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chapter_7.docxInternational Strategy:
Creating Value in Global Markets
After reading this chapter, you should have a good understanding of the following learning objectives:
LO7.1 The importance of international expansion as a viable diversification strategy.
LO7.2 The sources of national advantage; that is, why an industry in a given country is more (or less) successful than the same industry in another country.
LO7.3 The motivations (or benefits) and the risks associated with international expansion, including the emerging trend for greater offshoring and outsourcing activity.
LO7.4 The two opposing forces—cost reduction and adaptation to local markets—that firms face when entering international markets.
LO7.5 The advantages and disadvantages associated with each of the four basic strategies: international, global, multidomestic, and transnational.
LO7.6 The difference between regional companies and truly global companies.
LO7.7 The four basic types of entry strategies and the relative benefits and risks associated with each of them.
Learning from Mistakes
SAIC, a major Chinese automaker, wanted to grow outside its home market. As a step to achieve this aim, it acquired a controlling interest in SsangYong, a struggling Korean automaker, in 2004. 1 However, this investment didn’t turn out as SAIC had hoped. After five tumultuous years and $618 million in investment, SAIC decided to stop any further investments in SsangYong and saw its ownership stake erode when SsangYong went into bankruptcy in 2009. Why did SAIC’s takeover of SsangYong turn out so badly?
SAIC, formerly known as Shanghai Automotive Industry Corporation, grew from a small firm in the 1970s to the largest Chinese-based automaker by 2010. It has leveraged relationships with major global automakers, including Volkswagen and GM, to develop its resources to design and build world-class cars. Building off of its success at home, SAIC wanted to grow its global footprint.
As a first step in this effort, SAIC undertook its first acquisition of a non-Chinese firm. In 2004, SAIC paid $500 million to acquire 49 percent of SsangYong, the number four auto manufacturer in South Korea. SsangYong had a 10 percent share of the Korean car market and was especially strong in the small SUV market. In addition to its Korean sales base, it was building its export business.
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Analysts saw the acquisition as one with strong promise. SAIC would gain access to its first foreign markets and also access to SsangYong’s advanced technologies. Of great potential value was SsangYong’s hybrid engine technology. SsangYong, which was burdened by heavy debt, would be recapitalized by SAIC. Additionally, SAIC, which had very efficient plant operations, could help improve SsangYong’s production efficiency.
Even with all of the potential, problems quickly arose. Cultural differences between Chinese and Korean managers hampered their ability to agree on how to restructure SsangYong. SAIC had even greater difficulties negotiating with SsangYong’s unions. South Korea has a heritage of strong unions and difficult management-labor relations, something that was entirely new to SAIC.
These differences were exacerbated by a steep drop in demand for SsangYong’s vehicles. When gasoline prices spiked in 2006, SUV sales dropped dramatically. Further, when the global recession hit in late 2007, global auto sales tanked. SsangYong’s sales were cut in half by the end of 2008.
SAIC proposed a dramatic overhaul at SsangYong, with major changes in shop-floor practices to improve efficiency and a 36 percent reduction in SsangYong’s workforce. SsangYong’s unions rebelled and charged that SAIC was illegally transferring technology designs and technology to China. Without any further cash infusion from SAIC, SsangYong filed for bankruptcy in January 2009. The unions went on strike and barricaded themselves in SsangYong’s plants for 77 days. SAIC wrote off its investments in SsangYong and blamed the experience for their 26 percent drop in profits in the first half of 2009.
Discussion Questions
1. What lessons should SAIC learn from its acquisition of SsangYong?
2. When buying a firm in another country, what issues should the acquiring firm think about to limit the risks they will face with the acquisition?
3. How can a firm bridge cultural differences between their home market and a country they are moving into?
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In this chapter we discuss how firms create value and achieve competitive advantage in the global marketplace. Multinational firms are constantly faced with the dilemma of choosing between local adaptation—in product offerings, locations, advertising, and pricing—and global integration. We discuss how firms can avoid pitfalls such as those experienced by SAIC, a major Chinese automaker. In addition, we address factors that can influence a nation’s success in a particular industry. In our view, this is an important context in determining how well firms might eventually do when they compete beyond their nation’s boundaries.
LO7.1
The importance of international expansion as a viable diversification strategy.
The Global Economy: A Brief Overview
Managers face many opportunities and risks when they diversify abroad. 2 The trade among nations has increased dramatically in recent years and it is estimated that by 2015, the trade across nations will exceed the trade within nations. In a variety of industries such as semiconductors, automobiles, commercial aircraft, telecommunications, computers, and consumer electronics, it is almost impossible to survive unless firms scan the world for competitors, customers, human resources, suppliers, and technology. 3
GE’s wind energy business benefits by tapping into talent around the world. The firm has built research centers in China, Germany, India, and the U.S. “We did it,” says CEO Jeffrey Immelt, “to access the best brains everywhere in the world.” All four centers have played a key role in GE’s development of huge 92-ton turbines: 4
• Chinese researchers in Shanghai designed the microprocessors that control the pitch of the blade.
• Mechanical engineers from India (Bangalore) devised mathematical models to maximize the efficiency of materials in the turbine.
• Power-systems experts in the U.S. (Niskayuna, New York), which has researchers from 55 countries, do the design work.
• Technicians in Munich, Germany, have created a “smart” turbine that can calculate wind speeds and signal sensors in other turbines to produce maximum electricity.
The rise of globalization —meaning the rise of market capitalism around the world—has undeniably created tremendous business opportunities for multinational corporations. For example, mobile handset manufacturers sold over 700 million cell phones in emerging markets in 2012. 5
globalization
has two meanings. One is the increase in international exchange, including trade in goods and services as well as exchange of money, ideas, and information. Two is the growing similarity of laws, rules, norms, values, and ideas across countries.
This rapid rise in global capitalism has had dramatic effects on the growth in different economic zones. As shown in Exhibit 7.1 , the growth experienced by developed economies in the first decade of the 2000s was anemic, while the growth in developing economies was robust. 6 This trend is continuing, with emerging markets growing 4 percent faster than developed markets in 2011 and 2012. This has resulted in a dramatic shift in the structure of the global economy. As of 2013, over half the world’s output will come from emerging markets. This is leading to a convergence of living standards across the globe and is changing the face of business. One example of this is the shift in the global automobile market. China supplanted the United States as the largest market for automobiles in 2009.
One of the challenges with globalization is determining how to meet the needs of customers at very different income levels. In many developing economies, distributions of income remain much wider than they do in the developed world, leaving many impoverished even as the economies grow. Strategy Spotlight 7.1 provides an interesting perspective on global trade—marketing to the “bottom of the pyramid.” 7 This refers to the practice of a multinational firm targeting its goods and services to the nearly 5 billion poor people in the world who inhabit developing countries. Collectively, this represents a very large market with $14 trillion in purchasing power.
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STRATEGY SPOTLIGHT |
7.1 |
MEETING THE NEEDS AT THE “BOTTOM OF THE PYRAMID”
Unilever, the Anglo-Dutch maker of such brands as Dove, Lipton, and Vaseline, has found a vast market selling to poor consumers in emerging markets by upending some of the basic rules of marketing. Their efforts allow them to exploit vast opportunities that exist at “the bottom of the pyramid.”
Unilever’s strategy was forged about 25 years ago when its Indian subsidiary, Hindustan Lever (HL), found its products out of reach for millions of Indians. HL came up with a strategy to lower the price while making a profit: single-use packets for everything from shampoo to laundry detergent, costing pennies a pack. A bargain? Maybe not, but it put marquee brands within reach. Instead of focusing on value for money, it shrunk packages to set a price even consumers living on $2.50 a day could afford. HL also trained rural women to sell products to their neighbors. “What Unilever does well is get inside these communities, understand their needs, and adapt its business model accordingly,” notes a professor at Barcelona’s IESE Business School. “It’s not about doing good, but about tapping new markets,” says Chief Executive Patrick Cescau.
The potential goes well beyond personal products, such as shampoo and soap. Firms in a range of industries are seeing potential with the BOP market. For example, DataWind, a British firm, has developed a tablet computer in partnership with the Indian government that only costs $35. Similarly, Vodafone offers a cell phone in India for $15. These firms view the poor as a bold frontier of opportunity for those who can meet their needs.
Firms need to actively manage the risks that accompany BOP strategies. These include concerns about the image of the firm if they are perceived as exploiting underprivileged customers by providing them with substandard products or selling them something they don’t need or can’t afford. Second, there is a risk that a low-end version of a brand may detract from the overall attractiveness of the brand. Third, the new low-cost products they develop may cannibalize the sales of their core products. Finally, firms employing a BOP strategy need to be aware of the entrenched competitors they may face. For example, over 90 percent of India’s juice market is run by small players, many of whom do not conform to quality or safety standards.
Sources: Karamchandani, A., Kubzansky, M. & Lalwani, N. 2011. Is the bottom of the pyramid really for you? Harvarrd Business Review, 89(3): 107; Now for some good news. 2012. Economist, March 3: 80; McGregor, J. 2008. The world’s most influential companies. BusinessWeek, December 22: 43–53; and Prahalad, C. K. 2005. The Fortune at the Bottom of the Pyramid: Eradicating Poverty through Profits. Philadelphia: Wharton School Publishing.
EXHIBIT 7.1 Growth in GDP per Person from 2001–2011 by Region
Source: A game of catch-up. 2011. The Economist, September 24: 3–6
Next, we will address in more detail the question of why some nations and their industries are more competitive.8 This establishes an important context or setting for the remainder of the chapter. After we discuss why some nations and their industries outperform others, we will be better able to address the various strategies that firms can take to create competitive advantage when they expand internationally.
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LO7.2
The sources of national advantage; that is, why an industry in a given country is more (or less) successful than the same industry in another country.
Factors Affecting a Nation’s Competitiveness
Michael Porter of Harvard University conducted a four-year study in which he and a team of 30 researchers looked at the patterns of competitive success in 10 leading trading nations. He concluded that there are four broad attributes of nations that individually, and as a system, constitute what is termed the diamond of national advantage. In effect, these attributes jointly determine the playing field that each nation establishes and operates for its industries. These factors are:
diamond of national advantage
a framework for explaining why countries foster successful multinational corporations, consisting of four factors— factor endowments ; demand conditions ; related and supporting industries ; and firm strategy, structure, and rivalry .
• Factor endowments. The nation’s position in factors of production, such as skilled labor or infrastructure, necessary to compete in a given industry.
• Demand conditions. The nature of home-market demand for the industry’s product or service.
• Related and supporting industries. The presence or absence in the nation of supplier industries and other related industries that are internationally competitive.
• Firm strategy, structure, and rivalry. The conditions in the nation governing how companies are created, organized, and managed, as well as the nature of domestic rivalry.
factor endowments (national advantage)
a nation’s position in factors of production.
demand conditions (national advantage)
the nature of home-market demand for the industry’s product or service.
Factor Endowments9, 10
Classical economics suggests that factors of production such as land, labor, and capital are the building blocks that create usable consumer goods and services.11 However, companies in advanced nations seeking competitive advantage over firms in other nations create many of the factors of production. For example, a country or industry dependent on scientific innovation must have a skilled human resource pool to draw upon. This resource pool is not inherited; it is created through investment in industry-specific knowledge and talent. The supporting infrastructure of a country—that is, its transportation and communication systems as well as its banking system—are also critical.
Factors of production must be developed that are industry and firm specific. In addition, the pool of resources is less important than the speed and efficiency with which these resources are deployed. Thus, firm-specific knowledge and skills created within a country that are rare, valuable, difficult to imitate, and rapidly and efficiently deployed are the factors of production that ultimately lead to a nation’s competitive advantage.
For example, the island nation of Japan has little land mass, making the warehouse space needed to store inventory prohibitively expensive. But by pioneering just-in-time inventory management, Japanese companies managed to create a resource from which they gained advantage over companies in other nations that spent large sums to warehouse inventory.
Demand Conditions
Demand conditions refer to the demands that consumers place on an industry for goods and services. Consumers who demand highly specific, sophisticated products and services force firms to create innovative, advanced products and services to meet the demand. This consumer pressure presents challenges to a country’s industries. But in response to these challenges, improvements to existing goods and services often result, creating conditions necessary for competitive advantage over firms in other countries.
