International Business Chapter Twelve Country Evaluation and Selection

Chapter Objectives To grasp company strategies for sequencing the penetration of countries To see how scanning techniques can help managers both limit geographic alternatives and consider otherwise overlooked areas To discern the major opportunity and risk variables a com-pany should consider when deciding whether and where to expand abroad To know the methods and problems when collecting and comparing information internationally To understand some simplifying tools for helping to decide where to operate To consider how companies allocate emphasis among the countries where they operate To comprehend why location decisions do not necessarily compare different countries’ possibilities

The Basics of Country Selection Because firms lack sufficient resources to pursue all potential (international) opportunities, they must: determine the order of country entry establish the rates of resource allocation across countries In selecting geographic sites, firms must decide: where to market their products where to produce their products If transportation costs are high and/or government regulations require local production, a firm may be forced to produce a product in the same country in which it sells it.

Fig. 12.2: Place of Location Decisions in International Business Operations

Scanning vs. Detailed Examination Scanning techniques are based on broad vari- ables that identify both opportunities and risks. Scanning techniques help to assure that firms consider neither too many nor two few alternative countries. [For the most part, scanning requires information that is readily available, inexpensive, and fairly comparable.] Detailed examination generally requires on-site visits to collect and analyze specific information that increasingly contributes to the final location decision process. A feasibility study should have clear-cut decision points to guide managers in the decision-making process. Escalation of commitment: the more time and money a firm invests in examining an alternative, the more likely it is to accept it—regardless of its merits.

Fig. 12.3: Flowchart for Choosing Where to Operate

The Environmental Climate: Country Opportunities • Country opportunities are determined by competitiveness and profitability factors. • Factors that have the greatest influence on country selection are: market size [sales potential] ease and compatibility of operations costs and resource availability red tape and corruption Some factors are more important for the market location decision, others for the production location decision. Some factors affect both decisions.

Country Opportunities: Market Attractiveness Market size, i.e., sales potential, is probably the most important market selection variable. Market size predictors include: past and present sales data socioeconomic data [GDP, per capita income, population size, population growth rates, etc.] Other factors to be considered include: the obsolescence and leapfrogging of products price levels and elasticity income levels and elasticity income inequalities substitutability of products existence of trading blocs taste and other cultural factors

Fig. 12.4: Aluminum Consumption and GDP per Capita

Country Opportunities: Ease and Compatibility of Operations Firms are attracted to countries that: are located nearby share a common language have market conditions similar to those in their home countries present few market restrictions Firms’ decision points regarding country selection may include: the ability to operate with product types, technologies, and plant sizes familiar to their managers permissible levels of ownership and profit repatriation the availability of local resources [capital, viable partners, etc.]

Country Opportunities: Costs and Resource Availability • Firms go abroad to secure resources that are either unavailable or too expensive at home. • Increasingly, firms need to be near customers and suppliers in locations where (i) the infrastructure permits the efficient movement of people, materials, and products and (ii) trade restrictions are minimal. • Productivity-related decision factors include: the cost of labor ̶ utility costs tax rates ̶ real estate costs available capital costs ̶ transportation costs the cost of other inputs and supplies [continued]

• Labor costs are a particularly important factor in production location decisions. However, ̶ labor is not homogeneous ̶ capital intensity may reduce the differences in production costs from one location to another ̶ there may be sector and/or geographic differences in wage rates within countries When companies move to emerging economies because of labor cost savings, their advantages may be short-lived because: • competitors follow leaders to low-wage locations • there is little first-in advantage for this type of production migration • costs in emerging economies may rise quickly as a result of pressures on wages and/or exchange rates

Country Opportunities: Red Tape and Corruption Red tape: obstructive bureaucracy, i.e., disincentives related to the clarity of laws and whether and how they are enforced Red tape includes government obstacles with respect to: beginning and continuing operations hiring and/or firing workers the use of expatriate personnel producing and marketing goods satisfying local agencies on matters such as taxes, labor conditions, and environmental compliance [continued]

Corruption, i.e., the extortion of income or resources, may include: Corruption: the illegal sale of rights by govern-ment officials for their personal gain Corruption, i.e., the extortion of income or resources, may include: requirements of illegal payments to win a contract requirements of illegal payments to receive govern-ment services requirements of illegal payments to operate in a particular location or industry Firms are likely to avoid operating countries in which legal transparency is low and corruption is high.

