ib 2 modes of entry

8/3/2019 IB 2 Modes of Entry

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Richa Anand

IES Management College

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Modes of Entry

In Foreign markets


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Introduction

Entry decisions will heavily influence the firms other functionaldecisions.

Decision Criteria for Mode of Entry

External Factors Market Size and Growth

Risk

Government Regulations

Competitive Environment

Local Infrastructure physical factors

Internal factors Company Objectives

Need for Control

Internal Resources, Assets and

Capabilities Flexibility


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Modes of Entry

Decision Factors

Ownership Advantages

Location Advantages

Internalization Advantages


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Modes of Entry

Exporting

Direct Exports

Indirect Exports

Intracorporate Transfers

Licensing Franchising

Contract Manufacturing

Management Contract

Turnkey Projects

Strategic Alliance Foreign Investment

Green Field Investments

Joint Ventures

Mergers & Acquisitions

Portfolio Investment

Counter-trade

Pure Barter

Buy Back

Counter Purchase


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The Firm & ItsCompetitive Advantage


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Entry Modes - Exporting

Advantages Avoids the often substantial cost

of establishing manufacturing

May help firm achieveexperience curve & locationeconomies

Firm may manufacture incentralized location & export toother national markets to realizescale economies from globalsales volume (Sony/TV,Matsushita/VCR,Samsung/Chips)

Disadvantages

Not appropriate in lower costmanufacturing locations

High transport costs can make exportinguneconomical especially bulk products

Tariff barriers can make exportinguneconomical

If firm delegates marketing, sales & serviceto another company they may have dividedloyalties because they carry competingproducts or are a large MNE

Can set up wholly owned subsidiaries tohandle local marketing & sales -> canexercise tight control while reaping costadvantage of manufacturing in a singlelocation


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Licensing

Under International Licensing, a firm in one country

(the licensor) permits a firm in another country (thelicensee) to use its intellectual property. These knowledgemay be registered publicly, for example in the form of apatent or trademark, as a means of establishing ownershiprights. Or, it may be retained within the firm: referred to

as know-how, it is commonly based on operationalexperience. IFB washing machine was manufactured in India under license

from Bosch of Germany.

Nike entered Indian Market in mid 1990s by licensing.

Tommy Hilfiger corporation entered into licensing agreementwith Arvind Mills for selling its product in India.


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Licensing

The licensee usually makes a lump sum payment.Additionally there is normally a royalty rate which tends tovary around a rule of thumb of 5%, depending on the typeof industry and rate of technological change.

A minimum performance clause is considered essential andsome firms allow the licensee a period of grace' to getproduction and marketing started. There are also somecompanies that agree on a cross-licensing deal, wherebythey just swap licenses instead of paying.

There can also be a cross licensing agreement According to UNCTAD, flows of royalties and license fee

receipts amounted to US$ 72 billion in 2001.


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Licensing

Licensing is often used where there is a barrier totrade or constraints on and risk in foreign investment.

Licensing can serve as a Trojan Horse in the meaningthat it opens the possibility for a company to enter a

foreign market where it otherwise might have beenforbidden.

Problems with licensing is that it can create apotential competitor, and that it's often seen as a last-

resort strategic alliance when other options are notavailable.


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Entry Mode - Licensing

Advantages Receive royalties for granting the

rights to intangible property tolicensee for specified period (patents,inventions, formulas, processes,designs, copyrights, trademarks)

Licensee puts up most of the capital toget the operations goingmitigatesdevelopment cost & risk

Allows firm to participate where thereare barriers to investment (Fuji-Xerox)

Frequently used when firm possessesintangible property but does not wantto develop the business application

itself (Coco-Cola/clothing) Primarily used by manufacturing

firms

Disadvantages Does not give firm tight control

over manufacturing, marketing &strategy to realize experience curve& location economies

Does not allow firm to coordinatestrategic moves across countries byusing profits earned in one countryfor competitive attacks in another

Firms can lose control over thecompetitive advantage of theirtechnological know-how. Cross-licensing can mitigate risk

by holding each other hostage formisuse

Firms can reduce risk by forminga joint venture with each partytaking equity stakes


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Franchising

Afranchise agreementis an arrangement whereby a parent

company (thefranchisor) grants another independent (thefranchisee) the right to do business in a prescribed manner. Theright can take the form of selling the franchisors product. Using itsname, production & marketing techniques, or general businessapproach. Coca cola supplying the syrup to bottlers.