Countries with demanding consumers drive firms in that country to meet high standards, upgrade existing products and services, and create innovative products and services. The conditions of consumer demand influence how firms view a market. This, in turn, helps a nation’s industries to better anticipate future global demand conditions and proactively respond to product and service requirements.
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Denmark, for instance, is known for its environmental awareness. Demand from consumers for environmentally safe products has spurred Danish manufacturers to become leaders in water pollution control equipment—products it successfully exported.
Related and Supporting Industries
Related and supporting industries enable firms to manage inputs more effectively. For example, countries with a strong supplier base benefit by adding efficiency to downstream activities. A competitive supplier base helps a firm obtain inputs using cost-effective, timely methods, thus reducing manufacturing costs. Also, close working relationships with suppliers provide the potential to develop competitive advantages through joint research and development and the ongoing exchange of knowledge.
related and supporting industries (national advantage)
the presence, absence, and quality in the nation of supplier industries and other related industries that supply services, support, or technology to firms in the industry value chain.
Related industries offer similar opportunities through joint efforts among firms. In addition, related industries create the probability that new companies will enter the market, increasing competition and forcing existing firms to become more competitive through efforts such as cost control, product innovation, and novel approaches to distribution. Combined, these give the home country’s industries a source of competitive advantage.
In the Italian footwear industry the supporting industries enhance national competitive advantage. In Italy, shoe manufacturers are geographically located near their suppliers. The manufacturers have ongoing interactions with leather suppliers and learn about new textures, colors, and manufacturing techniques while a shoe is still in the prototype stage. The manufacturers are able to project future demand and gear their factories for new products long before companies in other nations become aware of the new styles.
Firm Strategy, Structure, and Rivalry
Rivalry is particularly intense in nations with conditions of strong consumer demand, strong supplier bases, and high new entrant potential from related industries. This competitive rivalry in turn increases the efficiency with which firms develop, market, and distribute products and services within the home country. Domestic rivalry thus provides a strong impetus for firms to innovate and find new sources of competitive advantage.
firm strategy, structure, and rivalry (national advantage)
the conditions in the nation governing how companies are created, organized, and managed, as well as the nature of domestic rivalry.
This intense rivalry forces firms to look outside their national boundaries for new markets, setting up the conditions necessary for global competitiveness. Among all the points on Porter’s diamond of national advantage, domestic rivalry is perhaps the strongest indicator of global competitive success. Firms that have experienced intense domestic competition are more likely to have designed strategies and structures that allow them to successfully compete in world markets.
In the European grocery retail industry, intense rivalry has led firms such as Aldi and Tesco to tighten their supply chains and improve store efficiency. Thus, it is no surprise that these firms are also strong global players.
The Indian software industry offers a clear example of how the attributes in Porter’s “diamond” interact to lead to the conditions for a strong industry to grow. Exhibit 7.2 illustrates India’s “software diamond,” and Strategy Spotlight 7.2 further discusses the mutually reinforcing elements at work in this market.
Concluding Comment on Factors Affecting a Nation’s Competitiveness
Porter drew his conclusions based on case histories of firms in more than 100 industries. Despite the differences in strategies employed by successful global competitors, a common theme emerged: Firms that succeeded in global markets had first succeeded in intensely competitive home markets. We can conclude that competitive advantage for global firms typically grows out of relentless, continuing improvement, and innovation.12
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7.2 |
INDIA AND THE DIAMOND OF NATIONAL ADVANTAGE
The Indian software industry has become one of the leading global markets for software. The industry has grown to over $60 billion, and Indian IT firms provide software and services to over half the Fortune 500 firms. What are the factors driving this success? Porter’s diamond of national advantage helps clarify this question. See Exhibit 7.2.
First, factor endowments are conducive to the rise of India’s software industry. Through investment in human resource development with a focus on industry-specific knowledge, India’s universities and software firms have literally created this essential factor of production. For example, India produces the second largest annual output of scientists and engineers in the world, behind only the United States. In a knowledge-intensive industry such as software, development of human resources is fundamental to both domestic and global success.
Second, demand conditions require that software firms stay on the cutting edge of technological innovation. India has already moved toward globalization of its software industry; consumer demand conditions in developed nations such as Germany, Denmark, parts of Southeast Asia, and the United States created the consumer demand necessary to propel India’s software makers toward sophisticated software solutions.*
Third, India has the supplier base as well as the related industries needed to drive competitive rivalry and enhance competitiveness. In particular, information technology (IT) hardware prices declined rapidly in the 1990s. Furthermore, rapid technological change in IT hardware meant that latecomers like India were not locked into older-generation technologies. Thus, both the IT hardware and software industries could “leapfrog” older technologies. In addition, relationships among knowledge workers in these IT hardware and software industries offer the social structure for ongoing knowledge exchange, promoting further enhancement of existing products. Further infrastructure improvements are occurring rapidly.
Fourth, with over 800 firms in the software services industry in India, intense rivalry forces firms to develop competitive strategies and structures. Although firms like TCS, Infosys, and Wipro have become large, they still face strong competition from dozens of small and midsized companies aspiring to catch them. This intense rivalry is one of the primary factors driving Indian software firms to develop overseas distribution channels, as predicted by Porter’s diamond of national advantage.
EXHIBIT 7.2 India’s Diamond in Software
Source: From Kampur D. and Ramamurti R., “India’s Emerging Competition Advantage in Services,” Academy of Management Executive: The Thinking Manager’s Source. Copyright © 2001 by Academy of Management. Reproduced with permission of Academy of Management via Copyright Clearance Center.
It is interesting to note that the cost advantage of Indian firms may be eroding. For example, TCS’s engineers’ compensation soared 13 percent in 2010. Further, IBM and Accenture
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are aggressively building up their Indian operations, hiring tens of thousands of sought-after Indians by paying them more, thereby lowering their costs while raising those of TCS. Finally, many low labor-cost countries, such as China, Philippines, and Vietnam, are emerging as threats to the Indian competitors.
*Although India’s success cannot be explained in terms of its home market demand (according to Porter’s model), the nature of the industry enables software to be transferred among different locations simultaneously by way of communications links. Thus, competitiveness of markets outside India can be enhanced without a physical presence in those markets.
Sources: Sachitanand, R. 2010. The New Face of IT. Business Today, 19:62; Anonymous. 2010. Training to Lead. www.Dqindia.com . October 5: np; Nagaraju, B.2011. India’s Software Exports Seen Up 16–18 pct.in Fy12. www.reuters.com. February 2: np; Ghemawat, P. & Hout, T. 2008. Tomorrow’s Global Giants. Harvard Business Review, 86(11): 80–88; Mathur, S. K. 2007. Indian IT Industry: A Performance Analysis and a Model for Possible Adoption. ideas.repec.org , January 1: np; Kripalani, M. 2002. Calling Bangalore: Multinationals Are Making It a Hub for High-Tech Research BusinessWeek, November 25: 52–54; Kapur, D. & Ramamurti, R. 2001. India’s Emerging Competitive Advantage in Services. 2001. Academy of Management Executive, 15(2): 20–33; World Bank. World Development Report: 6. New York: Oxford University Press. Reuters. 2001. Oracle in India Push, Taps Software Talent. Washington Post Online, July 3.
LO7.3
The motivations (or benefits) and the risks associated with international expansion, including the emerging trend for greater offshoring and outsourcing activity.
International Expansion: A Company’s Motivations and Risks
Motivations for International Expansion
Increase Market Size There are many motivations for a company to pursue international expansion. The most obvious one is to increase the size of potential markets for a firm’s products and services.13 The world’s population passed the 7 billion level in early 2013, with the U.S. representing less than 5 percent.
Many multinational firms are intensifying their efforts to market their products and services to countries such as India and China as the ranks of their middle class have increased over the past decade. The potential is great. An OECD study predicts that consumption by middle-class consumers in Asian markets with grow from $4.9 trillion in 2009 to over $30 trillion by 2020. At that point, Asia will make up 60 percent of global middle-class consumption, up from 20 percent in 2009.14
multinational firms
firms that manage operations in more than one country.
Expanding a firm’s global presence also automatically increases its scale of operations, providing it with a larger revenue and asset base.15 As we noted in Chapter 5 in discussing overall cost leadership strategies, such an increase in revenues and asset base potentially enables a firm to attain economies of scale. This provides multiple benefits. One advantage is the spreading of fixed costs such as R&D over a larger volume of production. Examples include the sale of Boeing’s commercial aircraft and Microsoft’s operating systems in many foreign countries.
Filmmaking is another industry in which international sales can help amortize huge developmental costs.16 For example, 71 percent of the $1 billion box office take for the James Bond thriller Skyfall came from overseas moviegoers. Similarly, the market for kids’ movies is largely outside of the U. S., with 82 percent of the ticket sales for Ice Age 4 being overseas.
Take Advantage of Arbitrage Taking advantage of arbitrage opportunities is a second advantage of international expansion. In its simplest form, arbitrage involves buying something from where it is cheap and selling it somewhere where it commands a higher price. A big part of Walmart’s success can be attributed to the company’s expertise in arbitrage. The possibilities for arbitrage are not necessarily confined to simple trading opportunities. It can be applied to virtually any factor of production and every stage of the value chain. For example, a firm may locate its call centers in India, its manufacturing plants in China, and its R&D in Europe, where the specific types of talented personnel may be available at the lowest possible price. In today’s integrated global financial markets, a firm can borrow anywhere in the world where capital is cheap and use it to fund a project in a country where capital is expensive. Such arbitrage opportunities are even more attractive to global corporations because their larger size enables them to buy in huge volume, thus increasing their bargaining power with suppliers.
an opportunity to profit by buying and selling the same good in different markets.
Enhancing a Product’s Growth Potential Enhancing the growth rate of a product that is in its maturity stage in a firm’s home country but that has greater demand potential
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elsewhere is another benefit of international expansion. As we noted in Chapter 5, products (and industries) generally go through a four-stage life cycle of introduction, growth, maturity, and decline. In recent decades, U.S. soft-drink producers such as Coca-Cola and PepsiCo have aggressively pursued international markets to attain levels of growth that simply would not be available in the United States. The differences in market growth potential has even led some firms to restructure their operations. For example, Procter & Gamble relocated its global skin, cosmetics, and personal-care unit headquarters from Cincinnati to Singapore to be closer to the fast-growing Asian market.17
Optimize the Location of Value-Chain Activities Optimizing the physical location for every activity in its value chain is another benefit. Recall from our discussions in Chapters 3 and 5 that the value chain represents the various activities in which all firms must engage to produce products and services. They include primary activities, such as inbound logistics, operations, and marketing, as well as support activities, such as procurement, R&D, and human resource management. All firms have to make critical decisions as to where each activity will take place.18 Optimizing the location for every activity in the value chain can yield one or more of three strategic advantages: performance enhancement, cost reduction, and risk reduction. We will now discuss each of these.
Performance Enhancement Microsoft’s decision to establish a corporate research laboratory in Cambridge, England, is an example of a location decision that was guided mainly by the goal of building and sustaining world-class excellence in selected value-creating activities.19 This strategic decision provided Microsoft with access to outstanding technical and professional talent. Location decisions can affect the quality with which any activity is performed in terms of the availability of needed talent, speed of learning, and the quality of external and internal coordination.
Cost Reduction Two location decisions founded largely on cost-reduction considerations are (1) Nike’s decision to source the manufacture of athletic shoes from Asian countries such as China, Vietnam, and Indonesia, and (2) the decision of Volkswagen to locate a new auto production plant in Chattanooga, Tennessee, to leverage the relatively low labor costs in the area as well as low shipping costs due to Chattanooga’s close proximity to both rail and river transportation. Such location decisions can affect the cost structure in terms of local manpower and other resources, transportation and logistics, and government incentives and the local tax structure.
Performance enhancement and cost-reduction benefits parallel the business-level strategies (discussed in Chapter 5) of differentiation and overall cost leadership. They can at times be attained simultaneously. Consider our example in the previous section on the Indian software industry. When Oracle set up a development operation in that country, the company benefited both from lower labor costs and operational expenses as well as from performance enhancements realized through the hiring of superbly talented professionals.
