Chapter 4: Modes of Entering IB

3. Modes of entry
1. International Business
3.1.Exporting,
Analysis
3.2. Licensing
Timing of Entry – Early 3.3. Franchising
entry vs. late entry 3.4. Contract manufacturing,
3.5. Turnkey projects,
2 - Factors affecting
3.6. FDI
operating modes
3.7. Mergers and acquisitions
- Internal 3.8. joint ventures
4 - Comparisons of different entry modes
- External
 Foreign Market Entry Modes

– Timing of Entry
– The moment when the initial decision is taken by the firm whether to
internationalize or not
Of two ways:
– Early entrant
– Late entrant
Advantages and Disadvantages of Early
Entry
– Advantages of being Early Entrant
– A competitive edge gained by being the first to introduce a product or service
in new market
– The opportunity to grab the best market place
– Technology leadership
– Chance to build brand loyalty
– Scope to create barriers to entry
– Enhance reputation
– Scope for creating a lead which others have to follow
– Disadvantages:
– The cost of pioneering can be high- techy, R & D, establishing distribution
channel, marketing know-how
– Weak loyalty of first time users
– Rapid technological change; skills & know-how easily imitated
 Advantages of late Entry
– Advantages of Being Late Entrant
– Having lower R & D and marketing costs;
– ability to learn from the mistakes of the early entrant;
– ability to polish the design & capture large market share;
– lower risks
 Modes of Entry – meaning
– A mode of entry - the channel employed to gain entry
into a new international markets
– there are many and diverse alternatives
– The decision of how to enter a foreign market can
have a significant impact on the results.
Mode of Entry – two broad
approaches
– Broadly speaking, there are 2 broad
approaches :
1 - Ownership forms. and
2 - Non-ownership forms
 Non-ownership forms
– Non-ownership forms- involve doing IB without
ownership interest in the foreign countries concerned.
– These are: merchandise export, import & counter trade,
service export and import, licensing and franchising,
contract manufacturing, management contracts and
turnkey contracts.
 Non-ownership forms

– Ownership forms- involve doing IB with

ownership interest in the foreign countries
concerned.
– These are: Joint venture, Wholly owned
subsidiary (FDI), Mergers and Acquisitions
 Alternative Operating Modes –
Modes of Entry
1. Exporting,
2. Licensing
3. Franchising
4. Contract manufacturing,
5. Turnkey projects,
6. FDI
7. Mergers and acquisitions
8. Joint ventures
 Factors Affecting Operating
Modes
– A firm can conduct operations in multiple modes
– IB operations can be carried out independently or in collaboration.
– The choice will be determined by:
– External factors (physical, social, competitive, etc) and
– Internal factors (objectives, strategies, & means of operations- modes,
functions)
Factors Affecting Operating Modes
Alternative Operating Modes
 Cont…d
– Merchandize exporting
– In economies, exchange of physically tangible goods b/n
countries, involving the export, import, and re-export of
goods at various stages of production = trade in merchandize
or tangible or visible items
– Exporting and importing are the basic and fundamental limbs
of IB by a firm
 Exporting
– Firms’ products are manufactured in the domestic market or a third country
& then transferred to the host market
– Is a traditional and well established method.
– No investment in foreign production facilities is required. Most of the costs
associated with exporting take the form of marketing expenses.
– Exporting commonly requires coordination among four players:
– Exporter
– Importer
– Transport provider
– Government
 Forms of Exporting
– Direct exporting- the organization makes a commitment to
market overseas on its own behalf.
– Involved in handling documentation, physical delivery & pricing policies
– Adv.: greater control over its brand and operations overseas

– Indirect exporting- when an exporting company (export house

or trading company) from ones home country is employed to
handle the exporting on ones behalf
– Cooperative export- allows to achieve higher economies of
scale & form broader product concept
 Conditions making Exporting
ideal
– The following Conditions justify Exporting as an entry mode:
– The volume of foreign business is not large enough to justify overseas
production
– Cost of production in the foreign market is high
– The foreign market is characterized by production bottlenecks like
infrastructural problems
– There are political or other risks of investment in the foreign country
– The company has no permanent interest in the foreign market or that there
is no guarantee of the market available for a long period
– Foreign investment is not favored by the foreign country concerned
– Licensing or contract manufacturing is not a better alternative
 Why Exporting May Not Be Feasible

