Module 5
International Expansion
Chapter Summary
We live in a highly interconnected global community where many of the best opportunities for growth and profitability lie beyond the boundaries of a company’s home country. Along with opportunities, of course, there are many risks associated with diversification into global markets.
The first section of the chapter addressed the factors that determine a nation’s competitiveness in a particular industry. The framework was developed by Michael Porter of Harvard University and was based on a four-year study that explored the competitive success of 10 leading trading nations. Professor Porter concluded that there are four broad attributes of nations that individually, and as a system, constitute what is termed “the diamond of national advantage”. These attributes collectively determine the playing field that each nation establishes for its industries. These factors are:
· Factor Conditions
· Demand Conditions
· Related and Supporting Industries
· Firm Strategy, Structure, and Rivalry
Factors of production include not only labor, capital, and natural resources (e.g., land and minerals) but also factors that can be created. The latter are more relevant to developed nations that are seeking competitive advantage over firms in other countries. These include a skilled human resource pool as well as the supporting infrastructure of a country, e.g., communication and transportation systems as well as a stable banking system.
Demand conditions refer to the demands that consumers place on an industry for goods and services. Consumers who demand highly specific, sophisticated products and services force firms to be more innovative to meet such demand. Such consumer pressure presents challenges to a country’s industries to also make it more competitive in international markets.
Related and supporting industries enable firms to more effectively manage inputs. For example, countries with a strong supplier base benefit by adding efficiency in downstream activities. That is because a competitive supplier base helps a firm obtain inputs using cost-effective, timely methods it contributes to reducing manufacturing costs.
Firms develop strategies and structures to compete with other firms in the same country that are trying to capture the same customer market. Rivalry is particularly intense in nations with strong consumer demand conditions, strong supplier bases, and high new entrant potential from related industries. Such rivalry provides a strong impetus for firms to innovate and find new sources of competitive advantage.
The discussion of Porter’s “diamond” helped, in essence, to set the broader context for exploring competitive advantage at the firm level. In the chapter’s second section, the primary motivations and the potential risks associated with international expansion are discussed. The primary motivations included increasing the size of the potential market for the firm’s products and services, achieving economies of scale, extending the life cycle of the firm’s products, and optimizing the location of every activity in the value chain. On the other hand, the key risks included political and economic risk, currency risks, and management risks. Management risks are the challenges associated with responding to the inevitable differences that exist across countries such as customs, culture, language, customer preferences, and distribution systems.
Managers must contend with two opposing forces—cost reduction and adaptation to local markets—when entering global markets. Pressure for cost reductions arise when global competitors seek to minimize unit costs through location economies and attain low-cost competitor status. Price pressure also arises in commodity-type product industries because intense price competition predominates strategic concerns. Pressure to adapt to local markets, on the other hand, arises from differences in local consumer tastes and preferences, differences in infrastructure and traditional practices, and differences in distribution channels among countries.
Host government economic and political demands also places pressure on managers to adapt to local markets.
The relative importance of these two factors play a major part in determining which of the three basic types of international strategies to select: global, multidomestic, or transnational. The strengths and limitations of such international strategies are presented in the following figure.
Insert Figure 1 about here
Strategies that favored global products and brands rest on three key assumptions.
· Customer needs and interests are becoming increasingly homogeneous worldwide.
· People around the world are willing to sacrifice preferences in product features, functions, design and the like for lower prices at high quality
· Substantial economies of scale in production and marketing can be achieved through supplying global markets.
There are, of course, some risks associated with a global strategy. These include:
· A firm can enjoy scale economies by concentrating scale-sensitive resources and activities in one or a few locations. Decisions about locating facilities must weigh the potential benefits from concentration against higher transportation and tariff costs.
· The geographical concentration of any activity may also tend to isolate that activity from the targeted markets.
· Concentrating an activity in a single location also makes the rest of the firm dependent on that location.
A firm whose emphasis is on differentiating their product and service offerings in order to adapt to local markets follows a multidomestic strategy. In contrast to a global strategy which tends to be highly centralized, decisions are more decentralized to enable the firm to tailor its products and services to rapidly respond to changes in demand.
As one might expect, there are some risks associated with a multidomestic strategy. These include:
· Typically, local adaptation of products and services will increase a company’s cost structure.
· At times, local adaptations, even well intentioned may backfire.
· Consistent with other aspects of global marketing, the optimal degree of local adaptation evolves over time.
Multinational firms following a transnational strategy strive to optimize the tradeoffs associated with efficiency, local adaptation, and learning. It seeks efficiency not for its own sake, but as a means to achieve global competitiveness. It recognizes the value of local responsiveness, but as a tool for flexibility in international operations. Also, a core tenet of the transnational model is that a firm’s assets and capabilities are dispersed according to the most beneficial location for a specific activity.
As with global and multidomestic strategies, there are some unique risks and challenges associated with transnational strategies:
· The choice of a seemingly optimal location cannot guarantee that the quality and cost of factor inputs (i.e., labor, materials, etc.) will be optimal. Managers must ensure that the relative advantage of a location is actually realized, not squandered because of weaknesses in productivity and the quality of internal operations.