Risk Reduction Given the erratic swings in the exchange ratios between the U.S. dollar and the Japanese yen (in relation to each other and to other major currencies), an important basis for cost competition between Ford and Toyota has been their relative ingenuity at managing currency risks. One way for such rivals to manage currency risks has been to spread the high-cost elements of their manufacturing operations across a few select and carefully chosen locations around the world. Location decisions such as these can affect the overall risk profile of the firm with respect to currency, economic, and political risks.20
new products developed by developed country multination firms for emerging markets that have adequate functionality at a low cost.
Explore Reverse Innovation Finally, exploring possibilities for reverse innovation has become a major motivation for international expansion. Many leading companies are discovering that developing products specifically for emerging markets can pay off in a big way.
In the past, multinational companies typically developed products for their rich home markets and then tried to sell them in developing countries with minor adaptations. However, as growth slows in rich nations and demand grows rapidly in developing countries such as India and China, this approach becomes increasingly inadequate. Instead, companies like GE have committed significant resources to developing products that meet the needs of developing nations, products that deliver adequate functionality at a fraction of the cost. Interestingly, these products have subsequently found considerable success in value segments in wealthy countries as well. Hence, this process is referred to as reverse innovation, a new motivation for international expansion.
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7.3 |
REVERSE INNOVATION: HOW DEVELOPING COUNTRIES ARE BECOMING HOTBEDS OF INNOVATION
A number of firms have seen the need to develop technologies and products that are appropriate to developing markets, only to find that these innovations are valuable in their home markets as well. Here are a few examples of firms who have leveraged or are striving to leverage “reverse innovation.”
• GE Healthcare developed a portable, inexpensive ultrasound device, called the Vscan, in China. This device cost one-tenth what a full-scale ultrasound device would cost in the United States. The product is a hit in China as well as in other developing markets. GE also sees tremendous potential for the product in developed markets. The main unit of the device is small enough and cheap enough to put one in the pocket of every physician, paramedic, and emergency room nurse. GE’s vision is to have the Vscan become as indispensable as the stethoscope as a diagnostic tool.
• Moline, Illinois-based Deere & Co. opened a center in Pune, India, almost a decade ago with the intention to penetrate the Indian market. Deere, a firm known for its heavy-duty farm equipment and big construction gear, used the Pune facility to design four no-frills models. Though lacking first-world features like GPS and air conditioning, they were sturdy enough to handle the rigors of commercial farming. The tractors cost as little as $7000, compared to over $300,000 for a fully loaded 8360R tractor in the United States. Subsequently, Deere targeted a segment of the home market that they had previously largely ignored—hobbyists as well as bargain hunters. These buyers do not care for advanced features but covet the same qualities as Indian farmers: affordability and maneuverability. Today, half of the no-frills models that Deere produces in India are exported to other countries.
• The potential even exists in service industries. Walmart developed “small mart stores” to meet the needs of customers in Argentina, Brazil, and Mexico but is now transferring this idea back to the United States to compete in areas, such as urban markets, where a full-size Walmart is not workable.
• Pepsi is now seeing potential with this model. It built a global innovation center in India in 2010 and hopes to develop products and packaging that will meet the needs of the Indian market and other markets as well.
Sources: Frugal ideas are spreading from East to West. 2012. Economist, March 24: 68; and Singh, S. & Nagarajan, G. 2011. Small is beautiful for John Deere. Bloomberg Businessweek, September 26: 33–34.
As $3,000 cars, $300 computers, and $30 mobile phones bring what were previously considered as luxuries within the reach of the middle class of emerging markets, it is important to understand the motivations and implications of reverse innovation. First, it is impossible to sell first-world versions of products with minor adaptations in countries where the average income per person is between $1,000 and $4,000, as is the case in most developing countries. To sell in these markets, entirely new products must be designed and developed by local technical talent and manufactured with local components. Second, although these countries are relatively poor, they are growing rapidly. Third, if the innovation does not come from first-world multinationals, there are any number of local firms that are ready to grab the market with low-cost products. Fourth, as the consumers and governments of many first-world countries are rediscovering the virtues of frugality and are trying to cut down expenses, these products and services originally developed for the first world may gain significant market shares in developing countries as well.
Strategy Spotlight 7.3 describes some examples of reverse innovation.
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Potential Risks of International Expansion
When a company expands its international operations, it does so to increase its profits or revenues. As with any other investment, however, there are also potential risks.21 To help companies assess the risk of entering foreign markets, rating systems have been developed to evaluate political, economic, as well as financial and credit risks.22 Euromoney magazine publishes a semiannual “Country Risk Rating” that evaluates political, economic, and other risks that entrants potentially face.23 Exhibit 7.3 presents a sample of country risk ratings, published by the World Bank, from the 178 countries that Euromoney evaluates. Note that the lower the score, the higher the country’s expected level of risk.24
Next we will discuss the four main types of risk: political risk, economic risk, currency risk, and management risk.
Political and Economic Risk Generally speaking, the business climate in the United States is very favorable. However, some countries around the globe may be hazardous to the health of corporate initiatives because of political risk .25 Forces such as social unrest, military turmoil, demonstrations, and even violent conflict and terrorism can pose serious threats.26 Consider, for example, the ongoing tension and violence in the Middle East associated with the revolutions and civil wars in Egypt, Libya, Syria, and other countries. Such conditions increase the likelihood of destruction of property and disruption of operations as well as nonpayment for goods and services. Thus, countries that are viewed as high risk are less attractive for most types of business.27
political risk
potential threat to a firm’s operations in a country due to ineffectiveness of the domestic political system.
Another source of political risk in many countries is the absence of the rule of law. The absence of rules or the lack of uniform enforcement of existing rules leads to what might often seem to be arbitrary and inconsistent decisions by government officials. This can make it difficult for foreign firms to conduct business.
rule of law
a characteristic of legal systems where behavior is governed by rules that are uniformly enforced.
For example, consider Renault’s experience in Russia. Renault paid $1 billion to acquire a 25 percent ownership stake in the Russian automaker AutoVAZ in 2008. Just one year later, Russian Prime Minister Vladimir Putin threatened to dilute Renault’s ownership stake unless it contributed more money to prop up AutoVAZ, which was then experiencing a significant slide in sales. Renault realized their ownership claim may not have held up in the corrupt Russian court system. Therefore, they were forced to negotiate and eventually agreed to transfer over $300 million in technology and expertise to the Russian firm to ensure its ownership stake would stay at 25 percent.28
Strategy Spotlight 7.4 discusses ways firms can reduce the political risk they face in countries with weak rules of law.
The laws, and the enforcement of laws, associated with the protection of intellectual property rights can be a major potential economic risk in entering new countries.29 Microsoft, for example, has lost billions of dollars in potential revenue through piracy of its software products in many countries, including China. Other areas of the globe, such as the former Soviet Union and some eastern European nations, have piracy problems as well.30 Firms rich in intellectual property have encountered financial losses as imitations of their products have grown due to a lack of law enforcement of intellectual property rights.31
economic risk
potential threat to a firm’s operations in a country due to economic policies and conditions, including property rights laws and enforcement of those laws.
Counterfeiting, a direct form of theft of intellectual property rights, is a significant and growing problem. The International Chamber of Commerce estimates that the value of counterfeit goods will exceed $1.7 trillion by 2015. “The whole business has just exploded,” said Jeffrey Hardy, head of the anticounterfeiting program at ICC. “And it goes way beyond music and Gucci bags.” Counterfeiting has moved well beyond handbags and shoes to include chemicals, pharmaceuticals, and aircraft parts. According to a University of Florida study, 25 percent of the pesticide market in some parts of Europe is estimated to be counterfeit. This is especially troubling since these chemicals are often toxic.32 In Strategy Spotlight 7.5, we discuss the challenge of fighting counterfeiting in the pharmaceuticals business and how Pfizer is attempting to fight this threat to their business.
counterfeiting
selling of trademarked goods without the consent of the trademark holder.
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|
STRATEGY SPOTLIGHT |
7.4 |
MANAGING POLITICAL RISK
Political instability and adverse actions by governments are two of the greatest risks that firms face in developing markets. However, there are a number of actions firms can take to lessen these risks.
• Market diversification. Competing in a range of geographic markets lessens the risk of actions by a single government or turmoil in a single nation. For example, BP has oil and natural gas exploration and drilling activities in 30 countries. As a result, when political instability struck in Algeria, this did not significantly hamper their global natural gas production.
• Developing stakeholder coalitions. Firms concerned about risks they face can develop stakeholder coalitions. Firms can develop coalitions with other multinationals investing in the country, local supplier and distributor firms, nongovernmental organizations, and governmental units to help reduce risk. These coalition partners can help a firm detect potential problems early so they can try to head them off and build contingency plans. These coalition partners can also help foreign firms navigate bureaucracies and foster relationships with power brokers.
• Wooing the influential. Smart firms identify the key influencers, such as legislative leaders, regulators, and local key officials, such as mayors or tribal heads. They further make the effort to identify which players are their supporters, which are indifferent but potentially could be influenced to support their case, and which are antagonistic. They then work to cultivate the first two groups and work around the third group.
• Putting key stakeholders on their boards. Inviting key public and private sector stakeholders to join a country board aligns their incentives with the company’s. It gives the locals a stake in the company’s success.
Source: Chironga, M. Leke, A., Lund, S, & van Wamelen, A. 2011. Cracking the next growth market: Africa. Harvard Business Review, May: 117–122.
EXHIBIT 7.3 A Sample of Country Risk Ratings, January 2013
|
Rank |
Country |
Overall Score |
Economic Risk |
Political Risk |
Structural Risk |
Debt Indicators |
Access to Capital |
|
1 |
Norway |
89.87 |
86.82 |
91.50 |
81.64 |
85.00 |
97.00 |
|
2 |
Luxembourg |
87.29 |
78.71 |
91.05 |
84.11 |
84.50 |
95.00 |
|
3 |
Singapore |
86.84 |
77.73 |
89.32 |
84.32 |
94.20 |
88.80 |
|
4 |
Sweden |
86.81 |
79.20 |
90.27 |
82.33 |
81.80 |
95.50 |
|
5 |
Switzerland |
86.78 |
83.01 |
89.12 |
86.39 |
69.00 |
96.00 |
|
10 |
Canada |
81.82 |
73.93 |
87.15 |
78.70 |
60.60 |
95.60 |
|
12 |
Germany |
80.88 |
71.75 |
83.75 |
77.49 |
67.30 |
97.50 |
|
15 |
United States |
74.68 |
56.64 |
81.19 |
78.55 |
60.00 |
97.10 |
|
32 |
Japan |
65.69 |
50.56 |
72.76 |
66.34 |
62.30 |
79.20 |
|
39 |
China |
59.88 |
64.08 |
49.26 |
54.63 |
54.90 |
70.00 |
|
60 |
Russia |
52.68 |
58.32 |
42.34 |
45.96 |
45.00 |
81.70 |
|
90 |
Vietnam |
38.89 |
45.14 |
37.43 |
47.50 |
45.50 |
27.50 |
|
112 |
Argentina |
33.72 |
39.97 |
29.71 |
50.38 |
45.20 |
22.50 |
|
138 |
Libya |
28.11 |
44.00 |
27.07 |
38.00 |
0.00 |
30.00 |
|
175 |
North Korea |
12.38 |
13.25 |
13.24 |
14.31 |
0.00 |
30.00 |
Source: euromoneycountryrisk.com
COUNTERFEIT DRUGS: A DANGEROUS AND GROWING PROBLEM
Brian Donnelly has an interesting background. He’s both a cop and a pharmacist. He worked as a special agent for the FBI for 21 years, but he also has a PhD in pharmacology. Now he’s on the front lines of an important fight: keeping counterfeit drugs from the market. He works as an investigator for Pfizer, one of the world’s largest pharmaceutical companies, putting both his pharmacology and law enforcement skills at work to blunt the growing flow of counterfeit drugs. He is one of a small army of former law enforcement officers employed by the pharmaceutical companies working for the same aim.
