Internationalization of the Firm A26E Summer

Internationalization of the Firm A26E00400 2012 Summer
Zuhair Al-Obaidi Part 2 Foreign Operations Methods

International Business Operations (26C020) Zuhair Al-Obaidi (Ph. D
International Business Operations (26C020) Zuhair Al-Obaidi (Ph.D. International Business) Objectives: Understand the various modes of entering foreign markets and the different strategies internationalizing firms can develop to capture opportunities through designing alternative methods of conducting business internationally. Examine the nature, reasons for their use, experiences in their application and possible problems and drawbacks which may be encountered. Compare these business operation modes and identify their advantages and disadvantages. Learn about the prerequisites before selecting an appropriate and adapted entry mode.

Contents of the Course Discussion of the various dimensions of internationalization & recent theoretical development relating to entry modes into foreign markets Presenting the modes of business operations, their nature, important features & demands Exporting, Licensing, Franchising, Project Operations, Subcontracting, Contract manufacturing, Management Contracts, Joint Ventures, other strategic alliances and Wholly owned subsidiaries Strategies and managerial considerations in order to determine the challenges and benefits managers can expect Longitudinal perspective in order to understand external & internal factors Factors may change over time Examining which operation modes might best apply at a particular point in time in the internationalization process. How different modes can be most appropriately fitted together over time to optimize the penetration of different foreign markets. Evaluation and comparison of the entry modes Discussions on the increasing use of cooperation modes and strategic alliances

Alternative Operation Modes
Defining the concept of Entry Mode: Delivery vehicle of market offerings and to convey benefits of assets Institutional arrangement to organize how to deliver the market offering Foreign market entry modes = International business operation modes

International Business Operations Modes
Refer to a firm’s efforts to expand across international borders and enter foreign markets in order to engage in market exchanges such as buying, selling, manufacturing etc. Can be defined as the institutional arrangement, including its legal and structural form, to organize the commitment and entry of a firm’s product and/or assets into foreign countries to pursue business activities One can view a business operation mode as a system of asset deployment and a delivery vehicle of market offerings and to enhance customers value Alternatively one can define it as: A package of assets pooled through certain institutional and structural forms to enable a firm enter a foreign market and pursue business activities Business operation modes can be classified as: Exporting Modes (Non-Investment) Subsidiary Modes (Investment) Contractual Modes (Co-operation with very little investments)

Foreign Business Operation Mode Alternatives
Contractual Modes Exporting Subsidiary Operations vs. may be combined in FOREIGN MARKET PENETRATION PACKAGES for example Turnkey Project Licensing Management Contract + Resulting in Optimal Market Penetration © Reijo Luostarinen & Lauren Welch

Holistic Internationalization Process
Inward Process Domestic Stage I Inward Stage Establishment of the firm Import of raw material/components Technology transfer Imports from manuf. subsidiary Import of subcontracted components, contract manufactured goods, licensed or OEM-products Domestic joint-venture with foreign partner Import of saleable goods Start of operation Outward Process Exporting (NIMOS) II Outward Stage Sales subsidiary (DIMOS) Subcontracting, contract manufacturing, licensing (NIPOS) Manufacturing subsidiary (DIPOS) III Coop. Stage Cooperation on R & D Cooperation on purchasing Cooperation agreement on manufacturing © Reijo Luostarinen

Dimensions of Internationalization
Operation Methods (How) agents, subsidiaries, licensing, franchising, management contracts... Market (Where) political/cultural/ physical distance differences, PEST Products or Sales Objects (What) goods, services, know-how, systems Organizational Structure Export department, international division... Finance Personnel International skills and expertise; training, ex.pat. Organizational Capacity International Firm Adapted from Reijo Luostarinen

Push and Pull Factor of Internationalization in Finnish Companies
Home country push factors Smallness Periferic Location Openness Bigness Push Pull Host country pull factors © Reijo Luostarinen

Global Enablers Smallness Company Advantages Bigness Domestic Foreign
Periferic Location Openness Bigness Domestic Push Foreign Pull Global Enablers Company Advantages INT/GLOB © Reijo Luostarinen

EXPORTING

Export Operations (for goods and services)
Exporter Final Customer MM national border Indirect exporting MM = Middleman

Producer or Manufacturer
border Final Customer own export Producer or Manufacturer direct export MM MM MM indirect exporting MM MM = Middleman

Problems & Disadvantages
Indirect Export Motives & Advantages Low risk Simple If limited resources Due to concentration Distant but promising market demanding special knowledge Standard products Problems & Disadvantages Costly (profit/price) Limited information flow Inactive (limited learning) No control (sell/not sell) Dependence on middleman

Types of Middlemen (Indirect Export)
Domestic Distributor (international sales) Joint Export Organization Public Export Organization Another Domestic Company Foreign Company’s Domestic Unit Foreign Tourists Sales in Domestic Ships Abroad etc.

Requirements (Direct Export)
Knowledge Personnel languages (oral & written) export sales, market planning & implement export manager (responsibility, planning) Commitment continuous activity top management

Direct Export Motives & Advantages Shorter distribution chain More direct contact Knowledge: market distribution customer procedures Problems & Disadvantages More knowledge & skill demanding Greater financial demands Middlemen may present a problem (compared to Own Exporting) Government

Types of Middlemen (Direct Export Operations)
Importing Distributor Joint Buying Organization Industrial Firm

Own Export Motives & Advantages Filterless & Rapid contact Long-term customer relationship development enabled Selling & marketing can be based on Customer Base Control Problems & Disadvantages No permanent presence No buffer stock Large & expensive export staff when many markets/customers

Preconditions (Own Export)
All that is demanded by Direct Exporting Ability to deal directly, with no intermediary help Ability to compete with local competitors (efficiency, skills, knowledge about customer) Advantage over local distributors (middlemen)

LICENSING Definition Types
Are firms really in the business of selling technology? The drive for competitiveness

Definition of Licensing
Licensing is an industrial contractual arrangement whereby a licensor grants the rights to use its intangible property to another firm (the licensee) for a specified period of time, and in return the licensor receives an agreed upon remuneration (e.g. royalty) from the licensee Intangible property includes patents, inventions, formulas, processes, know-how, designs, copyrights, and trademarks. What about trade secrets? Examples Bell Laboratories at AT&T originally invented the transistor circuit in the 1950’s, but AT&T decided it did not want to produce transistors itself, so it licensed the technology to a number of firms, such as Texas Instruments RCA Corporation licensed its color TV technology to Matsushita and Sony. Xerox licensed it’s patented xerographic know-how to Fuji-Xerox JV.

