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Selecting and Managing
Entry Modes

CHAPTER ELEVEN

INTERNATIONAL

BUSINESS

The Challenges of Globalization

Canadian Edition

Wild • Wild • Valladares Montemayor

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Chapter Objectives

Explain how companies use exporting, importing, and countertrade

Explain the various means of financing export and import activities

Describe the different contractual entry modes that are available to companies

Explain the various types of investment entry modes

Discuss the important strategic factors in selecting an entry mode

In this chapter, you will learn how a firm can achieve its objectives through exporting, importing, and countertrade.

You will also:

Understand the ways in which a firm finances its import and export activities.
Explore various contractual and investment entry modes.
And examine the strategic factors in selecting an entry mode.

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World Leading Economies of
Merchandise Trade

Figure 11.1 shows the leading economies of merchandise trade: the

United States, China, Germany, Japan, France, and the Netherlands

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Step 1

Step 2

Identify a potential market

Match needs to abilities

Step 3

Initiate

meetings

Developing an Export Strategy

Step 4

Commit resources

There are four steps to creating an export strategy for international markets.

Step 1 is to identify a potential market.

Research a target market to discover whether sufficient demand exists. A novice exporter may focus on one or a few markets that are best understood in cultural terms.

Step 2 is to match needs to abilities.

This involves a frank assessment of a company’s ability to satisfy the needs of a prospective market.

Step 3 is to initiate meetings.

Schedule meetings with potential distributors, buyers, and others to build trust and cooperation. Negotiations between the parties will hammer out details of the working relationship.

Step 4 is to commit resources.

After agreements are finalized, employ the company’s resources to clearly define the export program’s objectives for at least the next 3 to 5 years.

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Degree of Export Involvement

Direct exporting

(sell to buyers)

Indirect exporting

(sell to intermediary)

Sales representative

Distributor

Agent
Export management company
Export trading company

A company can use intermediaries to deliver its products to foreign markets or perform the export activities itself.

Direct exporting involves selling directly to buyers in a target market.

A sales representative does not take title to merchandise and generally represents only one company’s products.
A distributor takes ownership of merchandise when it enters their country and sells locally using its own distribution channels.

Indirect exporting is selling to intermediaries who resell to the target market.

An agent represents companies in the target market and tends to receive a commission on sales.
An export management company (EMC) exports on behalf of an indirect exporter and operates contractually as an agent or distributor. The typical EMC will gather market information, formulate promotional strategies, research customer credit, arrange shipping, and coordinate export documents. While the EMC offers a deep understanding of the target market, this can hinder development of a client’s own exporting skills.
An export trading company (ETC) provides more services than those directly related to exporting. The typical ETC offers its client import, export, and countertrade services, access to distribution channels, storage facilities, new trade and investment projects, and manufacturing services.

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Avoiding Export Blunders

Conduct market research

Obtain export advice

Hire a freight forwarder

Companies new to international business often make export and import blunders.

Common reasons for this include a failure to conduct adequate market research or a failure to obtain adequate export advice.
To avoid committing such blunders, a company might choose to hire a freight forwarder, which is a specialist in export-related activities such as customs clearing, tariff schedules, shipping fees, and insurance. A freight forwarder can also pack merchandise for export and will accept responsibility for getting a shipment from the port of export to the port of import.

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Discussion Question

Source: www.spinmaster.com .

Spin Master, a Toronto-based toy company founded in 1994 by three college friends with only a $10 000 investment, is now the third largest toy manufacturer in North America, after Mattel and Hasbro

What are the four steps companies can follow when building an export strategy?

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Answer to Discussion Question

A company should not simply respond to international requests for its products, but should follow a four-step procedure to developing an export strategy. First, it should identify a potential market through careful market research and analysis. Second, it should match the needs of the market to its ability to satisfy those needs. Third, it should initiate meetings with potential distributors, buyers, and others to build trust and cooperation. And fourth, it must commit the company’s human, financial, and physical resources to getting the job done.

Answer:

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Forms of Countertrade

Barter

Counterpurchase

Offset agreement

Switch trading

Buyback

Direct exchange without money

Sale to a nation in return for promise of future purchase from that nation

Offset a hard-currency sale to a nation

with future hard-currency purchase

Sale by a company of an obligation to purchase from a country

Export of industrial equipment in return for products that the equipment produces

Countertrade is the selling of products that are paid for with other goods or services. It is used to access markets that are otherwise off-limits because of a lack of hard currency. There are five basic types of countertrade.

Barter is an exchange of products directly for other goods or services without using money.
Counterpurchase is the sale of products to a nation by a company that promises to make a future specific purchase from that nation.
Offset is an agreement that a company will offset a hard-currency sale to a nation with a future hard-currency purchase of an unspecified product from that nation.
Switch trading is when one company sells to another its obligation to make a purchase in a given country.
Buyback is the export of industrial equipment in return for products produced by that equipment.