This is an important fight for two reasons. First, it is of economic consequence for the pharmaceutical companies. Counterfeit drugs are big business. In the United States alone, counterfeit drugs generated around $75 billion in revenue in 2010. They are enticing to customers. For example, while Pfizer’s erectile dysfunction pill, Viagra, sells for $15 per tablet, fake versions sold online can be gotten for as little as $1 a pill. The sales of counterfeit drugs cut into the sales and profits of Pfizer and the other pharmaceutical firms. Second and more importantly, these fake drugs are potentially dangerous. The danger comes both from what they contain and also what they don’t contain. Fake pills have been found to contain chalk, brick dust, paint, and even pesticides. Thus, they may be toxic, and ingesting them may cause significant health problems. On the other side, they may not contain the correct dose or even any of the active ingredients they are supposed to have. This may lead to severe health consequences. For example, fake Zithromax, an antibiotic, may contain none of the necessary chemical components, leaving the patient unable to fight their infection. According to one estimate, counterfeit drugs contribute to the death of upward of 100,000 people a year globally.
The pharmaceutical firms are fighting back with Donnelly and his colleagues. They use a common law enforcement technique. The fake drugs are sold by local dealers in the United States, who typically sell through websites, such as hardtofindrx.com and even Craigslist. These local dealers, called drop dealers, are the easiest to catch. From there, the investigators try to gain information on the major dealers from whom the drop dealers order. If they can get to these folks, they try to take it back to the kingpins manufacturing the drugs. This typically takes them through multiple law enforcement agencies in multiple countries, often back to manufacturing plants in China and India. To find the source, the pharmaceutical companies also use advanced technology. They determine the chemical composition of fake drugs they seize to search for common chemical signatures that point to the possible sourcing plant.
Pfizer is also fighting the fight from another angle. They are now tagging every bottle of Viagra and many other pharmaceuticals with radio-frequency identification (RFID) tags. Pharmacies can read these tags and input the data into Pfizer’s system to confirm that these bottles are legitimate Pfizer drugs. This won’t stop shady websites from delivering counterfeit drugs, but they will help keep the counterfeits out of legitimate pharmacies.
Sources: O’Connor, M. 2006. Pfizer using RFID to fight fake Viagra. RFIDjournal.com , January 6: np; and Gillette, F. 2013. Inside Pfizer’s fight against counterfeit drugs. Bloomberg BusinessWeek, January 17: np.
Currency Risks Currency fluctuations can pose substantial risks. A company with operations in several countries must constantly monitor the exchange rate between its own currency and that of the host country to minimize currency risks. Even a small change in the exchange rate can result in a significant difference in the cost of production or net profit when doing business overseas. When the U.S. dollar appreciates against other currencies, for example, U.S. goods can be more expensive to consumers in foreign countries. At the same time, however, appreciation of the U.S. dollar can have negative implications for American companies that have branch operations overseas. The reason for this is that profits from abroad must be exchanged for dollars at a more expensive rate of exchange, reducing the amount of profit when measured in dollars. For example, consider an American firm doing business in Italy. If this firm had a 20 percent profit in euros at its Italian center of operations, this profit would be totally wiped out when converted into U.S. dollars if the euro had depreciated 20 percent against the U.S. dollar. (U.S. multinationals typically engage in sophisticated “hedging strategies” to minimize currency risk. The discussion of this is beyond the scope of this section.)
currency risk
potential threat to a firm’s operations in a country due to fluctuations in the local currency’s exchange rate.
Below, we discuss how Israel’s strong currency—the shekel—forced a firm to reevaluate its strategy.
For years O.R.T. Technologies resisted moving any operations outside of Israel. However, when faced with a sharp rise in the value of the shekel, the maker of specialized software for
223
managing gas stations froze all local hiring and decided to transfer some developmental work to Eastern Europe. Laments CEO Alex Milner, “I never thought I’d see the day when we would have to move R&D outside of Israel, but the strong shekel has forced us to do so.”33
Management Risks Management risks may be considered the challenges and risks that managers face when they must respond to the inevitable differences that they encounter in foreign markets. These take a variety of forms: culture, customs, language, income levels, customer preferences, distribution systems, and so on.34 As we will note later in the chapter, even in the case of apparently standard products, some degree of local adaptation will become necessary.35
management risk
potential threat to a firm’s operations in a country due to the problems that managers have making decisions in the context of foreign markets.
Differences in cultures across countries can also pose unique challenges for managers.36 Cultural symbols can evoke deep feelings.37 For example, in a series of advertisements aimed at Italian vacationers, Coca-Cola executives turned the Eiffel Tower, Empire State Building, and the Tower of Pisa into the familiar Coke bottle. So far, so good. However, when the white marble columns of the Parthenon that crowns the Acropolis in Athens were turned into Coke bottles, the Greeks became outraged. Why? Greeks refer to the Acropolis as the “holy rock,” and a government official said the Parthenon is an “international symbol of excellence” and that “whoever insults the Parthenon insults international culture.” Coca-Cola apologized. Below are some cultural tips for conducting business in HongKong:
• Handshakes when greeting and before leaving are customary.
• After the initial handshake, business cards are presented with both hands on the card. Carefully read the card before putting it away.
• In Hong Kong, Chinese people should be addressed by their professional title (or Mr., Mrs., Miss) followed by their surname.
• Appointments should be made as far in advance as possible.
• Punctuality is very important and demonstrates respect.
• Negotiations in Hong Kong are normally very slow with much attention to detail. The same negotiating team should be kept throughout the proceedings.
• Tea will be served during the negotiations. Always accept and wait for the host to begin drinking before you partake.
• Be aware that “yes” may just be an indication that the person heard you rather than indicating agreement. A Hong Kong Chinese businessperson will have a difficult time saying “no” directly.
Below, we discuss a rather humorous example of how a local custom can affect operations at a manufacturing plant in Singapore.
Larry Henderson, plant manager, and John Lichthental, manager of human resources, were faced with a rather unique problem. They were assigned by Celanese Chemical Corp. to build a plant in Singapore, and the plant was completed in July. However, according to local custom, a plant should only be christened on “lucky” days. Unfortunately, the next lucky day was not until September 3.
The managers had to convince executives at Celanese’s Dallas headquarters to delay the plant opening. As one might expect, it wasn’t easy. But after many heated telephone conversations and flaming emails, the president agreed to open the new plant on a lucky day—September 3.38
Global Dispersion of Value Chains: Outsourcing and Offshoring
A major recent trend has been the dispersion of the value chains of multinational corporations across different countries; that is, the various activities that constitute the value chain of a firm are now spread across several countries and continents. Such dispersion of value occurs mainly through increasing offshoring and outsourcing.
224
A report issued by the World Trade Organization describes the production of a particular U.S. car as follows: “30 percent of the car’s value goes to Korea for assembly, 17.5 percent to Japan for components and advanced technology, 7.5 percent to Germany for design, 4 percent to Taiwan and Singapore for minor parts, 2.5 percent to U.K. for advertising and marketing services, and 1.5 percent to Ireland and Barbados for data processing. This means that only 37 percent of the production value is generated in the U.S.”39 In today’s economy, we are increasingly witnessing two interrelated trends: outsourcing and offshoring.
Outsourcing occurs when a firm decides to utilize other firms to perform value-creating activities that were previously performed in-house.40 It may be a new activity that the firm is perfectly capable of doing but chooses to have someone else perform for cost or quality reasons. Outsourcing can be to either a domestic or foreign firm.
outsourcing
using other firms to perform value-creating activities that were previously performed in-house.
Offshoring takes place when a firm decides to shift an activity that they were performing in a domestic location to a foreign location.41 For example, both Microsoft and Intel now have R&D facilities in India, employing a large number of Indian scientists and engineers. Often, offshoring and outsourcing go together; that is, a firm may outsource an activity to a foreign supplier, thereby causing the work to be offshored as well.42
offshoring
shifting a value-creating activity from a domestic location to a foreign location.
The recent explosion in the volume of outsourcing and offshoring is due to a variety of factors. Up until the 1960s, for most companies, the entire value chain was in one location. Further, the production took place close to where the customers were in order to keep transportation costs under control. In the case of service industries, it was generally believed that offshoring was not possible because the producer and consumer had to be present at the same place at the same time. After all, a haircut could not be performed if the barber and the client were separated!
For manufacturing industries, the rapid decline in transportation and coordination costs has enabled firms to disperse their value chains over different locations. For example, Nike’s R&D takes place in the U.S., raw materials are procured from a multitude of countries, actual manufacturing takes place in China, Indonesia, or Vietnam, advertising is produced in the U.S., and sales and service take place in practically all the countries. Each value-creating activity is performed in the location where the cost is the lowest or the quality is the best. Without finding optimal locations for each activity, Nike could not have attained its position as the world’s largest shoe company.
The experience of the manufacturing sector was also repeated in the service sector by the mid-1990s. A trend that began with the outsourcing of low-level programming and data entry work to countries such as India and Ireland suddenly grew manyfold, encompassing a variety of white collar and professional activities ranging from call-centers to R&D. The cost of a long distance call from the U.S. to India has decreased from about $3 to $0.03 in the last 25 years, thereby making it possible to have call centers located in countries like India, where a combination of low labor costs and English proficiency presents an ideal mix of factor conditions.
Bangalore, India, in recent years, has emerged as a location where more and more U.S. tax returns are prepared. In India, U.S.-trained and licensed radiologists interpret chest X-rays and CT scans from U.S. hospitals for half the cost. The advantages from offshoring go beyond mere cost savings today. In many specialized occupations in science and engineering, there is a shortage of qualified professionals in developed countries, whereas countries like India, China, and Singapore have what seems like an inexhaustible supply.43
While offshoring offers the potential to cut costs in corporations across a wide range of industries, many firms are finding the benefits of offshoring to be more elusive and the costs greater than they anticipated.44 A study by AMR research found that 56 percent of companies moving production offshore experienced an increase in total costs, contrary to their expectations of cost savings. In a more focused study, 70 percent of managers said sourcing in China is more costly than they initially estimated.
The cause of this contrary outcome is actually not all that surprising. Common savings from offshoring, such as lower wages, benefits, energy costs, regulatory costs, and taxes, are all easily visible and immediate. In contrast, there are a host of hidden costs that arise over time and often overwhelm the cost savings of offshoring. These hidden costs include:
• Total wage costs. Labor cost per hour may be significantly lower in developing markets, but this may not translate into lower overall costs. If workers in these markets are less productive or less skilled, firms end up with a higher number of hours needed to produce the same quantity of product. This necessitates hiring more workers and having employees work longer hours.
• Indirect costs. In addition to higher labor costs, there are also a number of indirect costs that pop up. If there are problems with the skill level of workers, the firm will find the need for more training and supervision of workers, more raw material and greater scrap due to the lower skill level, and greater rework to fix quality problems. They may also experience greater need for security staff in their facilities.
• Increased inventory. Due to the longer delivery times, firms often need to tie up more capital in work in progress and inventory.
• Reduced market responsiveness. The long supply lines from low-cost countries may leave firms less responsive to shifts in customer demands. This may damage their brand image and also increase product obsolescence costs, as they may have to scrap or sell at a steep discount products that fail to meet quickly changing technology standards or customer tastes.
• Coordination costs. Coordinating product development and manufacturing can be difficult with operations undertaking different tasks in different countries. This may hamper innovation. It may also trigger unexpected costs, such as paying overtime in some markets so that staff across multiple time zones can meet to coordinate their activities.
• Intellectual property rights. Firms operating in countries with weak IP protection can wind up losing their trade secrets or taking costly measures to protect these secrets.
• Wage inflation. In moving overseas, firms often assume some level of wage stability, but wages in developing markets can be volatile and spike unexpectedly. For example, the wages of a typical line production worker in Shanghai increased by 125 percent between 2006 and 2011. As Roger Meiners, chairman of the Department of Economics at the University of Texas at Arlington stated, “The U.S. is more competitive on a wage basis because average wages have come down, especially for entry-level workers, and wages in China have been increasing.”
Firms need to take into account all of these costs in determining whether or not to move their operations offshore. Strategy Spotlight 7.6 discusses the experience of a small firm that wrestled with this issue and decided to “reshore” its manufacturing.