Intellectual Property
To avoid confusion, the term „Industrial Property“ is often replaced by the term „Intellectual Property“ Trade Mark – Service Mark A mark on goods to identify their origin-producer An effective solution: How to protect the public against inferior goods produced by pirates Patent A right given to inventors for a limited period of time, during which they can treat an idea or invention as their own property. Copyright The same as patents, except that it deals with „Creations“, the expressions of the creative mind in literature, in music, or in visual art. As in patents „The right of ownership stimulate creativity“ Trade Secrets A commercially valuable idea, it could be related to a product, a process or any kind of knowledge, that is not disclosed to the public

The four major types of Intellectual Property
Type of Property Right The Subject of the Property Right The Nature of the Right How the Grants of Property Rights Benefits the Public Trademark Marks placed on the goods to guarantee their origin. No-one is allowed to use the mark without the permission of the owner. The public is defended from false goods effectively and at little cost to the Government. Patent Inventions (either of useful things or of processes for making things). No-one is allowed to profit from an invention without the inventor’s permission for a number of years. The invention is made public; after the patent period the public can use the idea freely. Invention is stimulated. Copyright Created works of writing music, or visual art. No-one is allowed to profit from the expression of the work without the permission of the creator for a number of years. Creative activity is stimulated. Trade Secret Inventions (of any kind). Uncertain.

Licensing as a Mode of International Business Operations
local sales Licensing Agreement Licensor Licensee hardware ** Licensing package software * lump sum down payment royalties products know-how cross licensing exporting * MAY INCLUDE (Intellectual Property) Software Intangibles Industrial property right d) design a) product patent e) copyright b) process patent f) some combination of a-e c) trademark ) secret know-how d) design ** MAY INCLUDE Hardware Tangible parts, components raw material machinery

The Licensing Package The Licensing Package determines the combination of the various elements: both tangible and intangible. The intangibles usually influence how the licensing is classified. Many classifications have been used: Product patent licensing Process patent licensing Design patent licensing Trademark licensing Copyright licensing Know-how licensing Software licensing Examples of combinations: The Know-how necessary to use the patent All necessary know-how and patents Patents and trademarks to increase protection Trade secrets to increase dependence

Determining the value of Trademark licensing.
THE RECEIVER ASKS: Shall I negotiate a trademark license? Will the use of the trademark increase my sales? By how much? (Figure) Does this figure balance the cost of licensing? Consider the license further No trademark license YES NO

The Licensing Package Typically:
Other supportive components may include: design copyright Technical Core product, process and technical K-H trademark marketing know-how managerial/ business know-how

The Licensing Package Sometimes:
Other supportive components may include: patent technical know-how Marketing Core Trademark: Marketing K-H copyright design managerial/ business know-how

Licensing into a Foreign Market A Process View
BACKGROUND preceding operations in the same market preceding operations in other markets – perhaps including licensing previous inward foreign licensing experience LICENSING SPECIFIC Key aspects: building up the licensing package search selection of suitable licensee/s negotiation Pre-Agreement Activities Agreement signed Technology Transfer Activities (Technical and Commercial) information flows training... May include technology updates, further training, defense of intellectual property... Immediate Post-Agreement Fulfillment Perhaps joint operations outside licensing arrangement Renewed licensing arrangement Termination of business: shift to another market Shift from licensing to other operation forms NEW LICENSEE

less valuable to licensee as much remains to be done
When to License? TECHNOLOGY CYCLE Research early less valuable to licensee as much remains to be done Commercialization late more valuable to licensee as most of the technology development, production and marketing problems are solved Development although, depends on technical and marketing ability of technology recipient rate of change of technology

Conditions Under which Licensing May Be Preferred Strategy
Strategic concept Conditions Firm level Licensor firm size Licensor firm too small to have financial, managerial or marketing expertise for overseas investment Licensor firm is too big (see below) Research intensity Licensor firm will remain technologically superior, so as to discount licensee competition in other markets ‚Choosing‘ competition With a patent about to expire, licensing gives a head start to a licensee firm favored by present patent holder. (May be illegal in some countries) Creation of auxiliary business Even if direct royalty income is inadequate, margins on components to or from licensee can be handsome (in the extreme, e.g. licensing automobile assemblers, licensing is tantamount to disguised imports). Other auxiliary business can be turnkey plants, joint bidding with licensee, etc. Diversification & product-line Especially in large diversified firms, with divisional attention focused on the ‚product organization licensor firm imperative‘, a centralized examination of the product/country matrix reveals neglected market penetration possibilities via licensing (especially where considerable diversification puts a constraint on the financial and managerial resources available for equity ventures overseas) Perpetuation of licensee dependency Even without or beyond the licensing agreement, effective licensee dependency maintained by trade marks, required components, or licensee hunger for technical improvements Industry/product level Product cycle standardization Obsolescing products considered for licensing Imminent technology or model change Increasing competition in product market High rate of technological turnover Change so rapid, and technologies so perishable (e.g. semiconductors) that even with equally proficient licenses, a design or a patent may be transferred with little fear of significant competition Reciprocal exchanges of technology Licensing as a valuable tool for obtaining technology or market rights, in industries c characterized by high R&D and market development costs and product diversity (e.g. pharmaceuticals, electricals, chemicals) Product v. process technologies Licensing opportunities in auxiliary processes (e.g. galvanizing in the steel industry, or anodising aluminum) even if the basic product technologies not licensed Country level Environmental constraints on foreign Government regulations restricting foreign direct investment to selected sectors only direct investment or foreign investment Highly political risk in nation income Market uncertain or volatile, licensor lacking in requisite marketing abilities, or market too small for foreign investment Constraints on imports into A high ratio of transport costs to value for item licensee nation Tariff or non-tariff barriers