A franchise agreement will usually specify the given territory thefranchisee can use as well as the extent to which the franchisee willbe supported by the franchisor (e.g. training and marketingcampaigns). Most franchisee agreements, however, do not providethe franchisee with exclusive control over the given territory.

Cross or reverse franchise agreements ITC Hotels & ITT Sheraton


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Franchising: Advantages As practiced in retailing, franchising offers franchisees the

advantage of starting up a new business quickly based on aproven trademark and formula of doing business, as opposed tohaving to build a new business and brand from scratch (oftenin the face of aggressive competition from franchise operators).

As long as their brand and formula are carefully designed andproperly executed, franchisors are able to expand their brandvery rapidly across countries and continents, and can reapenormous profits in the process, while the franchisees do allthe hard work of dealing with customers face-to-face.Additionally, the franchisor is able to build a captive

distribution network, with no or very little financialcommitment.


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Franchising: Disadvantages

For franchisees, the main disadvantage of franchising is a lossof control. While they gain the use of a system, trademarks,assistance, training, and marketing, the franchisee is requiredto follow the system and get approval of changes with thefranchisor.

Another problem is that the franchisor/franchisee relationship

can easily give rise to litigation if either side is incompetent(or just not acting in good faith).

For example, an incompetent franchisee can easily damagethe public's goodwill towards the franchisor's brand byproviding inferior goods and services, and an incompetent

franchisor can destroy its franchisees by failing to promotethe brand properly or by squeezing them too aggressively forprofits.


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Advantages Company does not have to commit resources for

setting up production facilities.

Freedom from risk of investing in foreign countries

If idle production capacity is readily available, it

enables the marketer to get started immediately.

Cost of production is lower.

Less risky way to start witheasy to drop if thebusiness is not profitable.


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Disadvantages

In some cases, there might be loss in potential

profit from manufacturing.

Less control over manufacturing process.

Risk of developing potential competitors.

Not suitable in case of high-tech products and

cases which involve technical secrets.


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Management Contracts

A management contract is an arrangement underwhich operational control of an enterprise is vestedby contract in a separate enterprise which performsthe necessary managerial functions in return for afee.

Tata Tea

Management contracts involve not just selling amethod of doing things (as with franchising orlicensing) but involves actually doing them. Amanagement contract can involve a wide range offunctions, such as technical operation of aproduction facility, management of personnel,accounting, marketing services and training.


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Management Contracts

Many hotels, especially in Asia, operate under managementcontract arrangements, as they can more easily obtaineconomies of scale, a global reservation systems, brandrecognition etc. It is not unusual for contracts to be signedfor 25 years, and having a fee as high as 3.5% of totalrevenues and 6-10% of gross operating profit.

Management contracts have been used to a wide extent inthe airline industry, and when foreign government actionrestricts other entry methods. Management contracts areoften formed where there is a lack of local skills to run aproject. It is an alternative to foreign direct investment as it

does not involve as high risk and can yield higher returns forthe company.


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Turnkey Projects

An agreement by the seller to supply a

buyer with a facility fully equipped and

ready to be operated by the buyer's

personnel, who will be trained by the seller.

Many Turnkey contracts involve

Government/public sector as buyer.


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Entry ModesTurnkey Project

Advantages

Means of exporting processtechnology (chemical,pharmaceutical, petroleum,mining)

Know-how to assemble & runtechnologically complex process isvaluable assetearn economicbenefit from asset

Strategy useful where governmentsrestrict FDI - less risky than

conventional FDI

Disadvantages

Firm has no long term interest inthe countrycan take minorityequity interest in company

Firm may inadvertently create acompetitor (middle east oil

refineries) If firms process technology is a

source of competitive advantage,then selling technology is alsoselling competitive advantage topotential competitors


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Strategic Alliances

Strategic Alliances (SAs)Typically a collaborative arrangement between firms, sometimes

competitors, across bordersBased on sharing of vital information, assets, and technology between the partners

Have the effect of weakening the tie between potential ownership advantages and

company controlEquity Strategic AlliancesJoint Ventures

Non-equity Strategic Alliances

Distribution AlliancesManufacturing Alliances

Research and Development Alliances


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Foreign Investment

Foreign Investment

Portfolio InvestmentForeign Direct Investment

WhollyOwned

Subsidiary

JointVentures

Mergers &Acquisitions

Investmentby FIIs

Investment inGDRs, FDRs,FCCBs, etc


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Foreign Direct Investment

Defined as Investment made to acquire lastinginterest in enterprises operating outside of theeconomy of the investor.