The Environmental Climate: Country Risks Risk: the possibility of suffering harm or loss, or a course involving uncertain danger or hazard Returns tend to be higher in countries where operating risks are higher. Firms may balance operations in low-return, low-risk countries with operations in high-return, high-risk countries. Firms may guard against currency fluctuations by locating operations in countries whose exchange rates are not closely correlated. Adverse situations may heighten the perceived needs for certain products.

Country Risks: Risk and Uncertainty Companies use a variety of financial techniques to compare potential projects, including: discounted cash flow ̶ return on assets employed economic value added ̶ internal rate of return payback period ̶ accounting rate of return net present value ̶ return on equity return on sales Given the same expected return, most decision makers prefer a more certain outcome to a less certain one. Firms may acquire insurance to reduce risk and uncertainty.

Comparison of ROI Certainty INVESTMENT A INVESTMENT B WEIGHTED WEIGHTED ROI PROBABILITY VALUE PROBABILITY VALUE 0% .15 0.0 0 0.0 5% .20 1.0 .30 1.5 10% .30 3.0 .40 4.0 15% .20 3.0 .30 4.5 20% .15 3.0 0 0.0 Est. ROI 10.0% 10.0% During the initial scanning stage a firm should weight the elements of risk and uncertainty; during a later feasibility study, the firm must determine whether the degree of risk is acceptable.

Country Risks: Liability of Foreignness Liability of foreignness: the lower survival rate of foreign firms in their initial years of operation Firms may reduce the associated risks by: first entering countries similar to their home countries enlisting experienced intermediaries to handle operations for them using operational forms that require a lower commitment of foreign resources initially moving to fewer, rather than more, foreign countries Foreign firms that manage to survive their early years of operation actually have long-term survival rates comparable to those of local competitors.

Fig. 12.5: The Usual Pattern of Internationalization

Country Risks: Competitive Risk Strategies designed to deal with the risks posed by competition include: the imitation lag: exploiting temporary innovative advantages by moving first into those countries most likely to catch up the first mover advantage: becoming the first major com-petitor to enter a country in order to gain the best partners, the best locations, and the best suppliers the oligopolistic reaction: purposely crowding a market to prevent competitors from gaining advantages they might use to improve their competitive positions elsewhere clustering: locating in places where competitors are present to gain access to multiple suppliers, skilled personnel, an existing customer base, and information regarding innovations

Country Risks: Monetary Risk Liquidity preference: the theory that presumes that investors generally want some of their holdings in highly liquid assets • When considering monetary risk, firms must carefully evaluate a country’s: present capital controls exchange rate stability balance-of-payments accounts inflation rates levels of government spending Investors are willing to accept a lower rate of return on liquid assets in order to be able to move them easily.

Country Risks: Political Risk Political risk: the expectation that the political climate in a given country will change in such a way that a firm’s operating position will deteriorate Firms can evaluate the potential political risk of a given country by: examining the country’s past patterns of political risk evaluating the direction of change in the views of government decision makers employing expert analysts tracking economic and social conditions Political risk may arise from war, the expropriation of property, changes in political leaders’ opinions and policies, civil disorder, and/or animosity between a home and host country.

Data Collection and Analysis Firms conduct research to: reduce uncertainties at all levels in their decision processes expand or narrow the alternatives they consider assess the merits of their existing programs The cost of data collection must be weighed against the probable payoff in terms of: revenue gains cost savings When firms conduct original studies in foreign countries, they may have to be extremely imaginative and observant and analyze indirect and/or complementary indicators.

Problems with International Data and Research Results The lack, obsolescence, and/or inaccuracy of data regarding many countries make much research difficult and expensive to undertake. Reasons for data inaccuracies include: the inability of governments to collect the needed information the publication of false or purposely inaccurate information designed to mislead constituencies the publication of conclusions based on too few observations, non-representative samples, and/or poorly designed research instruments [continued]

Data comparability problems are rooted in: definitional differences across countries [e.g., family categories, literacy levels, accounting rules] differences in base years and time periods distortions in foreign currency conversions differences in the measurement of investment flows the presence of black market activities Many countries have agreed to similar standards for collecting and publishing various categories of national data in response to a recommendation of the IMF.