Do’s & Don'ts of Foreign Licensing Arrangements
Three out of every 10 foreign licensing arrangements in the last six years failed in some important way to come up to expectations. Reasons given for failure, in order of frequency : Inadequate market analysis by licensor. Product defects not known or understood by licensing executives. Higher start-up costs than licensee anticipated. Insufficient attention, interest and support from licensee’s top management, marketing, engineering and production executives. Poor timing. Competition (not just local or other American competition, but from third country competitors). Insufficient marketing effort on the local scene (by licensor and/or licensee). Inadequate licensee “after sales” effort. Weakness in licensee market research and competitive intelligence. “If we have any one cause for failure which stands out above all others it is an unwillingness to commit to new product introduction ventures the ‘marketing resource’ that is required to compete in the foreign market.” Thomas P. Collier

Do’s & Don'ts of Foreign Licensing Arrangements
Most of the companies who failed in their offshore ventures have now taken positive steps to strengthen their licensing or joint programs and increase the likelihood of overseas market success. The major remedies involve: Providing better screening and research for foreign ventures. Revamping the organization that handles licensing responsibilities. Improving procedures and communications between product divisions, the international division and the licensee or joint venture partners. Ensuring better control of product quality and engineering support on part of licensor. Almost all companies realize and admit that these failures could have been avoided if they had retained expert advisers to counsel and guide them prior to their “do-it-yourself” approach. Thomas P. Collier

FRANCHISING Definition Types Impact of globalization

What is Franchising? A form of business in which the creator (franchisor) of a business idea, method, product or service obtains distribution through affiliated dealers in foreign markets (the franchisees) Granting the franchisees the right to do business in a prescribed and standardized manner over a certain period of time, in a specified place Giving the franchisees exclusive access to certain know-how The method, product or service being marketed is identified (tm, brand), protected and promoted by franchisor Control is maintained over quality, standard and marketing methods used by the franchisor Although some business people think that it is a specialized form of licensing in which the franchisee is allowed to use intangible property (trademark, brand name), the fact that the franchisee is required to agree on abiding by strict rules as to how it does business makes a lot of difference. International franchising refers to entering foreign markets by the above method

Characteristics of Franchising
A contractual relationship in which the franchisee carries out a business under a name owned by or associated with the international franchisor according to a certain business format established and protected by the franchisor The market offering is standardized, quality standards maintained and business format is controlled by the international franchisor Franchisor provides assistance to the franchisee in running the business both prior to commencement and throughout the period of the contract The franchisee owns his/her business, which is a separate entity from that of the franchisor. The franchisee provides and risks his own capital The franchisor manages the business © Zuhair Al-Obaidi

The Franchising Package
Franchisor Franchising Agreement Franchisee Payment: lump sum down payment + royalties (% of sales or surcharge on supplies) other mark-ups and contributions (e.g. rent, finance charges) Trademark protected business concept and format + everything needed for its implementation patents know-how training services hardware Adapted R.L. & L.W. (1990)

The Franchisee Balance
FOR AGAINST Well known brand name Training Independent yet size link Low failure rate Continuing technology transfer Financing support International network Inappropriate or unfamiliar brand name Exaggeration of franchise benefits Undelivered promises Lack of security Negotiating disadvantage Proliferation of outlets Unsuitable technical, managerial or marketing know-how Initial investment excessive Adapted R.L. & L.W. (1990)

The Most Important Impediments to International Franchising
Locating good and reliable franchisees overseas Knowing how to franchise overseas Protection of industrial property and trademarks in foreign countries Obtaining information on market prospects overseas Familiarity with business practices overseas Foreign government regulations on business operations Foreign regulations or limitations on royalty fees Negotiation with foreign franchisees Foreign regulations or limitations on entry of franchise business Collection and transfer of franchisee fee Quality or quantity of product or service Providing technical support overseas Pricing franchise for a foreign market Advertising franchise overseas Sourcing and availability of raw materials, equipment, and other products Shipping and distribution of raw materials required to operate a foreign franchise Financing franchise operations overseas Shipping and handling of equipment needed to operate a foreign franchise Source: Ben L. Kedia, David J. Ackerman, and Robert T. Justis, ”Changing Barriers to the Internationalization of Franchising Operation: Perceptions of Domestic and International Franchisors, ” The International Executive, 37 (4, July/August 1995):

How Licensing & Franchising Differ
The term ‚royalties‘ is normally used The item being exchanged is patented technology relating to a product or process know-how Licenses are usually taken by well-established business Terms of 16 to 20 years are common, particularly where they relate to technical know-how, copyright and trademarks. The terms are similar for patents Licensees tend to be self-selecting. They are often an established business and can demonstrate that they are in a strong position to operate the license in question. A licensee can often pass his license onto an associated or sometimes unconnected company with little or no reference back to the original licensor Usually concern specific existing products with very little benefit from ongoing research being passed on by the licensor to his licensee There is no goodwill attached to the license as it is totally retained by the licensor Licensees enjoy a substantial measure of fee negotiation. As bargaining tools, they can use their trade muscle and their established position in the marketplace. Franchising Management fees are regarded as the most appropriate term Covers the total business, including the know-how, intellectual rights, goodwill, trademark and business contacts. (Franchising is all-encompassing, whereas licensing concerns just one part of the business.) Tends to be a start-up situation, certainly as regards the franchisee The franchise agreement is normally for five years, sometimes extending to ten years. Franchises are frequently renewable The franchisee is very definitely selected by the franchisor, and his eventual replacement is controlled by the franchisor The franchisor is expected to pass on to his franchisees the benefits of his ongoing research program as part of the agreement Although the franchisor does retain the main goodwill, the franchisee picks up an element of localized goodwill There is a standard fee structure and any variation within an individual franchise system would cause confusion and mayhem. Compiled by Z.A.

MANAGEMENT CONTRACTS Definition Types Approaches Problems

Management Contracts A contractual arrangement through which a firm seeking international involvement agrees with a firm in the host country – known as the manager firm – that it will work as a contracting firm to provide management know-how and usually sends its own management team for services abroad without undertaking any type of direct investment The contracting firm receives compensation for personnel and/or material expenses as well as a share of turnover or profit as determined in the contract.