– Companies may find more advantages by producing in foreign countries

than by exporting to them. The advantages occur under six conditions∶
– 1. When Production abroad is cheaper than at home
– 2. When transportation costs to move goods or services internationally are
too expensive
– 3. When companies lack domestic Capacity
– 4. when products and services need to be altered substantially to gain
sufficient consumer demand abroad
– 5.When governments inhibit the import of foreign products
– 6. When buyers prefer products originating from a particu1ar country
 Non-collaborative Foreign
Equity Arrangements

– Usually, non-collaborative foreign equity

arrangements take two forms : Foreign
Direct Investment (Partially owned) and
Wholly-Owned Subsidiaries
 FDI vs Wholly Owned
Subsidiary
– FDI is an internationalization strategy involving the
transfer of equity funds to other nations to gain (whole or
partial) ownership and control of foreign assets. Partial
ownership relates to international collaborative ventures,
i.e. international joint ventures or international strategic
alliances
– Example - investment in bonds, stocks are typical
illustrations for FDI and it can also develop to joint
venture etc…
 FDI vs Wholly Owned
Subsidiary

– Wholly-owned subsidiaries, in contrast,

represent full ownership (100%) and full
control over foreign business entities.
– By establishing wholly-owned subsidiaries,
companies can achieve ownership, location
and internalisation advantages.
 Non-collaborative Foreign Equity
Arrangements
– Wholly owned operations and partially owned with the remainder
widely held-FDI
– The more ownership a company has, the greater its control over decisions
– Three primary explanations for companies want a controlling interest:

1 - internalization theory,
2 - appropriability theory and
3 - freedom to pursue global objectives
 Internalization theory
– Control through self-handling of operations is known as internalization.
– Self-handling may reduce costs for a number of reasons:
– Different operating units within the same company are likely to share a
common corporate culture, which expedites communications- a lack of
trust, common terminology, & knowledge are major obstacles to
successful collaboration
– The company can use its own managers, who understand and are
committed to carrying out its objectives.
– The company can avoid protracted negotiations with another company on
such matters as how each will be compensated for contributions
 Appropriability Theory
– Appropriability theory is the idea that companies want to deny rivals and
potential rivals’ access to resources such as capital, patents, trademarks, and
management know-how that might be captured through collaborative
agreements.
– Appropriability theory- the idea of denying rivals access to resources
– Companies are reluctant to transfer vital resources- capital, patents,
trademarks, and management know how- to another organization for fear of
their competitive position being undermined
– Companies are less concerned about appropriability in countries they
perceive as having a strong rule of law
 Freedom to pursue Global Strategy
– A company that has a wholly owned foreign operations
may find it easier to allow the operation to participate
in a global strategy
– Pursuit of Global Strategies. When a company has a
wholly owned foreign operation, it may more easily
have that operation participate in a global or
transnational strategy.
 Foreign Direct Investment (mostly
partial, when it is wholly…the FDI
becomes Wholly owned subsidiary)
– Is the direct ownership of facilities in the target country. It involves the
transfer of resources including capital, technology, and personnel. It may be
made through the acquisition of an existing entity or the establishment of a
new enterprise
– Involves substantial ownership & control, entrepreneurial risks, technology
and management transfer and hosts of implications for the host country and
the firm concerned
– Takes the form of starting a subsidiary, acquiring a stake in an existing firm
or starting a joint venture in the foreign market.
– Direct investment and management of the firms concerned normally go
hand in hand
 Wholly owned manufacturing
facilities
– Companies with long term & substantial interest in the foreign
market normally establish fully owned manufacturing faculties
there
– It is simply not possible to maintain substantial market
standing in an important area unless one has a physical
presence of a producer- Drucker
– A number of factors like trade barriers, differences in the
production and other costs, government policies, etc
encourage the establishment of production facilities in the
foreign markets
 Wholly owned subsidiary