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Export/Import Financing

International trade poses risks for both exporters and importers. Exporters risk not receiving payment after delivery, whereas importers fear that delivery might not occur once payment is made. Let’s examine four key methods of export and import financing.

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High Risk Methods

Exporter bills importer after merchandise ships

Importer pays exporter before merchandise ships

Open account

Advance payment

Open account financing is riskiest for the exporter, whereas advance payment is riskiest for the importer.

In open account, an exporter ships merchandise and later invoices the importer. This method is often used when two parties are familiar with each other, or for sales between two subsidiaries within an international company. This method creates the risk of nonpayment for exporters while removing the risk of non-shipment for importers.
In advance payment, an importer pays for merchandise before it is shipped. This method is often used when two parties are unfamiliar with each other, the value of the transaction is small, or the buyer has a poor credit rating. This method creates the risk of non-shipment for importers but eliminates the risk of nonpayment for exporters.

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Documentary Collection

Bank acts as intermediary without accepting financial risk

Draft (bill of exchange)

Document that orders an importer to pay an exporter a specific

sum of money at a specific time

Bill of lading

Contract between an exporter and shipper

specifying destination

and shipping costs

for merchandise

In the documentary collection financing method, a bank acts as an intermediary in a transaction without accepting financial risk. It is typically used in ongoing business relationships between two parties.

A draft (or bill of exchange) is a document ordering the importer to pay the exporter a specific sum of money at a specific time.
A bill of lading is a contract between the exporter and shipper that specifies the merchandise destination and its shipping costs.
Documentary collection reduces the risk of non-shipment because the bill of lading is proof of shipment. However, the risk of nonpayment increases because the importer does not pay until it receives all necessary documents from the exporter.

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Documentary Collection Process

This diagram shows how the documentary collection process actually works.

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Letter of Credit

Importer’s bank issues a document stating that the bank will pay the exporter when exporter fulfills document’s terms

Irrevocable

Revocable

Confirmed

In the letter of credit financing method, the importer’s bank issues a document stating that the bank will pay the exporter when the exporter fulfills the terms of the document. It is typically used when an importer’s credit rating is questionable, when an exporter needs to obtain financing, and when a market’s regulations require it. There are three main types of letters of credit.

An irrevocable letter of credit allows the bank issuing the letter to modify its terms only after obtaining the approval of both exporter and importer.
A revocable letter of credit can be modified by the issuing bank without obtaining approval from either the exporter or the importer.
And a confirmed letter of credit is guaranteed by both the exporter’s bank and the importer’s bank.
The letter of credit method reduces the risk of non-shipment for the importer because there is proof of shipment before payment. And although the risk of nonpayment increases, it is the importer’s bank that accepts this risk.

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Letter of Credit Process

This diagram shows how the letter of credit process actually works.

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Discussion Question

Barter, or trueque , became a way of life in Argentina when the nation’s economy was mired in a seemingly endless recession.

Export/import financing whereby a bank acts as an intermediary without accepting financial risk is called __________.

a. Offset financing

b. Letter of credit

c. Documentary collection

Export/import financing whereby a bank acts as an intermediary without accepting financial risk is called __________.

a. Offset financing

b. Letter of credit

c. Documentary collection

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Answer to Discussion Question

Export/import financing whereby a bank acts as an intermediary without accepting financial risk is called __________.

a. Offset financing

b. Letter of credit

c. Documentary collection

The correct answer is c. Documentary collection

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Licensing

Company owning intangible property (licensor) grants

another firm (licensee) the right to use it for a specific time

Advantages

Finance expansion
Reduce risks
Reduce counterfeits
Upgrade technologies

Restrict licensor’s activities
Reduce global consistency
Lend strategic property

Disadvantages

Let’s now turn our attention to several widely used contractual entry modes.

Licensing is when a company owning intangible property (the licensor) grants another firm (the licensee) the right to use that property for a specific period of time. Licensors receive royalty payments based on a percentage of revenue generated by property such as patents, copyrights, designs, formulas, trademarks, and brand names.
Licensing can allow a company to finance an international expansion, reduce international expansion risks, reduce the likelihood of counterfeit production, and help licensees upgrade their production technologies.
Yet, licensing may restrict a licensor’s future activities, reduce the global consistency of a product’s quality and marketing, and amount to “lending” strategically important property to future competitors.