Two Main Cases of Management Contracts Case 1
salaries, fringe benefits Management Contract Management Contractor Management Contractee Manager(s) Management fee

Two Main Cases of Management Contracts Case 2
Target contract venture Management fee salaries, fringe benefits Ownership Resources Management Contract Management Contractor Management Contractee manager(s)

Management Contract Plus Operation
Licensing Management Contract Equity Investment Project Delivery +

Approaches to Management Contracting
Consultancy approach management services The business extension aggressive approach means to enter new market The supplier approach supporting the buyer The purchaser approach safeguarding sources To support other contractual arrangements T-K projects The consortium approach administrative support to group of companies The part proprietor approach JV

M-C -Remuneration and Ownership
Many methods of payments exist Contractors will aim for methods which serve their objectives best but to ensure that risks are reduces they will also try to ensure that remittances come through a number of different routes There are also opportunities for non-financial benefits Direct remuneration Fees are calculated on the basis of one or a combination of: % of sales price or revenue % of profit lump sum sums contingent on the achievement of production norms Indirect remuneration Other income may be derive from dividends interest on loans turn-key –fees sales of equipment and intermediate goods technical assistance fees purchasing commissions sales of raw materials marketing commissions Non-financial benefits The M-C may link several agreements The contractor may use the venture to improve on or create access to the clients and other exports markets Valuable goodwill and PR may follow There may be suppliers for a contractors own operation

M-C Authority and Control
The contractor’s authority rests on his/her expertise and ability to handle the business relationship as much as the terms of the contract He/she may have some equity and privileged access to some of the facilities needed for production and distribution The legal contract: provides formal structure sets out objectives provides guideline for dealings with financial affairs, government agencies, customers and suppliers To ensure effectiveness, contractors install their own control system and an organization through which the requirement for success and good business relationship can be met Preliminary questions to be asked in designing a control system are: Which department of the contractor is to negotiate, monitor and evaluate the contract? What means of communications with the client, other than control system, are available? What decisions should be centralized at HQ of the contractor? What is an appropriate frequency in reporting? Which items are to be included in the control system?

M-C -Problems Sources of anticipated problems for example:
The place of the project in relation to government planning and its priority Implications of priority for permissions, concessions, suppliers, etc. Political uncertainties that might influence the operation or legal status of the contract The options available for payments and likelihood of obstruction on remittances (keep as many options open as possible) The need to check immigration rules, taxation laws, etc. Local facilities and customs The infrastructure The state and impact of educational system on availability of staff and trainees Within your own company Is income really worth the expense? e.g. head office expenses for supervision The ability to establish and maintain adequate communication with contract venture management The need to provide for personal motivation The need to develop innovation in management methods and technical capabilities

Managing Cultural Problems
Your firm cannot and should not simply try to impose its corporate culture on foreign business collaborators Key Questions: Should you totally adapt? Hold your own? Seek to work out a compromise corporate culture? Build a portfolio of adaptive techniques from experience in the various societies in which you operate? There is no single answer * Cultural policy cannot be stated categorically in such a way that will apply to all business situations * Different situations call for different cultural policies * Assessing the cultural environment is the best way to deal with these key questions * It helps you to adjust your cultural policy

CONTRACT MANUFACTURING & SUBCONTRACTING
Definitions Proliferation in use Problems Offshore outsourcing

International Subcontracting & Contract Manufacturing
Part 1 Part 2 Part 3 Part of the product is manufactured by the foreign contractee and is included in the production process of the contractor = international subcontracting Final product is manufactured by the foreign contractee international contract manufacturing TOTAL PRODUCT

Contract Manufacturing
A contractual arrangement in which a firm (an industrial firm or a trading firm) contracts a host/target country industrial firm (contractee) to produce a certain product or execute certain production phases. When the outcome is a complete product it is referred to as contract manufacturing and when it is only part of a total product it is referred to as subcontracting. In both cases, sales and marketing for the finished product/resultant is not undertaken by the contracted foreign firm but by the contractor. This business operation mode has been developed primarily as a vehicle to make full us of the advantages offered by low-cost/wage producers (see also later slides)

Contract Manufacturing (Finished Products)
Contractor Contractee home country third country production country payment agreement marketing components, technology, know-how, training, industrial rights* * = Private Label

Subcontracting (Components or semi-finished goods)
Contractor Contractee home country third country production country payment agreement marketing

Marketing by Contractor
International Contract Manufacturing International Subcontracting Contractor Contractee payment contract Contractor Contractee payment contract output for further processing output Marketing by Contractor various destinations

Growth Factors in International Subcontracting and Contract Manufacturing
Global company networks Cost differentials Know-how / Skills differentials Incentives by target countries FTZ Internationalization of retail sector Preferences to supply systems Technology: IT and ICT

Contract Manufacturing
The manufacturer undertakes to supply a stipulated volume to his customer’s specifications over an agreed period at a pre-negotiated price Things to note carefully: Even though the manufacturer may be able to take advantages of plant capacity and low local costs of certain inputs, his profit margin will be narrow (competitors have similar advantages) Continuity of contract work with same customer (i.e. contractor) is uncertain since the latter is continuously seeking alternative suppliers The customer will expect the deal to be trouble-free (especially quality standard). Thus, ensure that plant, quality control and labor force are adequate to fulfill contract terms

Advantages of Contract Manufacturing (Contractee)
Steady utilization of capacity for a defined period of time An opportunity to broaden export and internationalization experience Business expansion and assured sales of new products An opportunity to enlarge the skills and experience of production and design personnel or to acquire new technology

Outsourcing defined ” ... the transferring of an internal business function or functions, plus any associated assets, to an external supplier or service provider who offers a defined service for a specified period of time, at an agreed but probably qualified price.” The control of the functions in question will reside with the supplier or service provider The service provider, being a specialist in its field, will usually be in a position to add value not normally obtainable in a non-core function retained in house Outsourcing has become a familiar idea to the business & associated media world Often used as an umbrella term for a variety of different arrangements

Global Sourcing and CM and SC
Two major forces shaped the nature of competition for firms across national borders: a) the firm‘s desire to integrate and streamline its operations b) the diversity of markets Thus firms have been compelled to take a global view of their business and one outcome of that was the development of sourcing strategies Sourcing strategy includes a number of choices regarding how to serve foreign markets: 1. Imports, assembly, or production 2. Internal or external suppliers of components or finished goods These entail both contractual and locational implications Intra – firm sourcing Outsourcing

Examples of Factors Affecting Global Sourcing Decisions (1)
Plant-Market Factors Proximity of plant to market Speed of delivery Available plant capacity Quality of local subcontractors Acceptability of source to customer(s) Ability to supply parts Ability to grant adequate sales financing Source: Adapted from 201 Checklists: Decision Making in International Operations. New York: Business International, 1980, pp