– Direct ownership provides a high degree of control in the operations and

the ability to better know the consumers and competitive environment.
– However, it requires a high level of resources and high degree of
commitment
 How to Make FDI
– FDI ownership takes place by transferring abroad financial and/or
other tangible or intangible assets.
– Two ways: acquisition and Greenfield investment
– Acquisition:
– Reasons:
– To obtain some vital resources that may otherwise be slow or difficult to
secure
– To gain the goodwill, brand identification, & access to distribution channels
– Advantages:
– Adding no further capacity to the market
– Avoiding start-up problems
– Easier financing at times
 Merger or Acquisition
– A domestic company selects a foreign company and merger itself with
foreign country in order to enter international business
– Alternatively, the domestic company may purchase the foreign company &
acquires its ownership and control.
– It provides immediate access to international manufacturing facilities and
marketing network
 Advantages and disadvantages of
acquisition

Advantages Disadvantages
– Less time consuming and quick – Acquiring a firm in a foreign country
to execute is a complex task involving bankers,
lawyers, regulation, mergers and
– Less risky as compared to green acquisition specialists from the two
field countries
– Immediate grab of market share – Sometimes host countries imposed
restrictions on acquisition of local
– Reduce competition by taking companies by the foreign companies
over rival – Labor problem of the host country’s
– The investor can bank on the companies are also transferred to the
existing goodwill of the acquired acquired company
business
 Green field investment
– Making Greenfield Investments-constructing new facilities
– Is the process of expanding operations in foreign market from ground zero
– Requires purchase of local property and local man power
– Reasons: difficult to find a company to buy, local governments may prevent
acquisition- competition & market dominance
– Companies may choose to build if:
– No desired company is available for acquisition
– Acquisition will lead to carryover problems
– Acquisition is harder to finance
Advantages and disadvantages of
Greenfield investment

Advantages Disadvantages
– No risk of losing technical – Lengthy process from scratch

competence to a – Faces competition before it is

competitor setup
– Time consuming research has
– Tight control of to be carried out before hand
operations – Emerging markets might be
– New jobs created in the unstable hence leading to
extra cost and time
local market
 Assembly Opertions
– Assembly Operations
– A manufacturer who wants many of the advantages that are associated with
overseas manufacturing facilities and yet does not want to go that far may find it
desirable to establish overseas assembly facilities in selected markets
– Represents a cross between exporting and overseas manufacturing
– Benefits: lowers overall manufacturing costs, provides for guaranteed assembly
capacity and enables cycle time reductions
 Third country Location

– Third Country Location

– Is sometimes used as an entry strategy
– When there are no commercial transactions b/n two nations b/c of political
reasons or when direct transactions b/n two nations are difficult due to political
reasons, etc the firm in one of these nations which wants to enter the other
market will have to operate a third country base
Alliances

– This is collabortion
Why Companies Collaborate
 Alliance Types
– Differ based on their objectives and where they fit in a firm’s value chain
– Scale alliance- aim to provide efficiency by pooling similar assets so that
partners can carry out business activities in which they already have
experience
– Link alliances use complementary resources so that participating companies
can expand into new business areas
 Types of Collaborative Arrangements

– The forms of foreign operations differ in the amount of resources a company

commits & the proportion of the resources located abroad; e.g., Licensing <
JV in terms of additional capital commitment
– The higher managers perceive the risk to be in a foreign market, the greater
their desire to form collaborative arrangements in that market
– Companies have a wider choice of operating form when there is less
likelihood of competition
– Considerations in CA (Collaborative arrangement)
– Two factors influence managers’ choice of arrangement type: the desire for
control over foreign operations and their companies’ prior foreign expansion
 Licensing
– A formal permission or right offered to a firm or agent located in a host
country to use a home firm’s proprietary rights (trademarks, patents,
copyrights, technology, technical know-how, marketing skills) in return for
payment.
– Another way for a firm to establish local production in foreign markets
without capital investment. It is usually for a longer term than contract
manufacturing & involves more responsibilities for the national firm
– A licensing agreement is an arrangement wherein the licensor gives
something of value to the licensee in exchange for certain performance and
payments from the licensee. It should always be formulated in a written
document
 Licensing
– Licensing agreements may be:
– Exclusive or non-exclusive
– Used for patents, copyrights, trademarks, and other intangible property-
methods, programs, procedures, systems
– Licensing often has an economic motive, such as the desire for faster start-
up, lower costs, or access to additional resources
 Cont…d
– The licensor may give the licensee the right to use:
– A patent covering a product or process
– Manufacturing know-how not subject to a patent
– Technical advice & assistance
– Marketing advice and assistance
– The use of a trade mark/name
 Cont…d
Advantages Disadvantages

