1. 13 Selecting and Managing Entry Modes
Welcome to Chapter 13, Selecting and Managing Entry Modes.
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2. Chapter Objectives
Explain how companies use exporting, importing, and countertrade
Explain the various means of financing export and import activities
Describe the different contractual entry modes that are available to companies
Explain the various types of investment entry modes
Discuss the important strategic factors in selecting an entry mode
In this chapter, you will learn how a firm can achieve its objectives through exporting, importing, and countertrade.
You will also:
Understand the ways in which a firm finances its import and export activities.
Explore various contractual and investment entry modes.
And examine the strategic factors in selecting an entry mode.
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3. Marvel Enterprises Licenses characters for films and products
Earns royalties from licensing agreements
The licensing activities of Marvel Enterprises have taken it beyond being just a comics and toy company.
Marvel’s top comic-book characters—including Iron Man, Spider-Man, and the Hulk—have already made it to the big screen with enormous success.
Marvel also has licensing agreements for placing its characters on all sorts of products. Marvel, then, earns royalties on sales of the products.
And Marvel’s 50/50 joint venture with Sony oversees global licensing and merchandising activities for the film Spider-Man and the animated TV series titled Spider-Man.
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4. Exports to the United States
This chart shows the top 10 exporters to the United States in terms of the value of goods sold. Companies typically begin exporting to:
Expand sales when the domestic market is saturated.
Diversify sales to better match cash inflows with cash outflows.
Gain valuable experience through a relatively low-risk and low-cost method of conducting international business.
Source: Based on data contained in International Trade Statistics 2011 (Geneva, Switzerland: World Trade Organization, November 2011), Table II.30, p. 81–82.
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5. Developing an Export Strategy
Step 1
Step 2
Step 3
Step 4
There are four steps to creating an export strategy for international markets.
Step 1 is to identify a potential market.
This means researching a target market to discover whether sufficient demand exists. It is best to focus on one or a few markets that are best understood in cultural terms.
Step 2 is to match needs to abilities.
This involves a frank assessment of a company’s ability to satisfy the needs of a prospective market.
Step 3 is to initiate meetings.
Schedule meetings with potential distributors, buyers, and others to build trust and cooperation and to lay out the working relationship.
Step 4 is to commit resources.
After agreements are finalized, this involves employing resources to clearly define the export program’s objectives for at least the next 3 to 5 years.
Identify a potential market
Match needs to abilities
Initiate
meetings
Commit resources
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6. Degree of Export Involvement
Direct exporting
(sell to buyers)
Indirect exporting
(sell to intermediary)
Sales representative
Distributor
Agent
Export management company
Export trading company
A company can use intermediaries to deliver its products to foreign markets or perform the export activities itself.
Direct exporting involves selling directly to buyers in a target market using a sales representative or a distributor.
Indirect exporting is selling to intermediaries who resell to the target market using an agent, an export management company, or an export trading company.
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7. Avoiding Export Blunders
Conduct market research
Obtain export advice
Companies new to international business often make export and import blunders.
Common reasons for this include a failure to conduct adequate market research or a failure to obtain adequate export advice.
To avoid committing such blunders, a company might choose to hire a freight forwarder, which is a specialist in export-related activities such as customs clearing, tariff schedules, shipping fees, and insurance. A freight forwarder can also pack merchandise for export and will accept responsibility for getting a shipment from the port of export to the port of import.
Hire a freight forwarder
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8. Discussion Question
What are the four steps companies can follow when building an export strategy?
What are the four steps companies can follow when building an export strategy?
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9. Answer to Discussion Question
First, a firm should identify a potential market through careful market research and analysis. Second, it should match the needs of the market to its ability to satisfy those needs. Third, it should initiate meetings with potential distributors, buyers, and others. Fourth, it should commit human, financial, and physical resources to get the job done.
Answer:
First, a firm should identify a potential market through careful market research and analysis. Second, it should match the needs of the market to its ability to satisfy those needs. Third, it should initiate meetings with potential distributors, buyers, and others. Fourth, it should commit human, financial, and physical resources to get the job done.
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10. Forms of Countertrade Barter Counterpurchase Offset agreement
Switch trading
Buyback
Direct exchange without money
Sale to a nation in return for promise of future purchase from that nation
Offset a hard-currency sale to a nation
with future hard-currency purchase
Sale by a company of an obligation to purchase from a country
Export of industrial equipment in return for products that the equipment produces
Countertrade is the selling of products that are paid for with other goods or services. It is used to access markets that are otherwise off-limits because of a lack of hard currency. There are five basic types of countertrade.
