the target market: acquisition strategy

Answer:

The number of cross border acquisitions are increasing

Over the last decade, 40-80% of all FDI inflows have been mergers and acquisitions

Pros and Cons of Acquisitions

Acquisitions:

Are quick to execute

Enable firms to preempt their competitors

Can be less risky than greenfield ventures

However, many acquisitions are not successful

Pros and Cons of Acquisitions (continued from Slide 13-30)

Question: Why do acquisitions fail?

Answer:

Acquisitions fail when:

The firm overpays for the assets of the acquired firm

There is a clash between the cultures of the acquiring and acquired firm

Attempts to realize synergies by integrating the operations of the acquired and acquiring entities run into roadblocks and take much longer than forecast

There is inadequate pre-acquisition screening

Pros and Cons of Acquisitions (continued from Slide 13-31)

Question: How can firms reduce the problems associated with acquisitions?

Answer:

Firms can reduce the problems associated with acquisitions:

Through careful screening of the firm to be acquired

By moving rapidly once the firm is acquired to implement an integration plan

Pros & Cons of Greenfield Ventures

Question: Why are greenfield ventures attractive?

Answer:

Greenfield ventures are attractive because they allow the firm to build the kind of subsidiary company that it wants

However, greenfield ventures:

Are slower to establish

Are risky because they have no proven track record

Can be problematic if a competitor enters via acquisition and quickly builds market share

Advantage/Disadvantage entry mode

Advantages and Disadvantages of Entry Modes