LO7.4
The two opposing forces—cost reduction and adaptation to local markets —that firms face when entering international markets.
Achieving Competitive Advantage in Global Markets
We now discuss the two opposing forces that firms face when they expand into global markets: cost reduction and adaptation to local markets. Then we address the four basic types of international strategies that they may pursue: international, global, multidomestic, and transnational. The selection of one of these four types of strategies is largely dependent on a firm’s relative pressure to address each of the two forces.
Two Opposing Pressures: Reducing Costs and Adapting to Local Markets
Many years ago, the famed marketing strategist Theodore Levitt advocated strategies that favored global products and brands. He suggested that firms should standardize all of their products and services for all of their worldwide markets. Such an approach would
226
help a firm lower its overall costs by spreading its investments over as large a market as possible. Levitt’s approach rested on three key assumptions:
|
STRATEGY SPOTLIGHT |
7.6 |
RESHORING OPERATIONS: LIGHTSAVER’S EXPERIENCE
LightSaver Technologies is a small firm that produces emergency lights for homes. Much like the emergency lights on planes that direct you to an exit in an emergency, LightSaver’s product guides people to a home’s exits, which may not be visible during a fire, a blackout, or other emergencies. When they started the firm in 2009, Sonja Zozula and Jerry Anderson decided to outsource their manufacturing to factories in China to minimize costs. They changed course and in 2011 moved their manufacturing back to a facility in Carlsbad, California, only 30 miles from their headquarters in San Clemente.
Why did they move manufacturing to the United States? For LightSaver, the decision was easy. They found that time, language, and cultural differences made communicating with Chinese suppliers difficult. They also had serious logistical challenges, with components shipped from the U.S. to China often stuck in customs for weeks. Tweaking designs was also difficult and often required hours of phone conversations with the factories. As Anderson concluded, “It’s probably 30 percent cheaper to manufacture in China, but factor in shipping and all the other B.S. that you have to endure.” Once he factored in all of the costs, Anderson estimated that it is 2 to 5 percent cheaper to manufacture in the U.S. than in China.
Many other firms are reaching the same conclusion. Unilife, a medical device manufacturer, moved their manufacturing back to the United States to facilitate quicker FDA approval for their products. Pigtronix, a manufacturer of pedals that create electric guitar sound effects, moved its production to New York to improve quality and reduce its inventory levels. Bruce Chochrane moved furniture production back from China into a factory in North Carolina that his family’s firm abandoned over 15 years ago. In a survey by Tobias Schoenherr, a professor at Michigan State University, 40 percent of manufacturing firm managers believe there is an increase in the reshoring of manufacturing to the United States. To date, the numbers are fairly modest. From its low point in 2010 to the end of 2012, the United States gained just over 500,000 manufacturing jobs, but the Boston Consulting Group concluded that reshoring could result in a gain of 2.5 to 5 million jobs.
Sources: Rocks, D. & Leiber, N. 2012. Made in China? Not worth the trouble. Bloomberg Businessweek, June 25: 49–50; Cohen, S. 2012. Some industries ripe for reshoring. Dallas Morning News., April 8: 1D–5D; Minter, S. 2012. Evidence for U.S. manufacturing reshoring builds. Industryweek.com , October 8: np; and Jean, S. & Alcott, K., 2013. Manufacturing jobs have slid steadily as work has moved offshore. Dallas Morning News, Jan 14: 1D.
1. Customer needs and interests are becoming increasingly homogeneous worldwide.
2. People around the world are willing to sacrifice preferences in product features, functions, design, and the like for lower prices at high quality.
3. Substantial economies of scale in production and marketing can be achieved through supplying global markets.45
However, there is ample evidence to refute these assumptions.46 Regarding the first assumption—the increasing worldwide homogeneity of customer needs and interests—consider the number of product markets, ranging from watches and handbags to soft drinks and fast foods. Companies have identified global customer segments and developed global products and brands targeted to those segments. Also, many other companies adapt lines to idiosyncratic country preferences and develop local brands targeted to local market segments. For example, Nestlé’s line of pizzas marketed in the United Kingdom includes cheese with ham and pineapple topping on a French bread crust. Similarly, Coca-Cola in Japan markets Georgia (a tonic drink) as well as Classic Coke and Hi-C.
Consider the second assumption—the sacrifice of product attributes for lower prices. While there is invariably a price-sensitive segment in many product markets, there is no indication that this is increasing. In contrast, in many product and service markets—ranging from watches, personal computers, and household appliances, to banking and insurance—there is a growing interest in multiple product features, product quality, and service.
Finally, the third assumption is that significant economies of scale in production and marketing could be achieved for global products and services. Although standardization
227
may lower manufacturing costs, such a perspective does not consider three critical and interrelated points. First, as we discussed in Chapter 5, technological developments in flexible factory automation enable economies of scale to be attained at lower levels of output and do not require production of a single standardized product. Second, the cost of production is only one component, and often not the critical one, in determining the total cost of a product. Third, a firm’s strategy should not be product-driven. It should also consider other activities in the firm’s value chain, such as marketing, sales, and distribution.
Based on the above, we would have a hard time arguing that it is wise to develop the same product or service for all markets throughout the world. While there are some exceptions, such as Boeing airplanes and some of Coca-Cola’s soft-drink products, managers must also strive to tailor their products to the culture of the country in which they are attempting to do business. Few would argue that “one size fits all” generally applies.
The opposing pressures that managers face place conflicting demands on firms as they strive to be competitive.47 On the one hand, competitive pressures require that firms do what they can to lower unit costs so that consumers will not perceive their product and service offerings as too expensive. This may lead them to consider locating manufacturing facilities where labor costs are low and developing products that are highly standardized across multiple countries.
In addition to responding to pressures to lower costs, managers also must strive to be responsive to local pressures in order to tailor their products to the demand of the local market in which they do business. This requires differentiating their offerings and strategies from country to country to reflect consumer tastes and preferences and making changes to reflect differences in distribution channels, human resource practices, and governmental regulations. However, since the strategies and tactics to differentiate products and services to local markets can involve additional expenses, a firm’s costs will tend to rise.
The two opposing pressures result in four different basic strategies that companies can use to compete in the global marketplace: international, global, multidomestic, and transnational. The strategy that a firm selects depends on the degree of pressure that it is facing for cost reductions and the importance of adapting to local markets. Exhibit 7.4 shows the conditions under which each of these strategies would be most appropriate.
It is important to note that we consider these four strategies to be “basic” or “pure”; that is, in practice, all firms will tend to have some elements of each strategy.
EXHIBIT 7.4 Opposing Pressures and Four Strategies
The advantages and disadvantages associated with each of the four basic strategies: international, global, multidomestic, and transnational.
International Strategy
There are a small number of industries in which pressures for both local adaptation and lowering costs are rather low. An extreme example of such an industry is the “orphan” drug industry. These are medicines for diseases that are severe but affect only a small number of people. Diseases such as the Gaucher disease and Fabry disease fit into this category. Companies such as Genzyme and Oxford GlycoSciences are active in this segment of the drug industry. There is virtually no need to adapt their products to the local markets. And the pressures to reduce costs are low; even though only a few thousand patients are affected, the revenues and margins are significant, because patients are charged up to $100,000 per year. Legislation has made this industry even more attractive. The 1983 Orphan Drug Act provides various tax credits and exclusive marketing rights for any drug developed to treat a disease that afflicts fewer than 200,000 patients. Since 1983, more than 280 orphan drugs have been licensed and used to treat 14 million patients.48
a strategy based on firms’ diffusion and adaptation of the parent companies’ knowledge and expertise to foreign markets, used in industries where the pressures for both local adaptation and lowering costs are low.
An international strategy is based on diffusion and adaptation of the parent company’s knowledge and expertise to foreign markets. Country units are allowed to make some minor adaptations to products and ideas coming from the head office, but they have far less independence and autonomy compared to multidomestic companies. The primary goal of the strategy is worldwide exploitation of the parent firm’s knowledge and capabilities. All sources of core competencies are centralized.
The majority of large U.S. multinationals pursued the international strategy in the decades following World War II. These companies centralized R&D and product development but established manufacturing facilities as well as marketing organizations abroad. Companies such as McDonald’s and Kellogg are examples of firms following such a strategy. Although these companies do make some local adaptations, they are of a very limited nature. With increasing pressures to reduce costs due to global competition, especially from low-cost countries, opportunities to successfully employ international strategy are becoming more limited. This strategy is most suitable in situations where a firm has distinctive competencies that local companies in foreign markets lack.
Risks and Challenges Below are some of the risks and challenges associated with an international strategy.
• Different activities in the value chain typically have different optimal locations. That is, R&D may be optimally located in a country with an abundant supply of scientists and engineers, whereas assembly may be better conducted in a low-cost location. Nike, for example, designs its shoes in the United States, but all the manufacturing is done in countries like China or Thailand. The international strategy, with its tendency to concentrate most of its activities in one location, fails to take advantage of the benefits of an optimally distributed value chain.
• The lack of local responsiveness may result in the alienation of local customers. Worse still, the firm’s inability to be receptive to new ideas and innovation from its foreign subsidiaries may lead to missed opportunities.
Exhibit 7.5 summarizes the strengths and weaknesses of international strategies in the global marketplace.
Global Strategy
As indicated in Exhibit 7.4, a firm whose emphasis is on lowering costs tends to follow a global strategy. Competitive strategy is centralized and controlled to a large extent by the corporate office. Since the primary emphasis is on controlling costs, the corporate office strives to achieve a strong level of coordination and integration across the various businesses.49 Firms following a global strategy strive to offer standardized products and services as well as to locate manufacturing, R&D, and marketing activities in only a few locations.50
a strategy based on firms’ centralization and control by the corporate office, with the primary emphasis on controlling costs, and used in industries where the pressure for local adaptation is low and the pressure for lowering costs is high.
229
EXHIBIT 7.5 Strengths and Limitations of International Strategies in the Global Marketplace
|
Strengths |
Limitations |
|
• Leverage and diffusion of a parent firm’s knowledge and core competencies. |
• Lower costs because of less need to tailor products and services. |
|
• Limited ability to adapt to local markets. |
• Inability to take advantage of new ideas and innovations occurring in local markets. |
A global strategy emphasizes economies of scale due to the standardization of products and services, and the centralization of operations in a few locations. As such, one advantage may be that innovations that come about through efforts of either a business unit or the corporate office can be transferred more easily to other locations. Although costs may be lower, the firm following a global strategy may, in general, have to forgo opportunities for revenue growth since it does not invest extensive resources in adapting product offerings from one market to another.
A global strategy is most appropriate when there are strong pressures for reducing costs and comparatively weak pressures for adaptation to local markets. Economies of scale becomes an important consideration.51 Advantages to increased volume may come from larger production plants or runs as well as from more efficient logistics and distribution networks. Worldwide volume is also especially important in supporting high levels of investment in research and development. As we would expect, many industries requiring high levels of R&D, such as pharmaceuticals, semiconductors, and jet aircraft, follow global strategies.
Another advantage of a global strategy is that it can enable a firm to create a standard level of quality throughout the world. Let’s look at what Tom Siebel, former chairman of Siebel Systems (now part of Oracle), the $2 billion developer of e-business application software, has to say about global standardization.
Our customers—global companies like IBM, Zurich Financial Services, and Citicorp—expect the same high level of service and quality, and the same licensing policies, no matter where we do business with them around the world. Our human resources and legal departments help us create policies that respect local cultures and requirements worldwide, while at the same time maintaining the highest standards. We have one brand, one image, one set of corporate colors, and one set of messages, across every place on the planet. An organization needs central quality control to avoid surprises.52
Risks and Challenges There are, of course, some risks associated with a global strategy.53
• A firm can enjoy scale economies only by concentrating scale-sensitive resources and activities in one or few locations. Such concentration, however, becomes a “double-edged sword.” For example, if a firm has only one manufacturing facility, it must export its output (e.g., components, subsystems, or finished products) to other markets, some of which may be a great distance from the operation. Thus, decisions about locating facilities must weigh the potential benefits from concentrating operations in a single location against the higher transportation and tariff costs that result from such concentration.