Barter is an exchange of products directly for other goods or services without using money.
Counterpurchase is the sale of products to a nation by a company that promises to make a future specific purchase from that nation.
Offset is an agreement that a company will offset a hard-currency sale to a nation with a future hard-currency purchase of an unspecified product from that nation.
Switch trading is when one company sells to another its obligation to make a purchase in a given country.
Buyback is the export of industrial equipment in return for products produced by that equipment.
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11. Barter in Argentina Barter (Trueque) in Argentina
Clothing, food, cars, etc.
Barter became a way of life in Argentina when the nation’s economy was mired in a seemingly endless recession.
People bartered DVDs, clothing, fresh fruit and vegetables, plumbing supplies, and much more using Barter Vouchers.
Local newspapers run ads for such things as apartments, cars, and washing machines, all offered on a barter basis.
Agencia el Universal/El Universal de Mexico/Newscom
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12. Export/Import Financing
International trade poses risks for both exporters and importers. Exporters risk not receiving payment after delivery, whereas importers fear that delivery might not occur once payment is made. Let’s examine four key methods of export and import financing.
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13. High Risk Methods Open account Advance payment
Exporter bills importer after merchandise ships
Importer pays exporter before merchandise ships
Open account financing is riskiest for the exporter, whereas advance payment is riskiest for the importer.
In open account, an exporter ships merchandise and later invoices the importer. This method is often used when two parties are familiar with each other, or for sales between two subsidiaries within an international company. This method creates the risk of nonpayment for exporters while removing the risk of non-shipment for importers.
In advance payment, an importer pays for merchandise before it is shipped. This method is often used when two parties are unfamiliar with each other, the value of the transaction is small, or the buyer has a poor credit rating. This method creates the risk of non-shipment for importers but eliminates the risk of nonpayment for exporters.
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14. Documentary Collection
Bank acts as intermediary without accepting financial risk
Draft (bill of exchange)
Document that orders an importer to pay an exporter a specific
sum of money at a specific time
Bill of lading
Contract between an exporter and shipper
specifying destination
and shipping costs
for merchandise
In the documentary collection financing method, a bank acts as an intermediary in a transaction without accepting financial risk. It is typically used in ongoing business relationships between two parties.
A draft (or bill of exchange) is a document ordering the importer to pay the exporter a specific sum of money at a specific time.
A bill of lading is a contract between the exporter and shipper that specifies the merchandise destination and its shipping costs.
Documentary collection reduces the risk of non-shipment because the bill of lading is proof of shipment. However, the risk of nonpayment increases because the importer does not pay until it receives all necessary documents from the exporter.
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15. Documentary Collection Process
This diagram shows how the documentary collection process actually works.
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16. Letter of Credit
Importer’s bank issues a document stating that the bank will pay the exporter when exporter fulfills document’s terms
In the letter of credit financing method, the importer’s bank issues a document stating that the bank will pay the exporter when the exporter fulfills the terms of the document. It is typically used when an importer’s credit rating is questionable, when an exporter needs to obtain financing, and when a market’s regulations require it.
The three main types of letters of credit are an irrevocable letter of credit, a revocable letter of credit, and a confirmed letter of credit.
The letter of credit method reduces the risk of non-shipment for the importer because there is proof of shipment before payment. And although the risk of nonpayment increases, it is the importer’s bank that accepts this risk.
Irrevocable
Revocable
Confirmed
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17. Letter of Credit Process
This diagram shows how the letter of credit process actually works.
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18. Discussion Question
Export/import financing whereby a bank acts as an intermediary without accepting financial risk is called __________.
a. Offset financing
b. Letter of credit
c. Documentary collection
Export/import financing whereby a bank acts as an intermediary without accepting financial risk is called __________.
a. Offset financing
b. Letter of credit
c. Documentary collection
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19. Answer to Discussion Question
Export/import financing whereby a bank acts as an intermediary without accepting financial risk is called __________.
a. Offset financing
b. Letter of credit
c. Documentary collection
The correct answer is c. Documentary collection
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20. Licensing Advantages Disadvantages
Company owning intangible property (licensor) grants
another firm (licensee) the right to use it for a specific time
Advantages
Finance expansion
Reduce risks
Reduce counterfeits
Upgrade technologies
Restrict licensor’s activities
Reduce global consistency
Lend strategic property
Disadvantages
Let’s now turn our attention to several widely used contractual entry modes.
