Forms and Ownership of Foreign Production Chapter 15 Forms and Ownership of Foreign Production Chapter 15: Forms and Ownership of Foreign Production Copyright © 2015 Pearson Education Ltd.

Introduction Companies choose an international operating mode to achieve their objectives When exporting and importing is not possible, firms must explore other options Firms that depend on foreign production may own it outright or in part, develop or acquire it, and/or use some type of collaborative arrangement with another company. Copyright © 2015 Pearson Education Ltd.

Factors Affecting Operating Modes in International Business Introduction Factors Affecting Operating Modes in International Business This Figure shows the factors that affect a company’s choice of operating mode. Copyright © 2015 Pearson Education Ltd.

Why Exporting May Not Be Feasible When production abroad is cheaper than at home When transportation costs to move goods or services internationally are too expensive When companies lack domestic capacity In some cases, it can be more advantageous to produce in foreign countries that to export to them. In particular, exporting is not attractive when production abroad is cheaper than at home, transportation costs to move goods or services internationally are too expensive, companies lack domestic capacity, products and services need to be altered substantially to gain sufficient consumer demand abroad, governments inhibit the import of foreign products, or buyers prefer products originating from a particular country. production abroad is cheaper than at home, when transportation costs to move goods or services internationally are too expensive, when companies lack domestic capacity, when products and services need to be altered substantially to gain sufficient consumer demand abroad, when governments inhibit the import of foreign products, and when buyers prefer products originating from a particular country. Copyright © 2015 Pearson Education Ltd.

Why Exporting May Not Be Feasible When products and services need to be altered substantially to gain sufficient consumer demand abroad When governments inhibit the import of foreign products When buyers prefer products originating from a particular country Exporting may not be feasible: When products and services need to be altered substantially to gain sufficient consumer demand abroad When governments inhibit the import of foreign products When buyers prefer products originating from a particular country Copyright © 2015 Pearson Education Ltd.

Non-Collaborative Foreign Equity Arrangements Why do firms want control? Internalization choose the lower cost between conducting operations internally and contracting to another party it may be cheaper to handle operations internally Appropriability do not transfer vital resources to another company to avoid having competitive position undermined Freedom to pursue a global strategy In general, the more ownership a company has, the more control over decisions the firm has. Three main theories that explain why companies want control are internalization theory, appropriability theory, and freedom to pursue global objectives. Copyright © 2015 Pearson Education Ltd.

Non-Collaborative Foreign Equity Arrangements There are two ways to invest in a foreign country Acquisition of existing facilities Greenfield Investment – Building new facilities When investing in a foreign country, companies can either acquire an existing facility, or build a new one. The latter option is known as a greenfield investment. The advantages of acquiring an existing operation include: • Adding no further capacity to the market • Avoiding start-up problems • Easier financing at times Companies may choose to build if: • No desired company is available for acquisition • Acquisition will lead to carryover problems • Acquisition is harder to finance Copyright © 2015 Pearson Education Ltd.

Why Companies Collaborate Collaborative Arrangements and International Objectives Companies collaborate or form strategic alliances for many reasons. This Figure shows both the general and the internationally specific reasons for collaboration. Copyright © 2015 Pearson Education Ltd.

General Motives for Collaborative Arrangements To spread and reduce costs To specialize in competencies – the resource-based view To avoid or counter competition To secure Vertical and Horizontal Links To gain knowledge The general motives for collaborative arrangements are: To spread and reduce costs To specialize in competencies – the resource-based view To avoid or counter competition To secure Vertical and Horizontal Links To gain knowledge Copyright © 2015 Pearson Education Ltd.

International Motives for Collaborative Arrangements To gain location-specific assets To overcome governmental constraints Protecting assets To diversify geographically To minimize risk exposure Further motives are: To gain location-specific assets To overcome governmental constraints Protecting assets To diversify geographically To minimize risk exposure Copyright © 2015 Pearson Education Ltd.

Types of Collaborative Arrangements Two key factors influence the type of collaborative arrangement Control Prior expansion Compensation Choosing between the different types of collaborative arrangements involves tradeoffs. The more a company depends on collaboration, the more likely it is to lose decision making control. How much control a company is willing to give up will influence its choice of collaborative arrangement. Similarly, companies with prior international experience in a country are less likely to benefit from a partner’s knowledge of the market. Copyright © 2015 Pearson Education Ltd.

Types of Collaborative Arrangements Licensing a company grants intangible property rights to another company to use in a specified geographic area for a specified period in exchange for royalties Can be exclusive or nonexclusive used to protect intangible property Companies often engage in licensing agreements for economic reasons such as a faster start-up, lower costs, or to gain access to additional resources. Copyright © 2015 Pearson Education Ltd.

Licensing Applications Patents, inventions, formulas, processes, designs, patterns Copyrights for literary, musical or artistic compositions Trademarks, trade names, brand names Franchises, licenses, contracts Methods, programs, procedures, systems Licensing applies to many different aspects of business, such as: Patents, inventions, formulas, processes, designs, patterns Copyrights for literary, musical or artistic compositions Trademarks, trade names, brand names Franchises, licenses, contracts Methods, programs, procedures, systems Copyright © 2015 Pearson Education Ltd.

