International Business 7e by Charles W.L. Hill McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 14 Entry Strategy and Strategic Alliances

Introduction Firms expanding internationally must decide: which markets to enter when to enter them and on what scale which entry mode to use Entry modes include: exporting licensing or franchising to a company in the host nation establishing a joint venture with a local company establishing a new wholly owned subsidiary acquiring an established enterprise

Introduction Several factors affect the choice of entry mode including: transport costs trade barriers political risks economic risks costs firm strategy The optimal mode varies by situation – what makes sense for one company might not make sense for another

Basic Entry Decisions Firms entering foreign markets make three basic decisions: 1. which markets to enter 2. when to enter those markets 3. on what scale to enter those markets

Which Foreign Markets? The choice of foreign markets will depend on their long run profit potential Favorable markets are politically stable developed and developing nations with free market systems and relatively low inflation rates and private sector debt Less desirable markets are politically unstable developing nations with mixed or command economies, or developing nations with excessive levels of borrowing Markets are also more attractive when the product in question is not widely available and satisfies an unmet need

Timing Of Entry Once attractive markets are identified, the firm must consider the timing of entry Entry is early when the firm enters a foreign market before other foreign firms Entry is late when the firm enters the market after firms have already established themselves in the market

Timing Of Entry First mover advantages are the advantages associated with entering a market early First mover advantages include: the ability to pre-empt rivals and capture demand by establishing a strong brand name the ability to build up sales volume in that country and ride down the experience curve ahead of rivals and gain a cost advantage over later entrants the ability to create switching costs that tie customers into products or services making it difficult for later entrants to win business

Timing Of Entry First mover disadvantages are disadvantages associated with entering a foreign market before other international businesses First mover disadvantages include: pioneering costs - arise when the foreign business system is so different from that in a firm’s home market that the firm must devote considerable time, effort and expense to learning the rules of the game Pioneering costs include: the costs of business failure if the firm, due to its ignorance of the foreign environment, makes some major mistakes the costs of promoting and establishing a product offering, including the cost of educating customers

Classroom Performance System _______ refers to the time and effort spent learning the rules of a new market. a) First mover advantages b) Strategic commitments c) Pioneering costs d) Market entry costs The answer is c.

Scale Of Entry And Strategic Commitments After choosing which market to enter and the timing of entry, firms need to decide on the scale of market entry Entering a foreign market on a significant scale is a major strategic commitment that changes the competitive playing field Firms that enter a market on a significant scale make a strategic commitment to the market (the decision has a long term impact and is difficult to reverse) Small-scale entry has the advantage of allowing a firm to learn about a foreign market while simultaneously limiting the firm’s exposure to that market Management Focus: International Expansion at ING Group Summary This feature describes ING Group’s rapid expansion into the United States. ING, the third largest bank in the Netherlands, primarily expands through acquisitions. The company is seeking to be one of the top 10 financial services firms in the world. Discussion of the feature can revolve around the following questions: Suggested Discussion Questions 1. What makes ING’s strategy in its quest to become one of the top 10 financial services firms in the world so successful? What does ING’s entry into the United States market mean for competitors? Discussion Points: Many students will probably suggest that ING’s strategy is so successful because rather than growing its business from the ground up, it acquires existing firms, leaves them largely intact so as to retain the existing employees and customers, but adds in the ING name and products in order to capitalize on a global brand name. For American companies, ING’s presence in the market is significant. In just a few years, the company has gone from having virtually no position in the market, to being one of the country’s top 10 financial services firms. As it continues to build its name, American competitors and foreign companies will probably find it more and more difficult to break into the market in a meaningful way. 2. How did ING approach the United States? How did the company signal its commitment to the market? What effect will this commitment have for ING? Discussion Points: ING followed the same strategy in the United States that had proved to be successful in other countries. The company identified companies that it could acquire, left the companies’ management and products in place, and then, added in ING products and names. Because the United States is the world’s largest financial market, ING recognized that to be a key player, it would need a significant market presence. To become one of the 10 largest companies in the industry, the company embarked on a series of acquisitions beginning with the Equitable Life Insurance Company of Iowa in 1997. Another Perspective:Explore ING’s international operations by going to the company’s homepage at {http://www.ing.com}, clicking on “Personal Finance” and then on the country of your choice.