Cost Factors Landing costs (freight, tariffs, import taxes) Import obstacles (surcharges, import deposits) Exchange-rate effects Opportunity costs to other plants Plant utilization rate Source: Adapted from 2001 Checklists: Decision Making in International Operations. New York: Business International, 1980, pp

Government Relations and Restrictions Local content rules Export requirements (and desires) Social and political factors (layoffs at plants not given order) Ability to overcome nontariff barriers (product codes, specifications) Bilateral and multilateral agreements Exports and market expansion relationship Antitrust implications Source: Adapted from 201 Checklists: Decision Making in International Operations. New York: Business International, 1980, pp

Other Considerations Joint-venture partner interests Ability to benefit from special import-duty incentives (tariff preferences) Tax advantages (within and across countries, effects on income) Investment and market strategies (new plant) Source: Adapted from 201 Checklists: Decision Making in International Operations. New York: Business International, 1980, pp

Foreign Assembly/Processing in International Subcontracting
Principal (Contractor) Initial Processing Final Processing / Assembly MARKET final product Contractee in foreign market Further processing / assembly Inputs e.g. raw materials Part-processed products Part finished products, completed components

Destinations of Contract Manufactured Output
Contractor Contractee Sale to Contractee’s Domestic Market by Contractor Sale to Third Markets by Contractor Sale to Contractor’s Domestic Market Outward Orientation Inward Orientation Import by Contractor

Problems - Real or Anticipated by Contractees in Subcontracting & Contract Manufacturing
Negotiation smallness/size bargaining power  contractor’s conditions e.g. price lack of information No long term commitment Difficulties in predicting future market situation, Uncertainty Planning problems (Dependence on contractor) Reliance on contractors’ innovation, technology, demand, R&D

The Top 10 Global Food Retailers
Wal-Mart (US) Carrefour (FR) Ahold (NL) Kroger (US) Metro (D) Alberston’s (US) Kmart (US) Tesco (UK) Safeway (US) Rewe (D)

International Retailing
Examples: Metro, Ahold, Kingfisher, Sainsburg, Carrefour, Woolworth, Wall-Mart, Spiny‘s The traditional supply chain powered by the manufacturing push is becoming a demand chain driven by consumer pull The shift in power in the distribution channel is the product of the application of IT to store management Computer systems can tell the international retailer instantly what they are selling in hundreds of stores around the world, how much money they are making on each sale and who are their customers The consequences are: 1. Reduced inventory and better coordination of value chain 2. Market information of the retail level helps to extract better terms from the manufacturers Distribution is increasingly becoming concentrated and manufacturing, by contrast, is splintering Thus international retailers‘ power is increasing as they search for suppliers across the world

Retail Sector Internationalization
RETAILERS: EFFECT: Buying Offices & subsidiaries worldwide Contact manuf. to specifications Import & distribute through retailer‘s operations Increased International Contract Manufacturing Pressure on local manufact. Find cheap prod. source Contract manufacturing low-price end of product range Import, perhaps also re-export To contract manufacturing & retailing

Systems as a competitive response
PROJECT OPERATIONS Definition Types Projects and Systems marketing Systems as a competitive response

Project Operations Business
A contractual form of international business transaction in which an integrated package of resources to solve techno-economic problems, encountered by the buyer The problem could be on either macro or the micro economic level They are most common in the chemical, pharmaceutical, petroleum, metal, IT and construction industries, all of which use complex, expensive production process technologies. Basically the seller (i.e. provider) possesses the know-how and competences required to assemble and run a technologically complex process in order to solve the buyers problem.

Generic Elements of Projects Business
INTERACTION Marketing/Promotion Efforts Offers/Counteroffers (1) Interaction Mechanisms PROJECT A Special Combination of Goods, Services and Know-how (technology, software) (3) Seller Supplier Contractor (2) (4) Buyer Owner Employer OTHER PARTIES INVOLVED - Consultants - Governments - Financiers - Technology Suppliers

Project Operations a) Partial Project
B seller C subcontractors partial suppliers buyer total responsibility partial project agr. A B C partial delivery Plant

Project Operations b) Turnkey Project
principal contractor buyer subcontractors turnkey agreement total delivery control plant total responsibility

Project Operations c) Turnkey Plus Project
principal contractor buyer turnkey plus agreement turnkey delivery turnkey plus delivery subcontractors services and know-how inputs plant

Contents and Responsibilities in Project Operations Partial Project
Several contractors deliver parts of the whole project signing separate agreements with the buyer Contractor’s (seller’s) responsibility Delivered part only Contractee’s (buyer’s) responsibility Integration and coordination of different partial deliveries within the total project Collection of partial delivery Contractor may use subcontractors; signs the agreement for them with the contractee

Contents and Responsibilities in Project Operations Turnkey Project
One contractor delivers and signs for the whole project Contractor’s responsibility Integration and coordination of deliveries from different partners and subcontractors up to ”turning of key” Contractee’s responsibility Payment for the total project according to the agreement Collection of turnkey delivery Contractor may have partners and/or subcontractors

Contents and Responsibilities in Project Operations Turnkey-Plus Project
Contents of the delivery The whole project and all the software items (know-how and services) after the erection (turning the key) of the project Contractor’s responsibility As above in turnkey case plus supplying all the promised services and know-how after ”turning the key” Contractee’s responsibility As above in turnkey case plus payment for the post-erection software

Guidelines for Structuring the Financing of Projects in Risky Countries
Avoid excessive leveraging 70/30 debt – equity ratio should be the maximum Debt financing should include the following: Concessionary rates Grace period during construction and six months into production Foreign exchange and local currency borrowing based on uses of funds In case of consortium cost overrun expenses shared by partners on the basis of their share in the venture In case of JV project, equity capital contribution should be made concurrently with the conclusion of the JV agreement Contributions should be insured/guaranteed through governmental and/or private organizations

Some Criteria used by LDC Governments for Selecting Project Suppliers:
Financing package and price Reputation of the supplier firm(s) Flexibility Political considerations Cultural sensitivity Technology transfer and training (of the TK-plus) Using local suppliers

