International Business Decision Making

The most common method of buying and selling goods internationally is exporting and importing. Companies often import products in order to obtain less expensive goods or those that are simply unavailable in the domestic market. Companies export products when the international marketplace offers opportunities to increase sales and, in turn, profits. Companies worldwide (from both developed and developing countries) often see the United States as a great export opportunity because of the size of the market and the strong buying power of its citizens. Figure 13.1 showcases the top 10 exporters to the United States in terms of the value of goods sold.

Because this chapter focuses on how companies take their goods and services to the global marketplace, the following discussion concentrates on exporting. Following the presentation of exporting, we explain how companies use

countertrade

to conduct product exchanges across borders when cash transactions are not possible. Because importing is a sourcing decision for most firms, it is covered in Chapter 15.

Why Companies Export

In the global economy, companies increasingly sell goods and services to wholesalers, retailers, industrial buyers, and consumers in other nations. Generally speaking, there are three main reasons why companies begin exporting:

1.
Expand Sales.
Most large companies use exporting as a means of expanding total sales when the domestic market has become saturated. Greater sales volume allows them to spread the fixed costs of production over a greater number of manufactured products, thereby lowering the cost of producing each unit of output. In short, going international is one way to achieve economies of scale.

FIGURE 13.1 Land of Opportunity

Source: International Trade Statistics 2007 (Geneva, Switzerland: World Trade Organization, November 2007), Table II.24, p. 60.

2.
Diversify Sales.
Exporting permits companies to diversify their sales. In other words, they can offset slow sales in one national market (perhaps due to a recession) with increased sales in another. Diversified sales can level off a company’s cash flow, making it easier to coordinate payments to creditors with receipts from customers.

3.
Gain Experience.
Companies often use exporting as a low-cost, low-risk way of getting started in international business. Owners and managers of small companies, which typically have little or no knowledge of how to conduct business in other cultures, use exporting to gain valuable international experience.

Developing an Export Strategy: A Four-Step Model

Companies are often drawn into exporting when customers in other countries solicit their goods. In this way, companies become aware of their product’s international potential and get their first taste of international business.

Yet a company should not fall into the habit of simply responding to random international requests for its products. A more logical approach is to research and analyze international opportunities and to develop a coherent export strategy. A business with such a strategy actively pursues export markets rather than sitting back and waiting for international orders to come in. Let’s take a look at the four steps in developing a successful export strategy.

Step 1: Identify a Potential Market

To identify whether demand exists in a particular target market, a company should perform market research and interpret the results (see Chapter 12). Novice exporters should focus on one or only a few markets. For example, a first-time Brazilian exporter might not want to export simultaneously to Argentina, Britain, and Greece. A better strategy would likely be to focus on Argentina because of its cultural similarities with Brazil (despite having a different, though related, language). The company could then expand into more diverse markets after it gains initial international experience in a nearby country. The would-be exporter should also seek expert advice on the regulations and general process of exporting and any special issues related to a selected target market.

Step 2: Match Needs to Abilities

The next step is to determine whether the company is capable of satisfying the needs of the market. Suppose a market located in a region with a warm, humid climate for much of the year displays the need for home air-conditioning equipment. If a company recognizes this need but makes only industrial-sized air-conditioning equipment, it might not be able to satisfy demand with its current product. But if the company is able to use its smallest industrial air-conditioning unit to satisfy the needs of several homes, it might have a market opportunity. If there are no other options or if consumers want their own individual units, the company will likely need to design a smaller air-conditioning unit or rule out entry into that market.

Step 3: Initiate Meetings

Holding meetings early with potential local distributors, buyers, and others is a must. Initial contact should focus on building trust and developing a cooperative climate among all parties. The cultural differences between the parties will come into play already at this stage. Beyond building trust, successive meetings are designed to estimate the potential success of any agreement if interest is shown on both sides. At the most advanced stage, negotiations take place and details of agreements are finalized.