• The geographic concentration of any activity may also tend to isolate that activity from the targeted markets. Such isolation may be risky since it may hamper the facility’s ability to quickly respond to changes in market conditions and needs.
• Concentrating an activity in a single location also makes the rest of the firm dependent on that location. Such dependency implies that, unless the location has world-class competencies, the firm’s competitive position can be eroded if problems arise. A European Ford executive, reflecting on the firm’s concentration of activities during a global integration program in the mid-1990s, lamented, “Now if you misjudge the market, you are wrong in 15 countries rather than only one.”
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Many firms have learned through experience that products that work in one market may not be well received in other markets. For example, even Apple has found it a challenge to leverage their global products in some markets.54 Of their $108 billion in sales in 2011, only 12 percent came from sales in China. Apple, with its global focus, has not developed low-end smartphones to sell in developing markets. As a result, it has had some difficulty competing with Samsung in these markets, because Samsung has a much wider product range that effectively meets the needs of different markets. Wei Jinping, a potential Apple customer in China, outlined the challenge when he stated, “I like the IPhone. It’s very cool. But it is a bit out of my price range.”
Exhibit 7.6 summarizes the strengths and weaknesses of global strategies.
a strategy based on firms’ differentiating their products and services to adapt to local markets, used in industries where the pressure for local adaptation is high and the pressure for lowering costs is low.
Multidomestic Strategy
According to Exhibit 7.4, a firm whose emphasis is on differentiating its product and service offerings to adapt to local markets follows a multidomestic strategy.55 Decisions evolving from a multidomestic strategy tend to be decentralized to permit the firm to tailor its products and respond rapidly to changes in demand. This enables a firm to expand its market and to charge different prices in different markets. For firms following this strategy, differences in language, culture, income levels, customer preferences, and distribution systems are only a few of the many factors that must be considered. Even in the case of relatively standardized products, at least some level of local adaptation is often necessary.
Consider, for example, the Oreo cookie.56 Kraft has tailored the iconic cookie to better meet the tastes and preferences in different markets. For example, Kraft has created green tea Oreos in China, chocolate and peanut butter Oreos for Indonesia, and banana and dulce de leche Oreos for Argentina. Kraft has also lowered the sweetness of the cookie for China and reduced the bitterness of the cookie for India. The shape is also on the table for change. Kraft has even created wafer-stick style Oreos.
Kraft has tailored other products to meet local market needs. For example, with their Tang drink product, they developed local flavors, such as a lime and cinnamon flavor for Mexico and mango Tang for the Philippines. They also looked to the nutritional needs in different countries. True to the heritage of the brand, they have kept the theme that Tang is a good source of Vitamin C. But in Brazil, where children often have iron deficiencies, they added iron as well as other vitamins and minerals. The local focus strategy has worked well, with Tang’s sales almost doubling in five years.
To meet the needs of local markets, companies need to go beyond just product designs. One of the simple ways firms have worked to meet market needs is by finding appropriate names for their products. For example, in China, the names of products imbue them with strong meanings and can be significant drivers of their success. As a result, firms have been careful with how they translate their brands. For example, Reebok became Rui bu, which means “quick steps.” Lay’s snack foods became Le shi, which means “happy things.” And Coca Cola’s Chinese name, Ke Kou Ke Le, translates to “tasty fun.”
Strategy Spotlight 7.7 discusses how Procter & Gamble has undertaken a range of actions across their value chain to meet the needs of the Vietnamese market.
EXHIBIT 7.6 Strengths and Limitations of Global Strategies
|
Strengths |
Limitations |
|
• Strong integration across various businesses. |
• Limited ability to adapt to local markets. |
|
• Standardization leads to higher economies of scale, which lowers costs. |
• Concentration of activities may increase dependence on a single facility. |
|
• Helps create uniform standards of quality throughout the world. |
• Single locations may lead to higher tariffs and transportation costs. |
PROCTER & GAMBLE WORKS TO WIN THE HEARTS AND MINDS OF CUSTOMERS IN VIETNAM
Like many companies with product lines that are mature and seeing slow growth in developed economies, Procter & Gamble is focusing a great deal of energy on growing their business in developing economies. To effectively grow in these markets, P&G looks to tailor their product designs, packaging, and promotion efforts to meet the conditions of the markets they are entering.
In Vietnam, P&G has undertaken a range of efforts to meet the needs of the market and to grow their business. As done by firms for decades, they have developed lower-cost brands that can be sold to consumers with modest incomes, in the hopes that they will trade up to the premium brands P&G produces later. They have also found market-specific uses for their products in Vietnam, such as marketing their deodorizing spray, Ambi Pur (sold as Febreeze in the U.S.), as a means to deodorize motorcycle helmets that tend to be less than fresh smelling when worn in the hot and humid climate in Vietnam. This product is now one of P&G’s fastest-growing products in Vietnam. They have also changed the packaging of their products, moving from large bottles and containers to small, cheap one-use packages that are popular in the traditional small stores most customers use. They have also forward integrated into the sales business and operate a boat in the Mekong Delta area to sell to rural customers who live along the water. They also got involved in TV production and had employees travel the country in a van covered in advertisements for their products to recruit contestants for Vietnam’s Got Talent, a show for which P&G is the sole sponsor. Finally, they have leveraged social activism to build their market presence. They have established a charitable unit that brings needed health, educational, and community services to poor regions. They use these actions as a means to promote P&G brands. For example, employees of P&G raised 80 percent of the funds needed to open a new school in a poor village 80 miles from Hanoi. Each room in the school has a plaque advertising a P&G product.
These efforts to find new ways to design, promote, and distribute P&G products that match the economic and social environment of Vietnam and other developing markets have been effective for P&G. These markets accounted for 37 percent of P&G’s sales in 2012, up from 27 percent five years ago.
Source: Coleman-Lochner, L. 2012. P&G woos the hearts, minds, and schools of Vietnam. Bloomberg Businessweek, June 5, 19–21; and Rexrode, C. 2012. As U.S. slows, P&G turns to developing markets. Associated Press, February 2, np.
Risks and Challenges As you might expect, there are some risks associated with a multidomestic strategy. Among these are the following:
• Typically, local adaptation of products and services will increase a company’s cost structure. In many industries, competition is so intense that most firms can ill afford any competitive disadvantages on the dimension of cost. A key challenge of managers is to determine the trade-off between local adaptation and its cost structure. For example, cost considerations led Procter & Gamble to standardize its diaper design across all European markets. This was done despite research data indicating that Italian mothers, unlike those in other countries, preferred diapers that covered the baby’s navel. Later, however, P&G recognized that this feature was critical to these mothers, so the company decided to incorporate this feature for the Italian market despite its adverse cost implications.
• At times, local adaptations, even when well intentioned, may backfire. When the American restaurant chain TGI Fridays entered the South Korean market, it purposely incorporated many local dishes, such as kimchi (hot, spicy cabbage), in its menu. This responsiveness, however, was not well received. Company analysis of the weak market acceptance indicated that Korean customers anticipated a visit to TGI Fridays as a visit to America. Thus, finding Korean dishes was inconsistent with their expectations.
• The optimal degree of local adaptation evolves over time. In many industry segments, a variety of factors, such as the influence of global media, greater international travel, and declining income disparities across countries, may lead to increasing global standardization. On the other hand, in other industry segments, especially where the product or service can be delivered over the Internet (such as music), the need for
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even greater customization and local adaptation may increase over time. Firms must recalibrate the need for local adaptation on an ongoing basis; excessive adaptation extracts a price as surely as underadaptation.
EXHIBIT 7.7 Strengths and Limitations of Multidomestic Strategies
|
Strengths |
Limitations |
|
• Ability to adapt products and services to local market conditions. |
• Decreased ability to realize cost savings through scale economies. |
|
• Ability to detect potential opportunities for attractive niches in a given market, enhancing revenue. |
• Greater difficulty in transferring knowledge across countries. |
|
|
• May lead to “overadaptation” as conditions change. |
Exhibit 7.7 summarizes the strengths and limitations of multidomestic strategies.
Transnational Strategy
A transnational strategy strives to optimize the trade-offs associated with efficiency, local adaptation, and learning.57 It seeks efficiency not for its own sake, but as a means to achieve global competitiveness.58 It recognizes the importance of local responsiveness but as a tool for flexibility in international operations.59 Innovations are regarded as an outcome of a larger process of organizational learning that includes the contributions of everyone in the firm.60 Also, a core tenet of the transnational model is that a firm’s assets and capabilities are dispersed according to the most beneficial location for each activity. Thus, managers avoid the tendency to either concentrate activities in a central location (a global strategy) or disperse them across many locations to enhance adaptation (a multidomestic strategy). Peter Brabeck, former chairman of Nestlé, the giant food company, provides such a perspective.
a strategy based on firms’ optimizing the trade-offs associated with efficiency, local adaptation, and learning, used in industries where the pressures for both local adaptation and lowering costs are high.
We believe strongly that there isn’t a so-called global consumer, at least not when it comes to food and beverages. People have local tastes based on their unique cultures and traditions—a good candy bar in Brazil is not the same as a good candy bar in China. Therefore, decision making needs to be pushed down as low as possible in the organization, out close to the markets. Otherwise, how can you make good brand decisions? That said, decentralization has its limits. If you are too decentralized, you can become too complicated—you get too much complexity in your production system. The closer we come to the consumer, in branding, pricing, communication, and product adaptation, the more we decentralize. The more we are dealing with production, logistics, and supply-chain management, the more centralized decision making becomes. After all, we want to leverage Nestlé’s size, not be hampered by it.61
The Nestlé example illustrates a common approach in determining whether or not to centralize or decentralize a value-chain activity. Typically, primary activities that are “downstream” (e.g., marketing and sales, and service), or closer to the customer, tend to require more decentralization in order to adapt to local market conditions. On the other hand, primary activities that are “upstream” (e.g., logistics and operations), or further away from the customer, tend to be centralized. This is because there is less need for adapting these activities to local markets and the firm can benefit from economies of scale. Additionally, many support activities, such as information systems and procurement, tend to be centralized in order to increase the potential for economies of scale.
A central philosophy of the transnational organization is enhanced adaptation to all competitive situations as well as flexibility by capitalizing on communication and knowledge flows throughout the organization.62 A principal characteristic is the integration of unique contributions of all units into worldwide operations. Thus, a joint innovation by headquarters and by one of the overseas units can lead potentially to the development of relatively standardized and yet flexible products and services that are suitable for multiple markets.
Asea Brown Boveri (ABB) is a firm that successfully follows a transnational strategy. ABB, with its home bases in Sweden and Switzerland, illustrates the trend toward
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cross-national mergers that lead firms to consider multiple headquarters in the future. It is managed as a flexible network of units, and one of management’s main functions is the facilitation of information and knowledge flows between units. ABB’s subsidiaries have complete responsibility for product categories on a worldwide basis. Such a transnational strategy enables ABB to benefit from access to new markets and the opportunity to utilize and develop resources wherever they may be located.
Risks and Challenges As with the other strategies, there are some unique risks and challenges associated with a transnational strategy.
• The choice of a seemingly optimal location cannot guarantee that the quality and cost of factor inputs (i.e., labor, materials) will be optimal. Managers must ensure that the relative advantage of a location is actually realized, not squandered because of weaknesses in productivity and the quality of internal operations. Ford Motor Co., for example, has benefited from having some of its manufacturing operations in Mexico. While some have argued that the benefits of lower wage rates will be partly offset by lower productivity, this does not always have to be the case. Since unemployment in Mexico is higher than in the United States, Ford can be more selective in its hiring practices for its Mexican operations. And, given the lower turnover among its Mexican employees, Ford can justify a high level of investment in training and development. Thus, the net result can be not only lower wage rates but also higher productivity than in the United States.
• Although knowledge transfer can be a key source of competitive advantage, it does not take place “automatically.” For knowledge transfer to take place from one subsidiary to another, it is important for the source of the knowledge, the target units, and the corporate headquarters to recognize the potential value of such unique know-how. Given that there can be significant geographic, linguistic, and cultural distances that typically separate subsidiaries, the potential for knowledge transfer can become very difficult to realize. Firms must create mechanisms to systematically and routinely uncover the opportunities for knowledge transfer.