Summary There are no “right” decisions when deciding which markets to enter, and the timing and scale of entry, just decisions that are associated with different levels of risk and reward Large scale entry Strategic Commitments - a decision that has a long-term impact and is difficult to reverse May cause rivals to rethink market entry May lead to indigenous competitive response Small scale entry Time to learn about market Reduces exposure risk

Entry Modes These are six different ways to enter a foreign market: 1. exporting 2. turnkey projects 3. licensing 4. franchising 5. establishing joint ventures with a host country firm 6. setting up a new wholly owned subsidiary in the host country Managers need to consider the advantages and disadvantages of each entry mode Management Focus: The Jollibee Phenomenon—A Philippine Multinational Summary This feature describes the remarkable success story of Jollibee. Jollibee, a fast food chain from the Philippines, not only stood its ground when McDonald’s invaded its market in 1981, but also managed to find the weaknesses in the larger company’s global strategy and capitalize on them. Jollibee, unlike McDonald’s, tailored its menu to the local market. The company was able to build on this localization strategy as it expanded into neighboring Asian countries and the Middle East. Today, Jollibee has even managed to find success in the United States where it is being hailed as a strong niche player. Suggested Discussion Questions 1. How would Christopher Bartlett and Sumantra Ghoshal view Jollibee’s performance to date? Discussion Points: Many students will probably suggest that Bartlett and Ghoshal would have a positive view of Jollibee’s performance so far. Jollibee has managed to survive McDonald’s push into the Philippines, learn from the company, and even capitalize on gaps in McDonald’s strategy of having an essentially standardized marketing approach. Now, Jollibee has successfully entered McDonald’s home market, and become a niche player in the fast food industry. 2. A key difference between McDonald’s global strategy and that of Jollibee is that McDonald’s sees its path to success as offering a fairly standardized menu everywhere whereas Jollibee views localization as its ticket to success. In your opinion, would Jollibee have achieved its current position in the market if the company had standardized its menu like McDonald’s? Discussion Points: Most students will probably argue that Jollibee’s competitive advantage is that it offers fast food tailored to local tastes, and that if the company pursued a standardized approach it would have failed. Students might note that McDonald’s global success with this strategy is due in part to the fact that it is a symbol of America, and as such offers an American experience in other markets. Because Jollibee does not have this type of global reputation, it must look for alternative ways to compete. Another Perspective: It is worth visiting Jollibee’s web page to see the American influence on the company. Go to {http://www.jollibee.com.ph/} and click on “International” to explore some of the company’s foreign locations.

Exporting Exporting is a common first step in the international expansion process for many manufacturing firms Later, many firms switch to another mode to serve the foreign market

Exporting Exporting is attractive because: it avoids the costs of establishing local manufacturing operations it helps the firm achieve experience curve and location economies Exporting is unattractive because: there may be lower-cost manufacturing locations high transport costs and tariffs can make it uneconomical agents in a foreign country may not act in exporter’s best interest

Turnkey Projects In a turnkey project, the contractor agrees to handle every detail of the project for a foreign client, including the training of operating personnel At completion of the contract, the foreign client is handed the "key" to a plant that is ready for full operation Turnkey projects are common in the chemical, pharmaceutical, petroleum refining, and metal refining industries

Turnkey Projects Turnkey projects are attractive because: they are a way of earning economic returns from the know-how required to assemble and run a technologically complex process they can be less risky than conventional FDI Turnkey projects are unattractive because: the firm that enters into a turnkey deal will have no long-term interest in the foreign country the firm that enters into a turnkey project may create a competitor if the firm's process technology is a source of competitive advantage, then selling this technology through a turnkey project is also selling competitive advantage to potential and/or actual competitors

Licensing A licensing agreement is an arrangement whereby a licensor grants the rights to intangible property to another entity (the licensee) for a specified time period, and in return, the licensor receives a royalty fee from the licensee Intangible property includes patents, inventions, formulas, processes, designs, copyrights, and trademarks

Licensing Licensing is attractive because: the firm does not have to bear the development costs and risks associated with opening a foreign market the firm avoids barriers to investment firms with intangible property that might have business applications can capitalize on market opportunities without developing those applications itself

Licensing Licensing is unattractive because: the firm doesn’t have the tight control over manufacturing, marketing, and strategy required for realizing experience curve and location economies it limits a firm’s ability to coordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another proprietary (or intangible) assets could be lost One way of reducing this risk is through the use of cross-licensing agreements where a firm might license intangible property to a foreign partner, but requests that the foreign partner license some of its valuable know-how to the firm in addition to a royalty payment