Licensing is when a company owning intangible property (the licensor) grants another firm (the licensee) the right to use that property for a specific period of time. Licensors receive royalty payments based on a percentage of revenue generated by property such as patents, copyrights, designs, formulas, trademarks, and brand names.
Licensing can allow a company to finance an international expansion, reduce international expansion risks, reduce the likelihood of counterfeit production, and help licensees upgrade their production technologies.
Yet, licensing may restrict a licensor’s future activities, reduce the global consistency of a product’s quality and marketing, and amount to “lending” strategically important property to future competitors.
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21. Franchising Advantages Disadvantages
Company (franchiser) supplies another (franchisee)
with intangible property over an extended period
Advantages
Low cost and low risk
Rapid expansion
Local knowledge
Cumbersome
Lost flexibility
Disadvantages
Another contractual entry mode is franchising, which is when one company (the franchiser) supplies another (the franchisee) with intangible property and assistance over an extended period of time. Franchisers typically receive compensation as flat fees or royalty payments for use of an asset, which is commonly a brand name or trademark.
Franchising is a low-cost and low-risk entry mode into new markets, allows for rapid geographic expansion, and makes use of local managers’ cultural knowledge.
Yet, managing franchisees across several nations can become cumbersome, and such agreements may reduce organizational flexibility for franchisees.
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22. Management Contract Advantages Disadvantages
Company supplies another with
managerial expertise for a
specific period of time
Advantages
Few assets risked
Nations finance projects
Develops local workforce
Another contractual entry mode is a management contract, which is when one company supplies another with managerial expertise for a specific period of time. The supplier of expertise is compensated with either a lump-sum payment or a fee based on sales. Management contracts are used to transfer specialized knowledge of technical managers and business management skills.
Management contracts allow a firm to risk few assets when going international, let a nation upgrade its utilities when lacking financing, and help advance the skills of a nation’s workforce.
Yet, management contracts can endanger the lives of home-country managers when abroad in unstable markets, and can create new competitors in target markets by transferring valuable skills.
Disadvantages
Personnel at risk
Create competitor
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23. Turnkey Project Advantages Disadvantages
Company designs, constructs, and tests
a production facility for a client
Advantages
Firms specialize in competency
Nations obtain infrastructure
Politicized process
Create competitor
Disadvantages
Another contractual entry mode is a turnkey project, which is when a company designs, constructs, and tests a production facility for a client. These projects are often large-scale utility projects in host countries. They usually transfer special process technologies or facility designs to a client.
Turnkey projects let a firm specialize in its core competency to exploit international opportunities, and allow a nation to obtain the latest infrastructure from the world’s leading companies.
Yet, turnkey projects may be awarded for political reasons rather than for technological know-how, and can create future international competitors.
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24. Discussion Question
In what ways does franchising differ from licensing?
In what ways does franchising differ from licensing?
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25. Answer to Discussion Question
First, franchising gives a company greater control over the sale of its product in a target market than does licensing. Second, franchising is primarily used in the service sector, whereas licensing is common in manufacturing industries. Third, franchising requires ongoing assistance from the franchiser, but licensing normally involves a one-time transfer of property.
Answer:
First, franchising gives a company greater control over the sale of its product in a target market than does licensing. Second, franchising is primarily used in the service sector, whereas licensing is common in manufacturing industries. Third, franchising requires ongoing assistance from the franchiser, but licensing normally involves a one-time transfer of property.
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26. Wholly Owned Subsidiary
Facility entirely owned and controlled by
a single parent company
Advantages
Day-to-day control
Coordinate subsidiaries
We now turn our attention to investment entry modes, which entail direct investment and ongoing involvement in a target market or host country.
Wholly owned subsidiaries are entirely owned and controlled by a single parent company. A subsidiary’s planned operations largely determines whether a company purchases an existing company or builds new from the ground up. The benefits of building new must outweigh the time and resources required for construction, hiring and training employees, and launching production.
A wholly owned subsidiary gives a company total control over day-to-day local operations and valuable technologies, processes, and other intangibles. It also lets a firm coordinate activities of all its various national subsidiaries.