The Project Buying Cycle
CONTRACT FINAL SELECTION FINAL ASSESSMENT NEGOTIATION NEW PROPOSAL ANALYSIS NEW PROPOSALS SHORT LIST ANALYSIS OF PROPOSALS EXCHANGE OF INFORMATION REQUEST FOR PROPOSALS BIDDERS LIST SPECIFICATIONS RESEARCH ON SUPPLIERS AND CONTACT WITH SUPPLIERS FOR ADVICE NEED AWARENESS Source: COVA (1989)

An Interactive Model of Project Business
GOVERNMENT Linkage, Owner, Regulator, Lender GOVERNMENT Regulator, Supplier, Guarantor, Lender Political Relations Psychic Distance Cultural Bonds, Technical Bonds Positive & Negative Buyer/ Owner/ Employer Motives & Restraints Technical Disparity Linkage: Physical/Horizontal Infrastructure: Physical, Social Seller/ Supplier/ Contractor Technical Capability Resources Physical/ Intangible Mobilization, Management Alliances: Tactical/Strategic Consultant Designer, Supervisor Inspector Technical Expert Joint Venture Sub-contractor Sub-supplier Finance Commercial/ Concessional Equity, Loan Interaction PROJECT

BOO (Build-Own-Operate) BOOT (Build-Own-Operate-Transfer) BOOTT
Main Variants of Turnkey Project Business in DC‘s & Contractees‘ Responsibilities BOO (Build-Own-Operate) There is no transfer back to the government BOOT (Build-Own-Operate-Transfer) BOOTT A variant of BOOT with the addition of another ‚T‘ which represents training (Besant-Jones 1990) ROT (Refurbish-Operate-Transfer) Refers to situations where an existing facility is refurbished, operated and transferred (Quartey-Jnr 1996) DBFO (Design-Build-Finance-Operate) Frequently used in the United Kingdom to refer to schemes

Systems Marketing WHY SYSTEM SALES?
Why engage in Project System Sales? The ”Seller” can arrange coordination of relations between suppliers. Helps establishing Network. Expansion Potential: Components + Know-How + Services Close and long term relationship leads to: Management or Service Agreements To avoid competing only at level of component OR becoming a subcontractor to some other Systems Contractor

Examples of Industrial Firms Extending the Product Strategy to include also Systems
Good/Product Trucks Batteries Fans Welding equipment Plants Locks Extinguishers Theft prevention devices/-articles Radiosonde Packages System Material handling system Reserve energy system Air-conditioning system Welding system Planting system Security system Firefighting system Weather forecasting systems Packaging system

Projects/Systems Pricing
Issues in Pricing Projects / Systems Long periods of negotiation and implementation Bargaining Uniqueness / Types of Projects or Systems Number of parties involved Knowledge Gap Credibility

FDI / SUBSIDIARY OPERATIONS

FDI/Subsidiary Operations
Definitions Concepts: Growth Types: Reasons: Advantages, Disadvantages Decision Process Types of subsidiaries and their functions and reasons for establishment IJV

Foreign Direct Investment as a Business Operation Mode Concepts & Problems
FDI Theories External Motivations & Reasons Internal Decision Process Equity Ownership (Wholly owned/JV) Route Greenfield/Acquisition (Decision Factors) IJV 90% < Wholly Owned > 90% Minority 50/50 Majority (Subsidiary) (Mixed JV) (Contractual) Subsidiary Types Formation process issues Formation process issues Location issues Managerial Issues

Generic Motives for FDI
Market Seeking Knowledge Seeking Efficiency Seeking Risk- reduction Seeking

FDI (Subsidiary) Green Field Acquisition Subsidiary Joint Venture
(Strg. & Mgt Issues) Acquisition Determinants Assessments Decision processes Implementations Subsidiary (Org. & Mgt) Joint Venture Solo 100% (Wholly owned) Majority Equal 50/50 Minority

Decision making Checklist for Establishing Wholly Owned Foreign Subsidiaries
Plant location Entry of region Choice of country Choice of site Size and timing of the investment Entry method Greenfield v. Acquisition Production/ Plant roles and inter-plant relationships marketing Assembly v. manufacturing operation decisions Products/markets supplied Subsidiary procurement policies Subsidiary R&D Organisation and Subsidiary/parent company reporting relationship control Locus of decision-making (centralized v. decentralized) Performance evaluation systems Human resource Subsidiary staffing policies (home, host, third-country nationals) management Expatriate policies Labor relations Financial Financial planning and control management Working capital management Capital expenditure management Corporate/subsidiary financial reporting responsibilities Repatriation Foreign-exchange risk management Transfer pricing Political risk Management of political risk

Definitions Merger According Anna Lukkarinen the use of terms that refer to the action of combining the assets of two firms into unified entity is diverse. Existing literature uses the terms merger, acquisition ,and takeover in different and somewhat overlapping manner Hitt, Ireland and Hoskisson (2003) define merger as: “Strategy through which two firms agree to integrate their operations on a relative co-equals basis”. Sherman (2005) agrees with them, while he notes that technically the assets and liabilities of the selling company are absorbed by the buying firm. He emphasizes that a classic merger has no clear buyer or seller

Ganghan (2005) describes merger as a combination of two companies where only one of them, the buyer, survives and the merged company, or target, typically ceases to exist. Aherm and Weston (2007) provide the most generalized definitions, stating that a merger can be “any transaction that forms one economic unit from two or more previous units”.

Acquisition Researchers who require the terms of a merger to be relatively co-equal for the two parties generally relax this requirement for the concept of an acquisition. Hitt, Ireland and Hoskisson (2003) define it as a “Strategy through which one firm buys a controlling or 100% interest in the targeted firm with the intent of making it a subsidiary” Epstein (2005) describes it as the process of fitting a smaller company into the structure of a larger organization.