Consists of aparent enterprise

& aforeign

affiliate

,which together for a Transnational corporation (TNC).

Investment must afford the parent enterprise controlover its foreign affiliate (10% or more of ordinaryshares or voting power)

Can be Inward Directed or Outward Directed; Also can be classified as Horizontal FDI & Vertical

FDI (Backward vertical & Forward Vertical)


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Foreign Direct Investment

Foreign Direct Investment is now more important than

trade as a vehicle of international transactions.

Once a firm undertakes FDI it become a multinational

enterprise

Overseas production facilities comprise a large and

increasingly vital part of international business

Why is FDI growing at faster rates than trade?


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Motives for FDI

Market-seeking (market size, market growth,access to regional markets)

Resource-seeking (raw materials, naturalresources, low-cost skilled labour, knowledge,

technology)Efficiency-seeking (cost of resources under above

adjusted for productivity, transport/communication costs, membership of regionalintegration agreements/trading blocks)

These Categories are not mutually exclusive


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Greenfield or Acquisition

Greenfield better ability to build organization you want

Easier to establish own culture & operating routine

Do not have revenue & profit history

Slower to establishneed to understand how to do business in thatcountry

Acquisition 50%-80% of FDI is acquisition

Quick to executerapidly build presence

Acquisitions can preempt competition Buying known revenue & profit stream

Need to marry divergent corporate cultures


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Foreign Investment in India

India's direct investment abroad was initiated in1992. Streamlining of the procedures andsubstantial liberalization has been done since1995. As of now, Indian corporate/Registeredpartnership firms are allowed to invest abroad upto 100% of their net worth and are permitted tomake overseas investments in business activity.


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WHAT GOLDMAN SACHS HAS TO SAY

ABOUT INDIA

India has the potential to show the fastest growth over the next 30 and50 years

Growth could be higher than 5% over the next 30 years and close to5% as late as 2050

India has the potential to raise its US dollar income per capita in 2050to 35 times its current level

Indias GDP will exceed Italys in 2016, Frances in 2019, Germanys

in 2023 and Japans in 2032

2nd most attractive destinationA. T. Kearney Business ConfidenceIndex, 2005

2nd most attractive investment destination among TNCsUNCTADs

World Investment report, 2005 Most Attractive location for offshoring of service activities A. T.

Kearney Global Services Location Index, 2005


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FOREIGN DIRECT INVESTMENT - PROHIBITED

SECTORS

Foreign direct investment is prohibited in thefollowing cases:

Gambling and Betting

Lottery Business Retail Trading (except single brand retail trading-not

provided in Master Circular)

Atomic Energy

Agriculture (with certain exceptions) and Plantations(Other than Tea plantations


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ENTRY STRATEGIES FOR FOREIGN INVESTOR

Foreign Company has the following options to set up business

operations in India :

By incorporating a company under the Companies Act, 1956

A wholly owned subsidiary

Joint venture company - existing company or new company

with domestic partner

As an unincorporated entity

Liaison Office

Project Office Branch Office


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Liberalization of foreign direct investment norms


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Joint Ventures

Ajoint venture is a strategic alliance between

two or more parties to undertake economic

activity together. The parties agree to create a new

entity together by both contributing equity, andthey then share in the revenues, expenses, and

control of the enterprise.

The venture can be for one specific project only,

or a continuing business relationship such as theSony Ericsson joint venture.