External Sources of Information The major types of external, secondary information sources include: individualized reports from market research and business consulting firms [commissioned for a fee] specialized studies from research organizations regarding countries, regions, industries, issues, etc. service firm reports regarding relevant business topics government agency socioeconomic and other reports international organization and agency reports [e.g., the UN, the IMF, the World Bank, and the OECD] trade association reports information service company reports [fee-based databases] Both the specificity and the cost of information will vary by source.

Country Comparison Tools Grids can be used to: depict acceptable or unacceptable conditions [e.g., ownership rights] rank countries according to selected, weighted variables [e.g., return or risk] Matrices can be used to: incorporate weighted indicators of a firm’s risks and opportunities in specific countries plot the scores to more clearly reveal respective positions for comparative purposes It is useful to develop both present and future scores for countries; a significant shift in a future score could have serious implications with respect to the country selection process.

Simplified Country Comparison Grid: Three Types of Information VARIABLE WEIGHT I II III IV V 1. Ownership a. Sole — No Yes Yes Yes Yes b. Jt. venture — Yes Yes Yes Yes Yes 2. Return [higher number preferred] a. Investment 0-5 — 4 3 3 3 b. Direct costs 0-3 — 3 1 3 2 Total 7 4 6 5 3. Risk [lower number preferred] a. Exchange risk 0-3 — 0 0 3 3 b. Political risk 0-3 — 0 1 2 3 Total 0 1 5 6

Fig. 12.7: Opportunity-Risk Matrix

Country Resource Allocation: Reinvestment vs. Harvesting Reinvestment: the use of retained earnings to replace depreciated assets or to add to a firm’s existing stock of capital Over time, most of the value of a firm’s FDI comes from reinvestment; it may take several years and even the allocation of additional funds to meet stated objectives. Harvesting: the reduction in the amount of an invest-ment, either by simply harvesting earnings or by divesting assets as well If an operation no longer fits a firm’s overall strategy, or if better opportunities exist elsewhere, a firm must determine how to exit that operation. Managers are more likely to propose investments than divestments.

Country Resource Allocation: Diversification vs. Concentration Geographic diversification: moving rapidly into numerous foreign countries and then gradually building a presence in each Geographic concentration: moving into a limited number of countries and developing a strong competitive position in each • Factors to be considered when selecting a strategy (or perhaps a hybrid of the two) include: ̶ market growth rates ̶ the need for adaptation ̶ market sales stability ̶ program control ̶ competitive lead time requirements ̶ spillover effects ̶ constraints

Diversification vs. Concentration Strategies: Product and Market Factors Prefer Prefer Factor Diversification Concentration if: if: 1. Market growth rate low high 2. Market sales stability low high 3. Competitive lead time short long 4. Spillover effects high high 5. Need for product adaptation low high 6. Need for promotion and low high distribution adaptation 7. Program control requirements low high 8. Constraints low high Source: “Marketing Expansion Strategies in International Marketing,” Journal of Marketing, Spring 1979, p.89.

Final Country Selection Details and Non-comparative Decision Making For new investments, firms must: make on-site visits generate detailed estimates of all costs consider different locations within a given country evaluate partnership prospects For acquisitions firms must examine financial statements and operations in detail. For expansion within countries, decisions will most likely be made on the basis of capital budget requests. [continued]

Major factors restricting companies from compar-ing country investment opportunities in great detail are: costs—the additional time and resources required may increase costs to unacceptable levels time—firms may need to react quickly in order to capture first-mover advantages or respond to competitive threats Many firms consider proposals one at a time and accept them if they meet minimum threshold criteria.

Implications/Conclusions Firms use both qualitative and quantitative information to determine which markets to serve and where to locate production. Because each firm has unique competitive capabilities and objectives, the factors affecting the country selection decision will differ for each.

• When allocating resources across countries, a company must consider its need for reinvestment vs. divestment, its preference for diversification vs. concentration, as well as the interdependence of its operations. • The interdependence of a firm’s operations may obscure the real impact of a given operation on overall corporate activity and profitability.