· Although knowledge transfer can be a key source of competitive advantages, it does not take place “automatically.” It is important that business units and the headquarter office both recognize the potential value of such “know how.”
A firm has many options available to it when it decides to expand into international markets. These modes of foreign entry that include: exporting, licensing, franchising, strategic alliances, joint ventures, and wholly owned subsidiaries. The various types of entry form a continuum that ranges from exporting (low investment, low risk) to wholly-owned subsidiaries (high investment and risk, high control).
Exporting consists of producing goods in one country and selling them in another. This mode enables a firm to invest the least amount of resources in terms of product, its organization, and its overall corporate strategy. Not surprisingly, many host countries dislike this entry strategy because it provides limited opportunities for local employment.
As presented in Figure 2, exporting has both advantages and disadvantages. Its advantages are that it is a low cost/risk way to enter foreign markets and it may provide the firm with local distributors who can help them benefit from their valuable expertise and knowledge of local markets. After all, multinationals must recognize that they cannot immediately master local business practices, meet regulatory requirements, hire and manage local personnel, and gain access to potential customers.
Insert Figure 2 about here
There are also some disadvantages associated with exporting. Along with the lower cost/risk comes less control. A firm’s exporting partner may carry lines that compete with the firm’s products and they may not be willing to share market information with the exporting firm. Furthermore, the exporting firm has little control over how their products are marketed or sold in the foreign market.
Licensing and franchising are both forms of contractual arrangements. Franchise contracts typically include a broader range of factors in an operation and have a longer period during which the agreement is in effect. Franchising has the advantage of limiting the risk exposure that a firm has in overseas markets while expanding the revenue base of the parent company. The other side of the coin, of course, is that the multinational firm receives only a portion of the revenues in the form of franchise fees instead of the entire revenue—as would be the case if they set up the operation themselves (such as a restaurant) through direct investment.
Joint ventures and strategic alliances have become an increasingly popular way for firms to enter and succeed in foreign markets in recent years. These two forms of partnerships differ in that joint ventures entail the creation of a third-party legal entity, whereas strategic alliances do not. In addition, strategic alliances generally focus on initiatives that are smaller in scope than joint ventures. Chapter 6 (corporate-level strategy) addressed some of the major advantages and disadvantages of these forms of collaboration. In addition to the usual issues, cultural differences can create additional challenges in making strategic alliances and joint ventures work.
A wholly owned subsidiary is a situation in which a multinational company owns 100 percent of the stock in the venue. There are two means by which a firm can establish a wholly owned subsidiary: acquisition of an existing company or developing a totally new operation, termed a “greenfield venture.” Wholly owned subsidiaries are most appropriate when a firm already has the appropriate knowledge and capabilities that can be readily leveraged through multiple locations. We provide the example of Intel’s building of semiconductor plants overseas. Knowledge can be further leveraged by hiring managers and professionals from the home country.
While assuring the most control, wholly owned subsidiaries also are typically the most expensive and risky of the various modes of entry. Unlike strategic alliances and joint ventures, for example, the entire risk is borne by the corporation. The risks associated with doing business in a new country--such as the political, cultural, and legal nuances--may be mitigated by hiring local talent.
Key Terms and Concepts
Factor Conditions – a nation’s position in factors of production, such as skilled labor or infrastructure, necessary to compete in a given industry. For example, Japan’s expertise in JIT Systems—in part necessary because of Japan’s expensive land costs.
Demand Conditions – the nature of home-market demand for the industry’s product or service. For example, Denmark’s world-class position in water pollution control equipment. This is, in part, due to the nation’s environmental awareness and demands for environmentally safe products.
Related and Supporting Industries – the presence or absence in the nation of supplier industries and other related industries that are internationally competitive. For example, the Italian shoe manufacturing industry and the Swiss pharmaceutical industry.
Firm Strategy, Structure, and Rivalry – the conditions in the nation governing how companies are created, organized, and managed, as well as the nature of domestic rivalry. For example, the personal computer industry in the United States with such players as Dell, Compaq, and Hewlett-Packard.
Political and Economic Risk – risks leading to problems such as the destruction of property, nonpayment of goods and services, and the appropriation of a firm’s assets in a country.
Currency Risk – changes in exchange rates that can pose substantial risks that should be monitored constantly by companies with operations in countries other than the host country.
Management Risks - the challenges and risks that managers face when they must respond to the inevitable differences (e.g., culture, language, income levels, customer preferences, distribution systems) that they encounter in foreign markets.
Global Strategy - the pursuit of low-cost status by offering standardized global products.
Multidomestic Strategy - the maximization of local responsiveness by customizing products and marketing strategy for local markets.
Transnational Strategy - the use of global learning to achieve low-cost status, differentiation, and local responsiveness simultaneously.
Exporting - the least risky entry strategy into foreign markets through simple exportation of domestic products and services abroad.
Licensing and Franchising - entry strategies in which the domestic firm grants the rights to manufacture, distribute, or service products (or services) to a company in another country.
Strategic Alliances and Joint Ventures - entry strategies in which a domestic company “partners” with an international company to provide a good or service.
Wholly Owned Subsidiaries - most risky entry strategy where domestic firms create or purchase an entire business in the foreign market.