Takeover Hanson (1974) defines takeover as the event of one company buying all or large portion of the shares of a target that it wishes to bring under its control. Hoskisson (2003) define it as a special type of acquisition where the acquirer's bid has not been solicited by the target For this course the terms merger and acquisition are used interchangeably

Process of engaging in mergers and acquisitions involves 3 important aspects
Recognizing the drivers/reasons Investigating environmental factors (external and internal) impact on success Anticipating benefits, challenges and problems and preparation to deal with them

Source: Anna Luukkarinen 2011

Components of Successful Acquisition Strategy
Limit risk Synergy Scale and scope economies Sequential acquisitions Constancy in management Marketing Acquisition Strategy Distribution Research and development

Foreign Direct Investment: Country Selection Criteria (1)
Economic Parameters Economic Growth Domestic Demand and Competition Future Market Potential Political Situation Political Stability Scope and Tempo of Reforms

Legal Indicators Government Restrictions on Firms Availability of Potential Collaboration Partners Enforceability of Legal Rights Infrastructure Standards Infrastructure Facilities

Comparison of Total Costs Production Distribution and Marketing Finance and Taxation Level of Duties and Taxes Yield on Turnover

Reasons for Setting up Foreign Manufacture
Product avoiding problems related to the nature of the product Transporting and warehousing Tariff barriers/quotas Government regulation Market: local manufacture may be favoured Information quality of feedback International culture signifies international outlook and greater commitment Delivery JIT Labour costs Technology

Greenfield Foreign Investment Decision
I Initiation Phase Issues Foreign investment vs. other options Location Entry strategy (buy vs. build) Financing sources/financial risk Depth of operations (assembly – full) Timing Formal evaluation criteria Market factors (size, growth, etc.) Cost, profit estimates Investment climate – risk factors: political, economics, etc. II Establishment Phase III Management of Operations Phase

Key Location Success Factors
Optimum Location Decision Location choice should follow company strategy Focus on objectives and clearly define needs Establish project definition and selection criteria early in the process Secure qualified, dedicated and flexible resources Develop a disciplined and flexible approach Foster interactive cross function, country and cultural communications Develop international management controls Dispel/overcome long-held myths about countries/regimes Think long term about location and consider live-cycle of product Understand data and information constraints Minimize influence of personal preference Identify and resolve barriers to implementation Cope with time compression Ask more not fewer questions Obtain and maintain confidentiality (if desired)

Factors Influencing The Choice of Plant Location
Cost variables Costs and availability of trained or trainable labor Capital costs as well as the cost of financing and/or the opportunity cost of the capital required The availability and costs of raw materials and services Transportation costs Productivity Home or host government policies Foreign-exchange considerations Impact of the new investment on costs of existing production Variables influencing the expected return Market size and projected market growth Competitive considerations Effects of the new investment on existing production Variables influencing the riskiness of the investment Transparency and predictability of government policies Political and economic stability of the country The existence and reliability of safeguards incorporated in the contract with governments, as, for example, arbitration Flexibility for the company to divest or relocate its investment Social and economic variables Investment climate Global politics Social responsibilities

Evaluation of Political Risks of a Foreign Investment Entry Decision Process
Revolution? Subversion? Turmoil? External aggression? Nationalization? Intervention? Requisition? Coerced sale? Coerced contract renegotiation? Contract revocation? Import restrictions? Local content requirements? Taxation? Price control? Foreign staff limits? Labor codes/strikes? Export requirements? Discrimination? Restrictions on repatriation of dividends, royalties, interest, fees or capital? Exchange rates? General Instability Risk Ownership/ Control (Expropriation) Risk Operations Risk Transfer Risk GO STOP Chaotic? Too high? Unacceptable effects on local-currency ROI? Unacceptable effects on dollar ROI? Yes No

JOINT VENTURES

Diverse Objectives in Joint Ventures
MNC Profits Growth New markets Synergistic benefits Satisfy nationalistic demands HOST GOVERNMENT Employment Import substitution Conservation of foreign exchange Minimize foreign control NEGOTIATING CONFLICTS AND CO-OPERATION LOCAL FIRM Diversification Transfer of technology Acquire brand names and trademark Growth in domestic and international markets

Framework for Joint Venture Analysis
ENVIRONMENTAL FORCES INFLUENCING VENTURE -Economic -Political -Socio-cultural JOINT VENTURE OBJECTIVES -MNC -Local firm -Host government JOINT VENTURE STRATEGY ALTERNATIVES -Dominant parent -Shared parent -Independent JOINT VENTURE BENEFITS -Economies -Lower factor costs -Political benefits -Risk reduction CULTURAL & BEHAVIOURAL IMPEDIMENTS -Differences in cultures -Differences in style -Difference in managerial perceptions JOINT VENTURE IMPLEMENTATION AND MANAGEMENT ADMINISTRATIVE IMPEDIMENTS -Incompatible organizational system -Differences in organizational approach ACHIEVED JOINT VENTURE PERFORMANCE

Benefits of International Joint Ventures
Technology Transfer codified knowledge convert technical knowledge into goods/services discover price of technology Benefits of International Joint Ventures rapid product diversification local capital markets partners concentrate on area of comparative advantage more efficient competitive position Access to Resources International Joint Ventures knowledge of local environment and markets quick and efficient access to distribution avoid trade barriers local company image-attitude Access to Markets local participation in decisions local control of job creation and technology transfer preferential treatment (remittance of royalties) Political Risk Reduction Improve Competition Position good public relations curb potential competition provide temporary relief for weak

Export Oriented Joint Ventures Some Advantages and Disadvantages
Joint venturer Developed country partner firm: Advantages Access to raw materials Lower production costs Sharing of risks Maintenance/expansion of markets Incremental returns on maturing technology Adaptability to host country incentives/Access to preferential treatment in export Lower economic and political risks Use of knowledge and connection of local partner Increased economies of scale Entry into host country market/other markets Disadvantages Sharing of profits Loss or reduction of control Technology revealed to local partner Potential conflicts with local partner on strategic policies Reduces flexibility for future operations Creates competitors in global markets

Export Oriented Joint Ventures Some Advantages and Disadvantages (continued)
Joint venturer Developing country partner enterprise: Advantages Access to foreign markets Use of foreign partner’s distribution channels Access to foreign technology/technical skills Possible increase in financial resources Transfer of management and marketing know-how from abroad Upgrading and diversification of export products Increasing economies of scale Sharing of risks with foreign partner Access to promotional and other resources available to foreign partner Disadvantages Sharing of profits or payment of fees and royalties Potential conflicts with foreign partner on policy matters Reduced flexibility in future expansion Varying degrees of control from foreign partner Recent technological developments may be withheld

Alternative Joint Venture Strategies and Objectives
Spider‘s-web strategy Establishing a joint venture with a large competitor Avoid absorption through joint ventures with others in network Go-together-then-split strategy Cooperate over extended period on major projects Separate on completion of project Successive integration strategy Starts with weak inter-firm linkages Develop toward merger with convergence of interests