Yet, it can be an expensive entry mode and involve high risk exposure for a firm’s assets.
Disadvantages
Expensive
High risk
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27. Joint Venture
Company created and jointly owned by two or more entities to achieve a common objective
Advantages
Reduce risk level
Penetrate markets
Access channels
Disadvantages
Partner conflict
Lose control
Another investment entry mode is a joint venture, which is a separate company that is created and jointly owned by two or more independent entities to achieve a common objective.
A joint venture can reduce risk by sharing the investment with other parties, help penetrate international markets that are otherwise off-limits, and provide access to another party’s distribution channels.
Yet, conflict can develop between partners if objectives change, if one party’s goals are reached early, or if trust and cooperation break down. Also, parties may lose all control over the venture’s operations if the local government participates in the venture.
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28. Joint Venture Configurations
Joint ventures follow several common configurations.
In a forward integration joint venture, parties invest together in downstream business activities.
In a backward integration joint venture, parties invest together in upstream business activities.
In a buyback joint venture, each partner provides inputs and absorbs outputs.
And in a multistage joint venture, one partner integrates downstream while the other integrates upstream.
Source: Based on Peter Buckley and Mark Casson, “A Theory of Cooperation in International Business,” in Farok J. Contractor and Peter Lorange (eds.), Cooperative Strategies in International Business (Lexington, MA: Lexington Books, 1988), pp. 31–53.
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29. Tap competitors’ strengths
Strategic Alliance
Entities cooperate (but do not form a separate company) to achieve strategic goals of each
Advantages
Share project cost
Tap competitors’ strengths
Gain channel access
Disadvantages
Partner conflict
Create competitor
Another investment entry mode is a strategic alliance, which is when two or more entities cooperate (but do not form a separate company) to achieve the strategic goals of each. Alliances may be formed for short or long periods, and can be formed between a company and its suppliers, buyers, and competitors.
A strategic alliance can allow firms to share the cost of an international investment project, tap competitors’ specific strengths, and access distribution channels.
Yet, conflict among partners may undermine cooperation, and an alliance may create a future competitor in a target market or even globally.
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30. Selecting Partners Commitment Trustworthiness Cultural knowledge
Valuable contribution
There are several points to consider when selecting partners for cooperation.
First, each partner must be firmly committed to the stated goals of the cooperative arrangement. Detailing duties and contributions of each party through prior negotiations helps ensure continued cooperation.
Second, although the importance of locating a trustworthy partner seems obvious, cooperation should nevertheless be approached with caution.
Third, each party’s managers should be at ease working with people of other cultures and be comfortable traveling to, and perhaps living in, other cultures.
Fourth, managers should apply the same stringent evaluation criteria to a potential international cooperative arrangement as they would to any other investment opportunity.
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31. Strategic Factors Cultural environment Political/Legal environments
Market size
Firms should consider several strategic factors when selecting an entry mode.
Cultural differences can reduce managers’ confidence in their ability to control operations in the host country. A lack of cultural familiarity can cause a firm to avoid investment entry and pursue exporting or contractual entry.
Political instability in a host country increases the risk exposure of assets. Political uncertainty can cause companies to avoid investment entry in favor of other modes. But a target market’s laws can encourage investment if, for example, it imposes high tariffs or low quota limits on imports.
Market size is often a determining factor in entry mode choice. Rising incomes can encourage investment to help a firm better understand the target market and prepare for growing demand.
Low-cost production and shipping can give a company an advantage by helping it control total costs. If producing in a host country lowers a firm’s total production costs, it can encourage investment, licensing, or franchising.
As international experience grows, a firm may select entry modes that require deeper involvement, but which also involve greater exposure to risk.
Production and shipping costs
International experience
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32. Discussion Question
An investment entry mode that gives a company the most control over day-to-day activities in a host country is called a __________.
a. Joint venture
b. Strategic alliance
c. Wholly owned subsidiary
An investment entry mode that gives a company the most control over day-to-day activities in a host country is called a __________.
a. Joint venture
b. Strategic alliance
c. Wholly owned subsidiary
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33. Answer to Discussion Question
An investment entry mode that gives a company the most control over day-to-day activities in a host country is called a __________.
a. Joint venture
b. Strategic alliance
c. Wholly owned subsidiary
The correct answer is c. Wholly owned subsidiary
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34. Copyright © 2014 Pearson Education, Inc.
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