– Manufacturer is near the customers’

– Re-negotiation is expensive
base
– When agreement expires the former
– Little capital investment, high return on
licensee can be seen as a competitor
capital employed
– The licensee may not fully exploit the
– Valuable spin-off is possible
market leaving space for competitors’
– No danger of nationalization or entry
expropriation of assets – Licensee fees are often too small
– New product can be rapidly exploited on
– Lack of control over licensee
a worldwide basis
operations quality control of the
– Protects patents product is difficult
– Local manufacturer can secure – Governments often impose conditions
government contracts on royalties or supply
 Franchising
– Franchising includes providing an intangible asset (usually a trademark) and
continually infusing necessary assets
– It is a specialized form of licensing- granting the use of the intangible
property and operationally assisting the business on a continuing basis-
sales promotion & training
 Franchising
– An independent organization (the franchisee) operates
the business under the name of another company (the
franchisor) in return the franchisee pays a fee to the
franchisor
– The franchisor provides the right to use trade marks,
operating system, product reputation & continuous
support system like advertising, employee training.
– Two major types:
– Product and trade name franchising
– Business format “package” franchising
 Cont…d
– Product & trade name franchising
– Distribution system in which suppliers make contracts with
dealer to buy or sell products; dealers use the trade name,
trade mark & product line. E.g., Pepsi, CocaCola
– Business format “Package” franchising
– The package transferred by the franchisor contains most
elements necessary to establish a business and run it
profitably. The package can contain trade marks/names,
copyright, designs, patents, trade secrets, know-how. In
return the franchisor gets an initial fee and/or continuing fees
 Franchising
Advantages Disadvantages
– Greater degree of control compared to – Search for a competent franchisee is
licensing expensive & time consuming
– Low-risk, low-cost entry mode – Costs of creating/marketing a unique
– Using highly motivated business package of products recognized
contacts with money, local market internationally
knowledge & experience – Costs of protecting goodwill & brand
– Quick development of international name
markets – Problems with local legislation
– Generating economies of scale – Opening internal business knowledge
– Precursor to possible future direct may create a future competitor
investment in foreign markets – Risk to the company’s international
profile & reputation
– Lack of control
 Management Contracting
– The firm providing the management know-how may not have any
equity stake in the enterprise being managed.
– The supplier brings together a package of skills that will provide an
integrated service to the client without incurring the risk and
benefits of ownership.
– It is a low-risk method of getting into a foreign market and it starts
yielding income right from the beginning.
– It is attractive if the contracting firm is given an option to purchase
some shares in the managed company within a stated period.
– Could sometimes bring in additional benefits for the managed
company
 Management Contracts
– Foreign management contracts are used primarily
when the foreign company can manage better than
the owners
– A company is paid a fee to transfer management
personnel & administrative know-how abroad to
assist a company
 Turnkey Contracts
– The contractor will do all the works needed to fix up a
working network for you
– All you have to do is ‘open the door’ or ‘turn the key’ and
step into a working system
– Are common in IB in the supply, creation and commissioning
of plants; construction projects and franchising agreements
– It is an agreement by the seller to supply a buyer with a
facility fully equipped and ready to be operated by the
buyer’s personnel, who will be trained by the seller
– Turnkey project contracting firms have rich experience in the
field, provide complete solution
 Turnkey Operations
– Turnkey Operations are
– Most commonly performed by industrial-equipment, construction, & consulting
companies
– Often performed for a governmental agency
– One company contracts with another to build complete, ready-to-operate
facilities
– Turnkey operation is a contract in which one firm constructs a facility and
prepares it for operation and then relinquishes it to its new owners
 Joint Ventures
– Joint ventures may have various combinations of participants and
ownership
– A type of operational sharing
– Non-equity and equity ownership
 Joint Venture
– Two or more firms join together to create a new business entity that is
legally separate & distinct from its parents
– Involves shared ownership
– It provides strength in terms of required capital, latest technology, required
human talent, etc
– It enables the companies to share the risk in the foreign markets
– This act improves the local image in the host country & also satisfies the
governmental joint venture
 Joint venture
– There are five common objectives in a joint venture: market entry, risk/reward
sharing, technology sharing and joint product development, and conforming
to government regulations. Other benefits include potential connections and
distribution channel access that may depend on relationships.
– Such alliances often are favorable when:
– The partners’ strategic goals converge while their competitive goals diverge;
– The partners’ size, market power & resources are small compared to the industry
leaders; and
– Partners’ are able to learn from one another while limiting access to their own
proprietary skills
 Types of Joint Venture
– There are different types of joint ventures
– JVs by adoption: acquisition of part of the equity in a foreign
entrepreneurial company whereby the foreign country becomes
adopted unit of the Joint Venture along with the promoter
– JVs by rebirth: when the foreign partner transfers technology to an
ailing domestic business and takes equity stake in the revived
business
– JVs by procreation: a truly new venture is born out of a marriage
between the technical and/or market-know how of the partners
– JVs through family ties: this occurs when suppliers join together
with each other or when a manufacturer takes an equity position
in a supplier business
 Joint venture