Exhibit 7.8 summarizes the relative advantages and disadvantages of transnational strategies.
Global or Regional? A Second Look at Globalization
Thus far, we have suggested four possible strategies from which a firm must choose once it has decided to compete in the global marketplace. In recent years, many writers have asserted that the process of globalization has caused national borders to become increasingly irrelevant.63 However, some scholars have recently questioned this perspective, and they have argued that it is unwise for companies to rush into full scale globalization.64
LO7.6
The difference between regional companies and truly global companies.
EXHIBIT 7.8 Strengths and Limitations of Transnational Strategies
|
Strengths |
Limitations |
|
• Ability to attain economies of scale. |
• Unique challenges in determining optimal locations of activities to ensure cost and quality. |
|
• Ability to adapt to local markets. |
• Unique managerial challenges in fostering knowledge transfer. |
|
• Ability to locate activities in optimal locations. |
|
|
• Ability to increase knowledge flows and learning. |
|
Before answering questions about the extent of firms’ globalization, let’s try to clarify what “globalization” means. Traditionally, a firm’s globalization is measured in terms of its foreign sales as a percentage of total sales. However, this measure can be misleading. For example, consider a U.S. firm that has expanded its activities into Canada. Clearly, this initiative is qualitatively different from achieving the same sales volume in a distant country such as China. Similarly, if a Malaysian firm expands into Singapore or a German firm starts selling its products in Austria, this would represent an expansion into a geographically adjacent country. Such nearby countries would often share many common characteristics in terms of language, culture, infrastructure, and customer preferences. In other words, this is more a case of regionalization than globalization.
Extensive analysis of the distribution data of sales across different countries and regions led Alan Rugman and Alain Verbeke to conclude that there is a stronger case to be made in favor of regionalization than globalization. According to their study, a company would have to have at least 20 percent of its sales in each of the three major economic regions—North America, Europe, and Asia—to be considered a global firm. However, they found that only nine of the world’s 500 largest firms met this standard! Even when they relaxed the criterion to 20 percent of sales each in at least two of the three regions, the number only increased to 25. Thus, most companies are regional or, at best, biregional—not global—even today.
regionalization
increasing international exchange of goods, services, money, people, ideas, and information; and the increasing similarity of culture, laws, rules, and norms within a region such as Europe, North America, or Asia.
In a world of instant communication, rapid transportation, and governments that are increasingly willing to open up their markets to trade and investment, why are so few firms “global”? The most obvious answer is that distance still matters. After all, it is easier to do business in a neighboring country than in a far away country, all else being equal. Distance, in the final analysis, may be viewed as a concept with many dimensions, not just a measure of geographical distance. For example, both Canada and Mexico are the same distance from the U.S. However, U.S. companies find it easier to expand operations into Canada than into Mexico. Why? Canada and the U.S. share many commonalities in terms of language, culture, economic development, legal and political systems, and infrastructure development. Thus, if we view distance as having many dimensions, the U.S. and Canada are very close, whereas there is greater distance between the U.S. and Mexico. Similarly, when we look at what we might call the “true” distance between the U.S. and China, the effects of geographic distance are multiplied by distance in terms of culture, language, religion, and legal and political systems between the two countries. On the other hand, although U.S. and Australia are geographically distant, the “true” distance is somewhat less when one considers distance along the other dimensions.
Another reason for regional expansion is the rise of the trading blocs and free trade zones. A number of regional agreements have been created that facilitate the growth of business within these regions by easing trade restrictions and taxes and tariffs. These have included the European Union (EU), North American Free Trade Agreement (NAFTA), Association of Southeast Asian Nations (ASEAN), and MERCOSUR (a South American trading block).
trading blocs
groups of countries agreeing to increase trade between them by lowering trade barries.
Regional economic integration has progressed at a faster pace than global economic integration and the trade and investment patterns of the largest companies reflect this reality. After all, regions represent the outcomes of centuries of political and cultural history that results not only in commonalities but also mutual affinity. For example, stretching from Algeria and Morocco in the West to Oman and Yemen in the East, more than 30 countries share the Arabic language and the Muslim religion, making these countries a natural regional bloc. Similarly, the countries of South and Central America share the Spanish language (except Brazil), Catholic religion, and a shared history of Spanish colonialism. No wonder firms find it easier and less risky to expand within their region than to other regions.
Entry Modes of International Expansion
A firm has many options available to it when it decides to expand into international markets. Given the challenges associated with such entry, many firms first start on a small scale and then increase their level of investment and risk as they gain greater experience with the overseas market in question.65
LO7.7
The four basic types of entry strategies and the relative benefits and risks associated with each of them.
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EXHIBIT 7.9 Entry Modes for International Expansion
Exhibit 7.9 illustrates a wide variety of modes of foreign entry, including exporting, licensing, franchising, joint ventures, strategic alliances, and wholly owned subsidiaries.66 As the exhibit indicates, the various types of entry form a continuum ranging from exporting (low investment and risk, low control) to a wholly owned subsidiary (high investment and risk, high control).67
There can be frustrations and setbacks as a firm evolves its international entry strategy from exporting to more expensive types, including wholly owned subsidiaries. For example, according to the CEO of a large U.S. specialty chemical company:
In the end, we always do a better job with our own subsidiaries; sales improve, and we have greater control over the business. But we still need local distributors for entry, and we are still searching for strategies to get us through the transitions without battles over control and performance.68
Exporting
Exporting consists of producing goods in one country to sell in another.69 This entry strategy enables a firm to invest the least amount of resources in terms of its product, its organization, and its overall corporate strategy. Many host countries dislike this entry strategy because it provides less local employment than other modes of entry.70
exporting
producing goods in one country to sell to residents of another country.
Multinationals often stumble onto a stepwise strategy for penetrating markets, beginning with the exporting of products. This often results in a series of unplanned actions to increase sales revenues. As the pattern recurs with entries into subsequent markets, this approach, named a “beachhead strategy,” often becomes official policy.71
Benefits Such an approach definitely has its advantages. After all, firms start from scratch in sales and distribution when they enter new markets. Because many foreign markets are nationally regulated and dominated by networks of local intermediaries, firms need to partner with local distributors to benefit from their valuable expertise and knowledge of their own markets. Multinationals, after all, recognize that they cannot master local business practices, meet regulatory requirements, hire and manage local personnel, or gain access to potential customers without some form of local partnership.
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Multinationals also want to minimize their own risk. They do this by hiring local distributors and investing very little in the undertaking. In essence, the firm gives up control of strategic marketing decisions to the local partners—much more control than they would be willing to give up in their home market.
Risks and Limitations Exporting is a relatively inexpensive way to enter foreign markets. However, it can still have significant downsides. Most centrally, the ability to tailor the firm’s products to meet local market needs is typically very limited. In a study of 250 instances in which multinational firms used local distributors to implement their exporting entry strategy, the results were dismal. In the vast majority of the cases, the distributors were bought (to increase control) by the multinational firm or fired. In contrast, successful distributors shared two common characteristics:
licensing
a contractual arrangement in which a company receives a royalty or fee in exchange for the right to use its trademark, patent, trade secret, or other valuable intellectual property.
• They carried product lines that complemented, rather than competed with, the multinational’s products.
• They behaved as if they were business partners with the multinationals. They shared market information with the corporations, they initiated projects with distributors in neighboring countries, and they suggested initiatives in their own or nearby markets. Additionally, these distributors took on risk themselves by investing in areas such as training, information systems, and advertising and promotion in order to increase the business of their multinational partners.
The key point is the importance of developing collaborative, win–win relationships.
To ensure more control over operations without incurring significant risks, many firms have used licensing and franchising as a mode of entry. Let’s now discuss these and their relative advantages and disadvantages.
Licensing and Franchising
Licensing and franchising are both forms of contractual arrangements. Licensing enables a company to receive a royalty or fee in exchange for the right to use its trademark, patent, trade secret, or other valuable item of intellectual property.72
Franchising contracts generally include a broader range of factors in an operation and have a longer time period during which the agreement is in effect. Franchising remains a primary form of American business. According to a recent survey, more than 400 U.S. franchisers have international exposure.73 This is greater than the combined totals of the next four largest franchiser home countries—France, the United Kingdom, Mexico, and Austria.
franchising
a contractual arrangement in which a company receives a royalty or fee in exchange for the right to use its intellectual property; it usually involves a longer time period than licensing and includes other factors, such as monitoring of operations, training, and advertising.
Benefits In international markets, an advantage of licensing is that the firm granting a license incurs little risk, since it does not have to invest any significant resources into the country itself. In turn, the licensee (the firm receiving the license) gains access to the trademark, patent, and so on, and is able to potentially create competitive advantages. In many cases, the country also benefits from the product being manufactured locally. For example, Yoplait yogurt is licensed by General Mills from Sodima, a French cooperative, for sale in the United States. The logos of college and professional athletic teams in the United States are another source of trademarks that generate significant royalty income domestically and internationally.
Franchising has the advantage of limiting the risk exposure that a firm has in overseas markets. At the same time, the firm is able to expand the revenue base of the company.
Risks and Limitations The licensor gives up control of its product and forgoes potential revenues and profits. Furthermore, the licensee may eventually become so familiar with
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the patent and trade secrets that it may become a competitor; that is, the licensee may make some modifications to the product and manufacture and sell it independently of the licensor without having to pay a royalty fee. This potential situation is aggravated in countries that have relatively weak laws to protect intellectual property. Additionally, if the licensee selected by the multinational firm turns out to be a poor choice, the brand name and reputation of the product may be tarnished.74
With franchising, the multinational firm receives only a portion of the revenues, in the form of franchise fees. Had the firm set up the operation itself (e.g., a restaurant through direct investment), it would have had the entire revenue to itself.
Companies often desire a closer collaboration with other firms in order to increase revenue, reduce costs, and enhance their learning—often through the diffusion of technology. To achieve such objectives, they enter into strategic alliances or joint ventures, two entry modes we will discuss next.
Strategic Alliances and Joint Ventures
Joint ventures and strategic alliances have recently become increasingly popular.75 These two forms of partnership differ in that joint ventures entail the creation of a third-party legal entity, whereas strategic alliances do not. In addition, strategic alliances generally focus on initiatives that are smaller in scope than joint ventures.76
Benefits As we discussed in Chapter 6, these strategies have been effective in helping firms increase revenues and reduce costs as well as enhance learning and diffuse technologies.77 These partnerships enable firms to share the risks as well as the potential revenues and profits. Also, by gaining exposure to new sources of knowledge and technologies, such partnerships can help firms develop core competencies that can lead to competitive advantages in the marketplace.78 Finally, entering into partnerships with host country firms can provide very useful information on local market tastes, competitive conditions, legal matters, and cultural nuances.79
Risks and Limitations Managers must be aware of the risks associated with strategic alliances and joint ventures and how they can be minimized.80 First, there needs to be a clearly defined strategy that is strongly supported by the organizations that are party to the partnership. Otherwise, the firms may work at cross-purposes and not achieve any of their goals. Second, and closely allied to the first issue, there must be a clear understanding of capabilities and resources that will be central to the partnership. Without such clarification, there will be fewer opportunities for learning and developing competencies that could lead to competitive advantages. Third, trust is a vital element. Phasing in the relationship between alliance partners permits them to get to know each other better and develop trust. Without trust, one party may take advantage of the other by, for example, withholding its fair share of resources and gaining access to privileged information through unethical (or illegal) means. Fourth, cultural issues that can potentially lead to conflict and dysfunctional behaviors need to be addressed. An organization’s culture is the set of values, beliefs, and attitudes that influence the behavior and goals of its employees.81 Thus, recognizing cultural differences as well as striving to develop elements of a “common culture” for the partnership is vital. Without a unifying culture, it will become difficult to combine and leverage resources that are increasingly important in knowledge-intensive organizations (discussed in Chapter 4).82
Finally, the success of a firm’s alliance should not be left to chance.83 To improve their odds of success, many companies have carefully documented alliance-management knowledge by creating guidelines and manuals to help them manage specific aspects of the entire alliance life cycle (e.g., partner selection and alliance negotiation and contracting).