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Franchising

Company (franchiser) supplies another (franchisee)

with intangible property over an extended period

Advantages

Low cost and low risk
Rapid expansion
Local knowledge

Cumbersome
Lost flexibility

Disadvantages

Another contractual entry mode is franchising, which is when one company (the franchiser) supplies another (the franchisee) with intangible property and assistance over an extended period of time. Franchisers typically receive compensation as flat fees or royalty payments for use of an asset, which is commonly a brand name or trademark.

Franchising is a low-cost and low-risk entry mode into new markets, allows for rapid geographic expansion, and makes use of local managers’ cultural knowledge.
Yet, managing franchisees across several nations can become cumbersome, and such agreements may reduce organizational flexibility for franchisees.

Think – Pair - Share

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Tesco is the largest British-based international grocery and general merchandising retail chain

Franchising helps Tesco ensure that individual stores company policies, product offerings, and service.

Can you think of other industries that employ franchising?

Slide 20 is the first “Think-Pair-Share” in this chapter. These slides are intended to stimulate discussion between students. The activity requires students to consider the question individually, and then share their thoughts with one classmate or a small group. The goals of these slides are to 1) improve students’ conceptual understanding of the material, 2) hone critical thinking skills, and 3) improve problem solving.

Tesco is the largest British-based international grocery and general merchandising retail chain ranked by global sales. Originally specializing

in food and drink, it has diversified into areas such as consumer electronics, financial services, movies and music, Internet service, and health insurance. Franchising helps Tesco ensure that individual stores meet company guidelines on matters such as company policies, product offerings, and service.

Can you think of other industries that employ franchising?

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Management Contract

Company supplies another with

managerial expertise for a

specific period of time

Advantages

Few assets risked
Nations finance projects
Develops local workforce

Disadvantages

Personnel at risk
Create competitor

Another contractual entry mode is a management contract, which is when one company supplies another with managerial expertise for a specific period of time. The supplier of expertise is compensated with either a lump-sum payment or a fee based on sales. Management contracts are used to transfer specialized knowledge of technical managers and business management skills.

Management contracts allow a firm to risk few assets when going international, let a nation upgrade its utilities when lacking financing, and help advance the skills of a nation’s workforce.
Yet, management contracts can endanger the lives of home-country managers when abroad in unstable markets, and can create new competitors in target markets by transferring valuable skills.

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Turnkey Project

Company designs, constructs, and tests

a production facility for a client

Advantages

Firms specialize in competency
Nations obtain infrastructure

Politicized process
Create competitor

Disadvantages

Another contractual entry mode is a turnkey project, which is when a company designs, constructs, and tests a production facility for a client. These projects are often large-scale utility projects in host countries. They usually transfer special process technologies or facility designs to a client.

Turnkey projects let a firm specialize in its core competency to exploit international opportunities, and allow a nation to obtain the latest infrastructure from the world’s leading companies.
Yet, turnkey projects may be awarded for political reasons rather than for technological know-how, and can create future international competitors.

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Discussion Question

In what ways does franchising differ from licensing?

Even vending machines can be franchised.

A vending machine in Berlin, Germany dispenses plastic bottles of cold beer for about $1 Cdn

Photo: Gerry Taft, Mount Royal University

In what ways does franchising differ from licensing?

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Answer to Discussion Question

Although franchising and licensing are both contractual entry modes, several key differences set them apart. First, franchising gives a company greater control over the sale of its product in a target market than does licensing. Second, franchising is primarily used in the service sector, whereas licensing is common in manufacturing industries. And third, franchising requires ongoing assistance from the franchiser, but licensing normally involves a one-time transfer of property.

Answer:

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Wholly Owned Subsidiary

Facility entirely owned and controlled by

a single parent company

Advantages

Day-to-day control
Coordinate subsidiaries

Disadvantages

Expensive
High risk

We now turn our attention to investment entry modes, which entail direct investment and ongoing involvement in a target market or host country.

Wholly owned subsidiaries are entirely owned and controlled by a single parent company. A subsidiary’s planned operations largely determines whether a company purchases an existing company or builds new from the ground up. For example, a firm that makes high-tech devices may need to build facilities because state-of-the-art operations are nonexistent. The benefits of building new must outweigh the time and resources required for construction, hiring and training employees, and launching production.
A wholly owned subsidiary gives a company total control over day-to-day local operations and valuable technologies, processes, and other intangibles. It also lets a firm coordinate activities of all its various national subsidiaries.
Yet, it can be an expensive entry mode and involve high risk exposure for a firm’s assets.

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Joint Venture

Company created and jointly owned by two or more entities to achieve a common objective

Advantages

Reduce risk level
Penetrate markets
Access channels

Disadvantages

Partner conflict
Lose control

Another investment entry mode is a joint venture, which is a separate company that is created and jointly owned by two or more independent entities to achieve a common objective.