Advantages Disadvantages
– Access to expertise & contracts in local – Large investments of resources
markets – Partners may be locked into long-
– Reduced market & political risk term relations
– Shared knowledge & resources – Transfer pricing problems
– Economies of scale – The importance of venture to each
– Overcomes host government restrictions partner may change over time
– Cultural differences may result in
– May avoid local tariffs/non-tariffs barriers
management differences
– shared risk of failure
– Loss of flexibility & confidentiality
– Less costly than acquisitions
– Problems of management structures
– Better relations with national government & dual parenting
 Key issues to consider in Joint
Venture
– The key issues to consider in a joint venture are ownership, control, length
of agreement, pricing, technology transfer, local firm capabilities and
resources, and government intentions
– Potential problems include:
– Conflict over asymmetric new investments
– Mistrust over proprietary knowledge
– Performance ambiguity- how to split the pie
– Lack of parent firm support
– Cultural clashes
– If, how, and when to terminate the relationship
 Equity Alliances

– An equity alliance is a collaborative

arrangement in which at least one of the
companies takes an ownership position (almost
always minority) in the other(s).
 Cont…d
– The more equity a firm puts into a collaborative arrangements, coupled
with the fewer partners it takes on, the more control it will have over
the foreign operations conducted under the arrangement
– Non-equity arrangements typically entail at least one & often several
partners
Collaborative Strategy & Complexity
of Control
 Cont…d
– Strategic Alliance
– Has been becoming more and more popular in IB
– Seeks to enhance the long term competitive advantage of the firm by forming
alliance with its competitors, existing or potential in critical areas, instead of
competing with each other.
– Goals: leverage critical capabilities, increase the flow of innovation and
increase flexibility in responding to market and technological changes
– Sometimes used as a market entry strategy
 Comparison of Five Modes of Entry
into Foreign Markets

Indirect Direct Joint Direct

Licensing
exporting exporting ventures investment

Commitment, Risk, Control, Profit Potential

 Managing International
Collaborations
– Arrangements evolve due to changes in a company’s resource base,
external environment- a certain location becomes risky, or the host
government forbids or eases foreign ownership
– A company need to reexamine the fit between collaboration & its
strategy
– How companies change their operating forms, how they may find
potential partners & negotiate with them, and how they need to
assess the performance of collaborative arrangements
– Companies’ capabilities may change over time & influence the form
of operations undertaken. Collaboration may allow a company to
learn from its partner, enabling it to make a deeper commitment
confidently.
Country Attractiveness/Company Strength
Matrix