Guidelines for Controlling Foreign Joint Ventures
Issue two kinds of stock – voting and nonvoting – that will divide the profits evenly but give a majority vote to your side. Arrange the deal with 2% in the hands of a third party friendly to your side. Provide in the by-laws that your side will have a majority of directors. Have the by-laws stipulate that your directors (even though equal in number with the partner‘s directors) will appoint the management. Have the by-laws provide that in the case of tie vote, the position of your side will prevail. Arrange deal, but with a management contract awarded to your investor. Arrange contract for the entire output of the jointly owned producing facility to be sold to marketing company controlled by your country. The marketing company should get what it wants from the producing company. A modification of 7: give 51% of the producing company to the local partner in exchange for 51% of the selling company. Satisfy the pressure for 50% local ownership by putting the local 50% in the hands of a local insurance company that has no interest in management. Better yet, spread the local 50% over a multitude of shareholders. Union Carbide in India and Kaiser in Brazil have thousands of local shareholders.

Assessing Potential Partners in an International Joint Venture
International partner Local partner Resource audit technology finance human experience Product-market audit company objectives market attractiveness competitive position past performance country risk analysis Resources fit Product-market fit Determine strategic direction Strategic alliance marketing agreement license franchise joint venture

Advantages and Disadvantages of Joint Ventures in International Business
Suitable for Easier to adapt to host country demands Lower economic and political risks Effective use of knowledge and connections of local partner Effective use of available capital and personnel to cover larger segments of the world markets Loss of control of overseas market Less flexibility in integrating global operations Creates competitors in the global market Potential conflicts with the local partners/host government concerning major strategic and financial policies (sourcing, pricing, export, dividends) Smaller firms with limited resources Entrepreneurial firms Highly diversified firms Firms production mature product lines Firms averse to taking political and financial risks Firms making investment in their secondary product lines Countries demanding active local participation Countries with high economic and political instability Source: Negundhi, 1987

Difficulties with Joint Ventures
Loss of control over foreign operations Large investment of financial, technical, or managerial resources favors greater control than is possible in a joint venture Joint ventures are difficult to coordinate Lack adequate procedures for protecting proprietary information Share decisions affect global marketing arrangements Loss of flexibility and confidentiality Change in product-market mission may make joint venture a liability Unease about sharing technology One partner may form alliance with other partner‘s competitor Managerial dependency between joint venture and one of partners

Guidelines for Strategic Partnership
Building Trust Exit Strategies Define Mission Goals, and Objectives The ”Vow” and Legal Aspects Define Customer’s Products and Services Relationship Maintenance Self-Evaluation and Contribution Know Your Partner Maintain Independence Establish Relationship Boundaries Determine Initial Project © Al-Obaidi, adapted from R.Wallace (2004)

The Joint Venture Continuum
Moderately Coupled Tightly Coupled Loosely Coupled Tightly Coupled Mergers & Acquisitions Joint Venture Moderately Coupled Sub-contracting Arrangement Prime-sub Tier 1 – Tier 2 Manufacturer – Reseller Channel Partner Loosely Coupled ”Hand Shake” Co-marketing Relationship Marketing Sector Alliance © R.Wallace (2004)

STRATEGIC ALLIANCES

What is a Strategic Alliance?
A contractual arrangement between two or more organizations to achieve an agreed upon goal(s) and obtain a competitive advantage vis a vis others without loosing the organizations’ individual and independent identity. The alliance can take many forms and perform different functions in order to achieve the organizations’ common goal(s).

Cooperation Agreements (Alliances)
No generally accepted universal definition! Autonomous, independent companies No or limited equity Among competitors or non-competing firms Non-competing: complementary products, assets or know-how contributions Competing firms: managing logistics, software development, common services (airlines) Providing different functions R&D Promotion Outsourcing Duration Fixed period (usual), project business Permanent as in cross-licensing Out of every 100 negotiations to form AS, 90 fail to produce a workable agreement. Five of those formed fail to meet partners’ expectations Of the five that product acceptable results, only one may survive for more than 4 years

Global Growth in SAs Global competition Speed of entry
Cost reduction of technology development Protection of indigenous suppliers Governments encouraging collaboration Fashion – band wagon effect Fear motives – pre-empt competitive alliance

Four Main Types of SAs Technology Development Operation and Logistics
Marketing, Sales and Services Multiple Activity

Motivations for SAs Learning Cost Minimization & Risk Reduction
Organizational Technology Asymmetry Geographical KH Resources Market Cost Minimization & Risk Reduction Sourcing & production economies R&D economies Constrain decision Marketing economies Entry mode costs and risks reduction in new markets Risks: opportunism, quality, production, payment, contract enforcement, marketing control 3. Market Positioning & Market Seeking Market access Changing nature of competition Accelerate product introduction 4. Gap Filling Current market base Technological base

Complementarity in Strategic Alliances
market access/distribution product-market knowledge manufacturing competence management manufacturing competence raw materials management product know-how Home country partner Partner A International partner Partner B Strategic alliance product-market know-how product/process know-how process know-how product/process know how Marketing partnership Franchising Licensing Joint ventures

Structuring Alliances to Reduce Opportunism
Probability of opportunism by alliance partner reduced by Walling off critical technology Establishing contractual safeguards Agreeing to swap valuable skills and technologies Seeking credible commitments Structuring Alliances to Reduce Opportunism

MODE EVALUATION

Evaluation of Operation Modes
Functional orientation Direct investment content Need for financial resources Need for human resources Technology transfer capability Rapidity of entry Sensitivity to trade barriers Risk sensitivity Degree of control Information feedback possibility

Comparison and evaluation matrix of the characteristics of different modes of international business operations 1. Indirect Export 2. Direct Export 3. Own Export 4. Licensing 5. Contract. Manufact. 6. Co-Production 7. Co-Oper. Agreem. 8. Sales Subsidiary 9. Assemb. Subs. 10. Manufact. Subs. Solo Venture 11. Manufact. Subs. Joint Venture Type of Operation Characteristics of Operation Rapidity of Supply or Entry Sensitivity to Trade Barriers Risk Sensi- tivity Polit. Need of Resources Fin. Profi tability Effecti- venes Control Possibility Feedback Hum-an Com- m. Need for functional internat. Scale © Reijo Luostarinen

Internationalization of the Firm A26E Summer

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