A joint venture can reduce risk by sharing the investment with other parties, help penetrate international markets that are otherwise off-limits, and provide access to another party’s distribution channels.
Yet, conflict can develop between partners if objectives change, if one party’s goals are reached early, or if trust and cooperation break down. Also, parties may lose all control over the venture’s operations if the local government participates in the venture.

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Joint Venture Configurations

Joint ventures follow several common configurations.

In a forward integration joint venture, parties invest together in downstream business activities.
In a backward integration joint venture, parties invest together in upstream business activities.
In a buyback joint venture, each partner provides inputs and absorbs outputs.
And in a multistage joint venture, one partner integrates downstream while the other integrates upstream.

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Strategic Alliance

Disadvantages

Partner conflict

Create competitor

Advantages

Share project cost

Tap competitors’ strengths

Gain channel access

Entities cooperate (but do not form a separate company) to achieve strategic goals of each

Another investment entry mode is a strategic alliance, which is when two or more entities cooperate (but do not form a separate company) to achieve the strategic goals of each. Alliances may be formed for short or long periods, and can be formed between a company and its suppliers, buyers, and competitors.

A strategic alliance can allow firms to share the cost of an international investment project, tap competitors’ specific strengths, and access distribution channels.
Yet, conflict among partners may undermine cooperation, and an alliance may create a future competitor in a target market or even globally.

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Selecting Partners

Commitment
Trustworthiness
Cultural knowledge
Valuable contribution

There are several points to consider when selecting partners for cooperation.

First, each partner must be firmly committed to the stated goals of the cooperative arrangement. Detailing duties and contributions of each party through prior negotiations helps ensure continued cooperation.
Second, although the importance of locating a trustworthy partner seems obvious, cooperation should nevertheless be approached with caution.
Third, each party’s managers should be at ease working with people of other cultures and be comfortable traveling to, and perhaps living in, other cultures.
And fourth, managers should apply the same stringent evaluation criteria to a potential international cooperative arrangement as they would to any other investment opportunity.

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Strategic Factors

Cultural environment

Political/Legal environments

Market size

Production and shipping costs

International experience

Firms should consider several strategic factors when selecting an entry mode.

Cultural differences can reduce managers’ confidence in their ability to control operations in the host country. A lack of cultural familiarity can cause a firm to avoid investment entry and pursue exporting or contractual entry.
Political instability in a host country increases the risk exposure of assets. Political uncertainty can cause companies to avoid investment entry in favor of other modes. But a target market’s laws can encourage investment if, for example, it imposes high tariffs or low quota limits on imports.
Market size is often a determining factor in entry mode choice. Rising incomes can encourage investment to help a firm better understand the target market and prepare for growing demand. For example, companies are undertaking enormous investments in China, but making far more modest investments or pursuing exporting and contractual entry in smaller markets.
Low-cost production and shipping can give a company an advantage by helping it control total costs. If producing in a host country lowers a firm’s total production costs, it can encourage investment, licensing, or franchising.
As international experience grows, a firm may select entry modes that require deeper involvement, but which also involve greater exposure to risk.

Think – Pair - Share

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A German firm is considering a joint venture with a Chinese firm.

People from China and Germany have very different cultural backgrounds.

Is there anything the two companies can do to establish ethical principles, either before or after formation of the joint venture?

Source: Matthias Hiekel/Newscom.

Employees of Solar World monitor the automated

refinement process of silicon wafers at the company plant in Freiberg, Germany.

Slide 31 is the second “Think-Pair-Share” in this chapter. These slides are intended to stimulate discussion between students. The activity requires students to consider the question individually, and then share their thoughts with one classmate or a small group. The goals of these slides are to 1) improve students’ conceptual understanding of the material, 2) hone critical thinking skills, and 3) improve problem solving.

There are many differences between the German and Chinese cultures that can add to the complexity of a joint venture agreement. The differences in saving face, low versus high context culture, and individualism between German and Chinese workers should be considered when developing any cooperative policies. These differences can lead to ethical misconceptions due to different behavioral expectations. Further, up-front and frank discussions of potentially damaging ethical issues can help avoid potentially disastrous results based in ethical dilemmas. Better late than never if the formation has already taken place.

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Discussion Question

An investment entry mode that gives a company the most control over day-to-day activities in a host country is called a __________.

a. Joint venture

b. Strategic alliance

c. Wholly owned subsidiary

An investment entry mode that gives a company the most control over day-to-day activities in a host country is called a __________.

a. Joint venture

b. Strategic alliance

c. Wholly owned subsidiary

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Answer to Discussion Question

An investment entry mode that gives a company the most control over day-to-day activities in a host country is called a __________.

a. Joint venture

b. Strategic alliance

c. Wholly owned subsidiary

The correct answer is c. Wholly owned subsidiary