For example, a group of environmental technology companies in Arizona was searching for markets abroad. A delegation from Taiwan soon arrived in the Arizona desert to survey the group’s products. Although days were busy with company visits, formal meetings, and negotiations, evenings were designed to build relationships. There were outdoor barbecues, hayrides, line dancing, and frontier-town visits to give the visitors a feel for local culture and history. To make their counterparts from Taiwan feel comfortable, nighttime schedules included visits to karaoke spots and Chinese restaurants where a good deal of singing took place. Follow-up meetings resulted in several successful deals.

Step 4: Commit Resources

After all the meetings, negotiations, and contract signings, it is time to put the company’s human, financial, and physical resources to work. First, the objectives of the export program must be clearly stated and should extend out at least three to five years. For small firms, it may be sufficient to assign one individual the responsibility for drawing up objectives and estimating resources. Yet as companies expand their activities to include more products and/or markets, many firms discover the need for an export department or division. The head of this department usually has the responsibility (and authority) to formulate, implement, and evaluate the company’s export strategy. See Chapter 11 for a detailed discussion of organizational design issues to consider at this stage.

Degree of Export Involvement

Companies of all sizes engage in exporting but not all companies become involved in exporting to the same extent. Some companies (usually entrepreneurs and small and medium-sized firms) perform few or none of the activities necessary to get their products in a market abroad. Instead, they use intermediaries that specialize in getting products from one market into another. Other companies (usually only the largest companies) perform all of their export activities themselves, with an infrastructure that bridges the gap between the two markets. Let’s take a closer look at the two basic forms of export involvement—direct exporting and indirect exporting.

Direct Exporting

Some companies become deeply involved in the export of their products.
Direct exporting
occurs when a company sells its products directly to buyers in a target market. Direct exporters operate in many industries, including aircraft (Boeing) (www.boeing.com), industrial equipment (John Deere) (www.deere.com), apparel (Lands’ End) (www.landsend.com), and bottled beverages (Evian) (www.evian.com). Bear in mind that “direct exporters” need not sell directly to end users. Rather, they take full responsibility for getting their goods into the target market by selling directly to local buyers and not going through intermediary companies. Typically, they rely on either local sales representatives or distributors.

direct exporting

Practice by which a company sells its products directly to buyers in a target market

SALES REPRESENTATIVES

A sales representative (whether an individual or an organization) represents only its own company’s products, not those of other companies. They promote those products in many ways, such as by attending trade fairs and making personal visits to local retailers and wholesalers. They do not take title to the merchandise. Rather, they are hired by a company and normally are compensated with a fixed salary plus commissions based on the value of their sales.

DISTRIBUTORS

Alternatively, a direct exporter can sell in the target market through distributors, who take ownership of the merchandise when it enters their country. As owners of the products, they accept all the risks associated with generating local sales. They sell either to retailers and wholesalers or to end users through their own channels of distribution. Typically, they earn a profit equal to the difference between the price they pay and the price they receive for the exporter’s goods. Although using a distributor reduces an exporter’s risk, it also weakens an exporter’s control over the price buyers are charged. A distributor who charges very high prices can stunt the growth of an exporter’s market share. Exporters should choose, if possible, distributors who are willing to invest in the promotion of their products and who do not sell directly competing products.

Indirect Exporting

Some companies have few resources available to commit to exporting activities. Others simply find exporting a daunting task because of a lack of contacts and experience. Fortunately, there is an option for such firms.
Indirect exporting
occurs when a company sells its products to intermediaries who then resell to buyers in a target market. The choice of an intermediary depends on many factors, including the ratio of the exporter’s international sales to its total sales, the company’s available resources, and the growth rate of the target market. Let’s take a closer look at several different types of intermediaries:

agents

,
export management companies
, and
export trading companies
.

indirect exporting

Practice by which a company sells its products to intermediaries who then resell to buyers in a target market

AGENTS

Individuals or organizations that represent one or more indirect exporters in a target market

are called
agents
. Agents typically receive compensation in the form of commissions on the value of sales. Because establishing a relationship with an agent is relatively easy and inexpensive, it is a fairly common approach to indirect exporting. Agents should be chosen very carefully because it can be costly and difficult to terminate an agency relationship if problems arise. Careful selection is also essential because agents often represent several indirect exporters simultaneously. Agents might focus their promotional efforts on the products of the company paying the highest commission rather than on the company with the better products.