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Reasons for Forming JVsInternal reasons1. Spreading costs and risks2. Improving access to financial resources

3. Economies of scale and advantages ofsize

4. Access to new technologies andcustomers

5. Access to innovative managerial practices

Competitive goals1. Influencing structural evolution of the

industry

2. Pre-empting competition

3. Defensive response to blurring industryboundaries

4. Creation of stronger competitive units

5. Speed to market6. Improved agility

Strategic goals1. Synergies

2. Transfer of technology/skills3. Diversification


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Joint VenturesAdvantages

Typically 50/50 with contributed team ofmanagers to share operating control

Firm benefits from local partnersknowledge of competitive conditions,culture, language, political system &business system

Sharing market development costs &risks with local partner

In some countries, politicalconsiderations make JVs the only feasibleentry mode

Disadvantages Risk of giving away your technology to a

partner

Hold majority ownership for morecontrol in venture

Wall-off technology that is central toyour core competency

Does not give firm control over

subsidiaries that it might need to realizeexperience curve or location economies

Global strategic coordinationfirm useJV for checking competitor market shareand limiting cash available for invadingother markets (TI & Japan)

Shared ownership can lead to conflicts &

battles for control if goals/objectiveschange or they take different views onstrategy


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Joint venture versus wholly owned subsidiary

Some advantages of a MNE working with a local

joint venture partner are:

Better understanding of local customs, mores and

institutions of government Providing for capable mid-level management

Some countries do not allow 100% foreign ownership

Local partners have their own contacts and reputation

which aids in business


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Joint venture versus wholly owned

subsidiary

However, joint ventures are not as common as 100%-

owned foreign subsidiaries as a result of potential conflicts

or difficulties including:

Increased political risk if the wrong partner is chosen

Divergent views about the need for cash dividends, or the

best source of funds for growth (new financing versus

internally generated funds)

Transfer pricing issues

Difficulties in the ability to rationalize production on a

worldwide basis


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Cross-Border Mergers & Acquisitions

Mergers & acquisition refers to the aspect of corporate strategy,corporate finance and management dealing with the buying,selling and combining of different companies that can aid,finance, or help a growing company in a given industry growrapidly without having to create another business entity.

Cross-border mergers, acquisitions, and strategic alliances allface similar challenge: they must value the target enterprise onthe basis of its projected performance in its market.

An enterprises potential value is a combination of the intendedstrategic plan and the expected operational effectiveness to beimplemented post-acquisition.


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Cross-Border Mergers and Acquisitions

The number and dollar value of cross-border mergersand acquisitions (M&A) have grown rapidly in recentyears, but the growth and magnitude of activity aretaking place in the developed countries, not developing

countries. Among the developing regions of the world, cross-

border M&A activity has been focused nearlyexclusively on Latin America and Asia.

West Asia, Eastern Europe and Africa have largely beenbypassed in the international rush to acquire.


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Merger Synergies

The key principle behind buying or merging

a company is to create shareholders value

over and above that of the sum of the two

companies.

They intend to create value through either

revenue synergies or cost synergies


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Merger Synergies

Revenue synergy implies the increased cash

flows (revenue gains) of the merged entity

because of its ability to cross-sell products

and services, better leverage the saleschannels and marketing programmes, offer

products at a higher selling prices and other

similar competitive advantages.


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Merger Synergies

Cost synergies deal with reduced cash outflows(cost savings) from economies of scale, reductionin capital expenditures, production efficiencies,elimination of duplicate costs in areas such as

R&D, administration etc. 70% of the mergers fall short in achieving their

revenue targets and 40% face cost synergydisappointments

Where Mergers Go Wrong,McKinsey & Co


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The Cross-Border Acquisition Strategy

The process of acquiring an enterprise

anywhere in the world has three common

elements:

Identification and valuation of the target

Completion of the ownership change

transaction (the tender)

Management of the post-acquisitiontransition


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As opposed to a greenfield investment, a crossborder acquisitionhas a number of significant advantages.

First, it is quicker (shortening the time required to gain apresence and facilitate competitive entry into the market).

Second, acquisition may be a cost-effective way of gaining

competitive advantages such as technology, brand names, and/orlogistic/distribution capabilities while eliminating a localcompetitor.

Third, specific to cross-border acquisitions, internationaleconomic, political, and foreign exchange conditions may resultin market imperfections, allowing target firms to beundervalued.


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Cross-border acquisitions are not, however, without theirpitfalls.

There are still problems with paying too much or sufferingexcessive financing costs.

Melding corporate cultures can also be traumatic.

In addition, management of the post-acquisition process isextremely difficult to do successfully.

Internationally, additional difficulties arise from hostgovernments intervening in pricing, financing, employment

guarantees, market segmentation, and general nationalismand favoritism.

ib 2 modes of entry

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