Franchising Franchising is basically a specialized form of licensing in which the franchisor not only sells intangible property to the franchisee, but also insists that the franchisee agree to abide by strict rules as to how it does business Franchising is used primarily by service firms

Franchising Franchising is attractive because: Firms avoid many costs and risks of opening up a foreign market Firms can quickly build a global presence Franchising is unattractive because: It may inhibit the firm's ability to take profits out of one country to support competitive attacks in another the geographic distance of the firm from its foreign franchisees can make poor quality difficult for the franchisor to detect

Joint Ventures A joint venture is the establishment of a firm that is jointly owned by two or more otherwise independent firms Most joint ventures are 50:50 partnerships

Joint Ventures Joint ventures are attractive because: they allow the firm to benefit from a local partner's knowledge of the host country's competitive conditions, culture, language, political systems, and business systems the costs and risks of opening a foreign market are shared with the partner When political considerations make joint ventures the only feasible entry mode Joint ventures are unattractive because: the firm risks giving control of its technology to its partner the firm may not have the tight control over subsidiaries need to realize experience curve or location economies shared ownership can lead to conflicts and battles for control if goals and objectives differ or change over time

Wholly Owned Subsidiaries In a wholly owned subsidiary, the firm owns 100 percent of the stock Firms can establish a wholly owned subsidiary in a foreign market: setting up a new operation in the host country acquiring an established firm in the host country

Wholly Owned Subsidiaries Wholly owned subsidiaries are attractive because: they reduce the risk of losing control over core competencies they give a firm the tight control over operations in different countries that is necessary for engaging in global strategic coordination they may be required in order to realize location and experience curve economies Wholly owned subsidiaries are unattractive because: the firm bears the full cost and risk of setting up overseas operations

Classroom Performance System How do most firms begin their international expansion? a) with a joint venture b) with a wholly owned subsidiary c) with licensing or franchising d) with exporting The answer is d.

Classroom Performance System What is the main disadvantage of wholly owned subsidiaries? a) they make it difficult to realize location and experience curve economies b) the firm bears the full cost and risk of setting up overseas operations c) they may inhibit the firm's ability to take profits out of one country to support competitive attacks in another d) high transport costs and tariffs can make it uneconomical The answer is b.

Selecting An Entry Mode All entry modes have advantages and disadvantages The optimal choice of entry mode involves trade-offs

Selecting An Entry Mode Table 14.1:

Core Competencies And Entry Mode The optimal entry mode depends to some degree on the nature of a firm’s core competencies When a firm’s competitive advantage is based on proprietary technological know-how, the firm should avoid licensing and joint venture arrangements unless it believes its technological advantage is only transitory, or that it can establish its technology as the dominant design in the industry When a firm’s competitive advantage is based on management know-how, the risk of losing control over the management skills is not high, and the benefits from getting greater use of brand names is significant

Pressures For Cost Reductions And Entry Mode When pressure for cost reductions is high, firms are more likely to pursue some combination of exporting and wholly owned subsidiaries This will allow the firm to achieve location and scale economies as well as retain some degree of control over its worldwide product manufacturing and distribution So, firms pursuing global standardization or transnational strategies prefer wholly owned subsidiaries

Classroom Performance System If a firm wants the option of global strategic coordination, the firm should choose a) franchising b) joint ventures c) licensing d) a wholly owned subsidiary The answer is d.

Greenfield Ventures Or Acquisitions Firms can establish a wholly owned subsidiary in a country by: Using a greenfield strategy - building a subsidiary from the ground up Using an acquisition strategy

Pros And Cons Of Acquisition Acquisitions are attractive because: they are quick to execute they enable firms to preempt their competitors acquisitions may be less risky than greenfield ventures

Pros And Cons Of Acquisition Acquisitions can fail when: the acquiring firm overpays for the acquired firm the cultures of the acquiring and acquired firm clash attempts to realize synergies run into roadblocks and take much longer than forecast there is inadequate pre-acquisition screening To avoid these problems, firms should: carefully screening the firm to be acquired move rapidly once the firm is acquired to implement an integration plan

Pros And Cons Of Greenfield Ventures The main advantage of a greenfield venture is that it gives the firm a greater ability to build the kind of subsidiary company that it wants However, greenfield ventures are slower to establish Greenfield ventures are also risky

Greenfield Or Acquisition? The choice between a greenfield investment and an acquisition depends on the situation confronting the firm Acquisition may be better when the market already has well-established competitors or when global competitors are interested in building a market presence A greenfield venture may be better when the firm needs to transfer organizationally embedded competencies, skills, routines, and culture

Classroom Performance System All of the following are advantages of acquisitions except a) they are quicker to execute b) it is easy to realize synergies by integrating the operations of the acquired entities c) they enable firms to preempt their competitors d) they may be less risky The answer is b.