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For example, Lotus Corp. (part of IBM) created what it calls its “35 rules of thumb” to manage each phase of an alliance from formation to termination. Hewlett-Packard developed 60 different tools and templates, which it placed in a 300-page manual for guiding decision making. The manual included such tools as a template for making the business case for an alliance, a partner evaluation form, a negotiation template outlining the roles and responsibilities of different departments, a list of the ways to measure alliance performance, and an alliance termination checklist.
When a firm desires the highest level of control, it develops wholly owned subsidiaries. Although wholly owned subsidiaries can generate the greatest returns, they also have the highest levels of investment and risk. We will now discuss them.
Wholly Owned Subsidiaries
A wholly owned subsidiary is a business in which a multinational company owns 100 percent of the stock. Two ways a firm can establish a wholly owned subsidiary are to (1) acquire an existing company in the home country or (2) develop a totally new operation (often referred to as a “greenfield venture”).
wholly owned subsidiary
a business in which a multinational company owns 100 percent of the stock.
Benefits Establishing a wholly owned subsidiary is the most expensive and risky of the various entry modes. However, it can also yield the highest returns. In addition, it provides the multinational company with the greatest degree of control of all activities, including manufacturing, marketing, distribution, and technology development.84
Wholly owned subsidiaries are most appropriate where a firm already has the appropriate knowledge and capabilities that it can leverage rather easily through multiple locations. Examples range from restaurants to semiconductor manufacturers. To lower costs, for example, Intel Corporation builds semiconductor plants throughout the world—all of which use virtually the same blueprint. Knowledge can be further leveraged by hiring managers and professionals from the firm’s home country, often through hiring talent from competitors.
Risks and Limitations As noted, wholly owned subsidiaries are typically the most expensive and risky entry mode. With franchising, joint ventures, or strategic alliances, the risk is shared with the firm’s partners. With wholly owned subsidiaries, the entire risk is assumed by the parent company. The risks associated with doing business in a new country (e.g., political, cultural, and legal) can be lessened by hiring local talent.
For example, Wendy’s avoided committing two blunders in Germany by hiring locals to its advertising staff.85 In one case, the firm wanted to promote its “old-fashioned” qualities. However, a literal translation would have resulted in the company promoting itself as “outdated.” In another situation, Wendy’s wanted to emphasize that its hamburgers could be prepared 256 ways. The problem? The German word that Wendy’s wanted to use for “ways” usually meant “highways” or “roads.” Although such errors may sometimes be entertaining to the public, it is certainly preferable to catch these mistakes before they confuse the consumer or embarrass the company.
We have addressed entry strategies as a progression from exporting through the creation of wholly owned subsidiaries. However, we must point out that many firms do not follow such an evolutionary approach. For example, because of political and regulatory reasons, Pepsi entered India through a joint venture with two Indian firms in 1998. As discussed in Strategy Spotlight 7.8, this provided Pepsi with a first-mover advantage within the Indian market, where it remains well ahead of its archrival, Coca-Cola.
PEPSI’S FIRST-MOVER ADVANTAGE IN INDIA HAS PAID OFF
Pepsi (pronounced “Pay-psee”) became a common synonym for cola in India’s most widely spoken language after having the market to itself in the early 1990s. PepsiCo’s linguistic advantage translates into higher sales for its namesake product. Although Atlanta-based Coke has larger total beverage sales in India because it owns several non-cola drink brands, Pepsi’s 4.5 percent of the soft drink market outshines Coke’s 2.6 percent, according to Euromonitor. That’s a notable exception to much of the rest of the world, where Coke’s cola soundly beats its main rival.
What explains Pepsi’s success in India? Coke pulled out of the market in 1977 after new government regulations forced it to partner with an Indian company and share the drink’s secret formula. In contrast, Pepsi formed a joint venture in 1988 with two Indian companies and introduced products under the Lehar brand. (Lehar Pepsi was introduced in 1990.) Coke then re-entered the market in 1993 after Indian regulations were changed to permit foreign brands to operate without Indian partners.
Coke’s time out of India cost it dearly. “Pepsi got here sooner, and got to India just as it was starting to engage with the West and with Western products,” said Lalita Desai, a linguist at Jadavpur University who studies how English words enter Indian languages. “And with no real international competition, ‘Pepsi’ became the catch-all for anything that was bottled, fizzy, and from abroad.”
PepsiCo has also been very successful in promoting water conservation in India. Its Indian operation became the first of its global units (and probably the only one in the beverage industry) to conserve and replenish more water that it consumed in 2009. Its rival, Coca Cola, on the other hand, is facing a serious situation in India as it has been fined Rs 216 crore ($4.7 million) as compensation for groundwater pollution and depletion.
As of 2012, PepsiCo was experiencing a double-digit rate of growth in India and had staked out a position as the country’s fourth largest consumer products company. The firm also has invested more than $1 billion in India, created direct and indirect employment to almost 200,000 people in the country, and has 13 company-owned bottling plants, according to its website.
Source: Srivastava, M. 2010. For India’s Consumers, Pepsi Is the Real Thing. Bloomberg Businessweek. September 20–26: 26–27; Bhushan, R. 2010. Pepsi India Touches Eco Watershed, First Unit to Achieve Positive Water Balance. www.indiatimes.com . May 27: np; and www.pepsicoindia .
ISSUE FOR DEBATE
Ethics
All across India and other developing markets, local salespeople working for Danone, a French multinational in the food products industry, travel around cities and dusty towns on scooters filled with probiotic dairy products that they assert will help solve and build immunity against a range of digestive ailments, including constipation, diarrhea, and infections. Probiotics are dairy-based products, such as yogurt, that contain billions of microbes that some believe help with digestion. Drawing on corporate leaflets that they are given and can distribute to customers, the salespeople tell customers that the microbes will cultivate their “intestinal flora.” The typical customers for these products are low-to middle-class women who are either stay-at-home moms or work in domestic-oriented careers, such as washing or cleaning ladies. Many of these people have little, if any, access to medical treatment for ailments. For them, the promise of health improvement from probiotic products is very enticing.
However, the claims that Danone’s salespeople make are controversial. For example, one of the core probiotic products Danone sells is Actimel, a yogurt drink. Danone has been barred by the European Food Safety Authority (EFSA) from claiming that Actimel
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either encourages helpful microbes to flourish in the bowel or that Actimel reduces the chances of getting diarrhea. The EFSA ruled that there was not substantial clinical evidence of these purported benefits. Danone countered that there were a number of studies, including one published in the British Medical Journal, that found benefits from Actimel, but the EFSA concluded that there were problems with these studies that called into question the validity of their conclusions. In their decision, the EFSA also cited a larger number of studies that did not support any health benefits from Actimel. The U.S. FDA similarly concluded that the clinical evidence for the benefits of probiotics is insufficient and has blocked Danone from making similar claims for its Dannon Activia yogurt in the United States. But these same claims are made daily by the 250 saleswomen who sell the products manufactured by Danone and its partner, Yakult, in India.
The drive to build Danone’s probiotic market position in India and other Asian markets is understandable from a business sense. The fortified drink market in Asia is very large, $18 billion in sales per year and growing. The Danone-Yakult alliance is seeing success in India selling their probiotic products, with their sales growing 60 percent annually the last few years. But their health claims remain controversial and unsubstantiated in the eyes of European and American regulators.
Discussion Questions
1. Is Danone providing a product that may offer help to people who otherwise have no means to solve digestive problems, or are they simply misleading unsophisticated customers to make a profit?
2. Is it ethical to use a marketing claim that has been deemed unjustified by regulators in developed countries to sell products in developing markets?
3. Should there be consistent or varying standards for product design and marketing in developed and developing markets? For example, would you expect the safety features in a car in India to be the same as in Europe?
Sources: Danone’s Actimel does not alleviate diarrhea – EFSA. 2010. Independent.co.uk , December 9: np; and Doherty, D., Sharma, M., Narayan, A., & Yamaguchi, Y. 2012. Asia’s growing thirst for gut-cleaning drinks. Bloomberg Businessweek, Octomber 1: 28–29.
Reflecting on Career Implications …
International Strategy: Be aware of your organization’s international strategy. What percentage of the total firm activity is international? What skills are needed to enhance your company’s international efforts? How can you get more involved in your organization’s international strategy? For your career, what conditions in your home country might cause you to seek careers abroad?
Outsourcing and Offshoring: More and more organizations have resorted to outsourcing and offshoring in recent years. To what extent has your firm engaged in either? What activities in your organization can/should be outsourced or offshored? Be aware that you are competing in the global marketplace for employment and professional advancement. What is the likelihood that your own job may be outsourced or off-shored? In what ways can you enhance your talents, skills, and competencies to reduce the odds that your job may be offshored or outsourced?
International Career Opportunities: Taking on overseas assignments in other countries can often provide a career boost. There are a number of ways in which you can improve your odds of being selected for an overseas assignment. Studying abroad for a semester or doing an overseas internship are two obvious strategies. Learning a foreign language can also greatly help. Anticipate how such opportunities will advance your short- and long-term career aspirations.
Management Risks: Explore ways in which you can develop cultural sensitivity. Interacting with people from other cultures, foreign travel, reading about foreign countries, watching foreign movies, and similar activities can increase your cultural sensitivity. Identify ways in which your perceptions and behaviors have changed as a result of increased cultural sensitivity.
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summary
We live in a highly interconnected global community where many of the best opportunities for growth and profitability lie beyond the boundaries of a company’s home country. Along with the opportunities, of course, there are many risks associated with diversification into global markets.
The first section of the chapter addressed the factors that determine a nation’s competitiveness in a particular industry. The framework was developed by Professor Michael Porter of Harvard University and was based on a four-year study that explored the competitive success of 10 leading trading nations. The four factors, collectively termed the “diamond of national advantage,” were factor conditions, demand characteristics, related and supporting industries, and firm strategy, structure, and rivalry.
The discussion of Porter’s “diamond” helped, in essence, to set the broader context for exploring competitive advantage at the firm level. In the second section, we discussed the primary motivations and the potential risks associated with international expansion. The primary motivations included increasing the size of the potential market for the firm’s products and services, achieving economies of scale, extending the life cycle of the firm’s products, and optimizing the location for every activity in the value chain. On the other hand, the key risks included political and economic risks, currency risks, and management risks. Management risks are the challenges associated with responding to the inevitable differences that exist across countries such as customs, culture, language, customer preferences, and distribution systems. We also addressed some of the managerial challenges and opportunities associated with offshoring and outsourcing.
Next, we addressed how firms can go about attaining competitive advantage in global markets. We began by discussing the two opposing forces—cost reduction and adaptation to local markets—that managers must contend with when entering global markets. The relative importance of these two factors plays a major part in determining which of the four basic types of strategies to select: international, global, multidomestic, or transnational. The chapter covered the benefits and risks associated with each type of strategy.
The final section discussed the four types of entry strategies that managers may undertake when entering international markets. The key trade-off in each of these strategies is the level of investment or risk versus the level of control. In order of their progressively greater investment/risk and control, the strategies range from exporting to licensing and franchising, to strategic alliances and joint ventures, to wholly owned subsidiaries. The relative benefits and risks associated with each of these strategies were addressed.
SUMMARY REVIEW QUESTIONS
1. What are some of the advantages and disadvantages associated with a firm’s expansion into international markets?
2. What are the four factors described in Porter’s diamond of national advantage? How do the four factors explain why some industries in a given country are more successful than others?
3. Explain the two opposing forces—cost reduction and adaptation to local markets—that firms must deal with when they go global.
4. There are four basic strategies—international, global, multidomestic, and transnational. What are the advantages and disadvantages associated with each?
5. What is the basis of Alan Rugman’s argument that most multinationals are still more regional than global? What factors inhibit firms from becoming truly global?
6. Describe the basic entry strategies that firms have available when they enter international markets. What are the relative advantages and disadvantages of each?
(Dess 239-241)
Dess, Gregory, G.T. Lumpkin, Alan Eisner, Gerry McNamara. Strategic Management: Text and Cases, 7th Edition. McGraw-Hill Learning Solutions, 09/2013. VitalBook file.
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