Types of Collaborative Arrangements Franchising a specialized form of licensing includes providing an intangible asset and also operational assistance on a continuing basis Franchise organization Master franchise Operational modifications Franchising is often associated with U.S. fast food companies, but in fact many international franchisors are from other countries and sectors. Companies can expand in foreign markets using individual franchises, or by setting up a master franchisor which then establishes sub-franchisees. Because the success of a franchise depends on product and service standardization, high identification through promotion, and effective cost controls, companies need to be sure that operational modifications don’t compromise what the company has to offer. Copyright © 2015 Pearson Education Ltd.

Types of Collaborative Arrangements Management contract a company is paid a fee to transfer management personnel and administrative know-how abroad to assist a company Foreign management contracts are used primarily when the foreign company can manage better than the owners A company may pay for managerial assistance when it believes another company can better manage its operation. Copyright © 2015 Pearson Education Ltd.

Types of Collaborative Arrangements Turnkey operation one company contracts with another to build complete, ready-to-operate facilities Most commonly performed by industrial-equipment, construction, and consulting companies Often performed for a governmental agency Turnkey operations are often very large, running into the hundreds of millions and even billions of dollars. For example, a current turnkey project run by Spain’s Sacyr Vallehermoso involves building a wider Panama Canal. Copyright © 2015 Pearson Education Ltd.

Types of Collaborative Arrangements Joint ventures involve more than two companies, one of which may own more than 50 percent may have various combinations of ownership A consortium involves more than two organizations Possible joint venture combinations include • Two companies from the same country joining together in a foreign market • A foreign company joining with a local company • Companies from two or more countries establishing a joint venture in a third country • A private company and a local government forming a joint venture • A private company joining a government-owned company in a third country Copyright © 2015 Pearson Education Ltd.

Types of Collaborative Arrangements Equity alliances an arrangement in which at least one of the companies takes an ownership position in the other The purpose of the equity ownership is to solidify a collaborating contract, such as a supplier-buyer contract, so that it is more difficult to break—particularly if the ownership is large enough to secure a board membership for the investing company. Copyright © 2015 Pearson Education Ltd.

Types of Collaborative Arrangements Collaborative Strategy and Complexity of Control This Figure shows that as a company increases the number of partners and decreases the amount of equity it owns in a foreign operation, its ability to control that operation decreases. Copyright © 2015 Pearson Education Ltd.

Problems with Collaborative Arrangements Problems with collaborative arrangements include Relative importance Divergent objectives Questions of control Comparative contributions and appropriations Culture clashes Differences in corporate cultures Collaborative arrangements don’t always work out. The most common challenges involve the relative importance of the project to each company, divergent objectives, control issues, contribution issues, culture clashes, and different corporate cultures. Copyright © 2015 Pearson Education Ltd.

Managing International Collaboration Collaborative arrangements are dynamic The motivation for collaboration can change over time because of changes in the company’s capabilities the external environment Companies need to continually reassess the fit between collaboration and strategy to determine if it still makes sense. Keep in mind that moving to a different operating mode can be the result of experience, may necessitate costly termination fees, and can create organizational tension. Copyright © 2015 Pearson Education Ltd.

Managing International Collaboration Country Attractiveness/Company Strength Matrix This Figure relates country attractiveness with operating forms. Copyright © 2015 Pearson Education Ltd.

Managing International Collaboration Potential collaborative partners should be evaluated in terms of the resources they will supply their motivation compatibility Trust is essential in collaborative arrangements. Companies without proven track records may have to negotiate harder and make more concessions. Copyright © 2015 Pearson Education Ltd.

Managing International Collaboration Contracts should address Whether the contract will be terminated if the parties do not adhere to the directives What methods will be used to test for quality What geographic limitations should be placed on an asset’s use Which company will manage which parts of the operation What each company’s future commitments will be How each company will buy from, sell to, or otherwise use intangible assets that result from the arrangement Contracts should spell out mutual goals and expectations. Copyright © 2015 Pearson Education Ltd.

Managing International Collaboration When collaborating with another company, managers must Continue to monitor performance Assess whether to change the form of operations Develop competency in managing a portfolio of arrangements Finally, keep in mind that finding a capable and compatible partner is not enough. Managers must also look for ways to improve performance. Copyright © 2015 Pearson Education Ltd.

Why Innovation Breeds Collaboration Collaborative arrangements will bring both opportunities and problems as companies move simultaneously to new countries and to contractual arrangements with new companies Collaborative arrangement must overcome differences in a number of areas • Country cultures that may cause partners to obtain and evaluate information differently • National differences in governmental policies, institutions, and industry structures that constrain companies from operating as they would prefer • Corporate cultures that influence ideologies and values underlying company practices that strain relationships among companies • Different strategic directions resulting from partners’ interests that cause companies to disagree on objectives and contributions • Different management styles and organizational structures that cause partners to interact ineffectively Copyright © 2015 Pearson Education Ltd.