Strategic Alliances Strategic alliances refer to cooperative agreements between potential or actual competitors Strategic alliances range from formal joint ventures to short-term contractual agreements The number of strategic alliances has exploded in recent decades

The Advantages Of Strategic Alliances facilitate entry into a foreign market allow firms to share the fixed costs (and associated risks) of developing new products or processes bring together complementary skills and assets that neither partner could easily develop on its own can help a firm establish technological standards for the industry that will benefit the firm Management Focus: Cisco and Fujitsu Summary This feature examines Cisco Systems’ joint venture with Fujitsu. Cisco, the world’s largest manufacturer of Internet routers, entered the alliance in 2004 in an effort to jointly develop the next generation of high end routers for sales in Japan. Cisco believes that the Japanese market will be important, and wants to expand its presence there. Fujitsu wanted the routers so that it can offer end-to-end communications solutions to its customers. Discussion of the feature can begin with the following questions. Suggested Discussion Questions 1. What did Cisco hope to gain by forming an alliance with Fujitsu? What risks are involved for Cisco with this alliance? How can Cisco limit those risks? Discussion Points: Cisco hoped to achieve several goals through its alliance with Fujitsu. The company hoped that by sharing R&D, new product development would be quicker, that combining its technology expertise with Fujitsu’s production expertise would result in more reliable products, that it would gain a bigger sales presence in Japan, and that by bundling its routers together with Fujitsu’s telecommunications equipment, the alliance could offer end-to-end communications solutions to customers. Students will probably suggest that the biggest risk for Cisco is that by sharing its proprietary technology with Fujitsu, it could potentially create a competitor. To avoid this, Cisco will need to take steps to protect its technology by making sure that safeguards are written into alliance agreements, and ensure that it is getting an equitable gain from the agreement. 2. What did Fujitsu bring to the alliance? Why was it important for Cisco to have a Japanese presence? What were the advantages of the alliance for Fujitsu? Discussion Points: One of the key attractions of an alliance with Fujitsu’s was the company’s strong presence in the Japanese market. Japan is at the forefront of second generation high speed Internet based telecommunications networks, and Cisco wanted to be a part of that market. For Fujitsu, the alliance meant that it could fill the gap in its product line for routers, reduce product development costs and time, and produce more reliable products. 3. What does the alliance between Cisco and Fujitsu mean to other competitors in the router market? Discussion Points: For other competitors in the market, the alliance between Cisco and Fujitsu is significant. Together, the companies can offer one-stop shopping end-to-end communications solutions. Furthermore, because the two companies are pooling their resources, development costs are lower, which will put additional pressure on competitors. Another Perspective:To find out more about Cisco and Fujitsu, students can visit the company web sites at {http://www.cisco.com/} and {http://www.fujitsu.com/global/}. In addition, a new release about the Cisco- Fujitsu alliance is available at {http://newsroom.cisco.com/dlls/2004/prod_120604c.html}.

The Disadvantages Of Strategic Alliances Strategic alliances can give competitors low-cost routes to new technology and markets, but unless a firm is careful, it can give away more than it receives

Making Alliances Work The success of an alliance is a function of: partner selection alliance structure the manner in which the alliance is managed

Making Alliances Work A good partner: helps the firm achieve its strategic goals and has the capabilities the firm lacks and that it values shares the firm’s vision for the purpose of the alliance is unlikely to try to opportunistically exploit the alliance for its own ends: that it, to expropriate the firm’s technological know-how while giving away little in return

Making Alliances Work Once a partner has been selected, the alliance should be structured: to make it difficult to transfer technology not meant to be transferred with contractual safeguards written into the alliance agreement to guard against the risk of opportunism by a partner to allow for skills and technology swaps with equitable gains to minimize the risk of opportunism by an alliance partner

Making Alliances Work After selecting the partner and structuring the alliance, the alliance must be managed Successfully managing an alliance requires managers from both companies to build interpersonal relationships A major determinant of how much a company gains from an alliance is its ability to learn from its alliance partners

Classroom Performance System Which of the following is not important to a successful strategic alliance? a) establishing a 50:50 relationship with partner b) creating strong interpersonal relationships c) a shared vision d) learning from the partner The answer is a.