agents
Individuals or organizations that represent one or more indirect exporters in a target market

EXPORT MANAGEMENT COMPANIES

A company that exports products on behalf of an indirect exporter is called an

export management company (EMC)

. An EMC operates contractually, either as an agent (being paid through commissions based on the value of sales) or as a distributor (taking ownership of the merchandise and earning a profit from its resale).

export management company (EMC)

Company that exports products on behalf of indirect exporters

An EMC will usually provide additional services on a retainer basis, charging set fees against funds deposited on account. Typical EMC services include gathering market information, formulating promotional strategies, performing specific promotional duties (such as attending trade fairs), researching customer credit, making shipping arrangements, and coordinating export documents. It is common for an EMC to exploit contacts predominantly in one industry (say, agricultural goods or consumer products) or in one geographic area (such as Latin America or the Middle East). Indeed, the biggest advantage of an EMC is usually a deep understanding of the cultural, political, legal, and economic conditions of the target market. Its staff works comfortably and effectively in the cultures of both the exporting and the target nation. The average EMC tends to deploy a wide array of commercial and political contacts to facilitate business activities on behalf of its clients.

Perhaps the only disadvantage of hiring an EMC is that the breadth and depth of its service can potentially hinder the development of the exporter’s own international expertise. But an exporter and its EMC typically have such a close relationship that an exporter often considers its EMC as a virtual exporting division. When this is the case, exporters learn a great deal about the intricacies of exporting from their EMC. Then, after the EMC contract expires, it is common for a company to go it alone in exporting its products.

EXPORT TRADING COMPANIES

A company that provides services to indirect exporters in addition to activities directly related to clients’ exporting activities is called an

export trading company (ETC)

. Whereas an EMC is restricted to export-related activities, an ETC assists its clients by providing import, export, and countertrade services; developing and expanding distribution channels; providing storage facilities; financing trading and investment projects; and even manufacturing products.

export trading company (ETC)

Company that provides services to indirect exporters in addition to activities related directly to clients’ exporting activities

European trading nations first developed the ETC concept centuries ago. More recently, the Japanese have refined the concept, which they call sogo shosha. The Japanese ETC can range in size from small, family-run businesses to enormous conglomerates such as Mitsubishi (www.mitsubishi.com), Mitsui (www.mitsui.com), and ITOCHU (www.itochu.co.jp). An ETC in South Korea is called a chaebol and includes well-known companies such as Samsung (www.samsung.com) and Hyundai (www.hyundaigroup.com).

Japanese and South Korean ETCs have become formidable competitors because of their enormous success in gaining global market share. These Asian companies quickly came to rival the dominance of the largest U.S. multinationals, which lobbied U.S. lawmakers for assistance in challenging Asian ETCs in global markets. The result was the Export Trading Company Act passed in 1982. Despite this effort, the ETC concept never really caught on in the United States. Operations of the typical ETC in the United States remain small and are dwarfed by those of their Asian counterparts. One reason for the lack of interest in the ETC concept in the United States relative to Asia is that governments, financial institutions, and companies have much closer working relationships in Asia. The formation of huge conglomerates that engage in activities ranging from providing financing to manufacturing to distribution is easier to accomplish there. By contrast, the regulatory environment in the United States is wary of such cozy business arrangements, and the lines between companies and industries are more clearly drawn.

Avoiding Export and Import Blunders

There are several errors common to companies new to exporting. First, many businesses fail to conduct adequate market research before exporting. In fact, many companies begin exporting by responding to unsolicited requests for their products. If a company enters a market in this manner, it should quickly devise an export strategy to manage its export activities effectively and not strain its resources.

Second, many companies fail to obtain adequate export advice. National and regional governments are often willing and able to help managers and small-business owners understand and cope with the vast amounts of paperwork required by each country’s export and import laws. Naturally, more experienced exporters can be extremely helpful as well. They can help novice exporters avoid embarrassing mistakes by guiding them through unfamiliar cultural, political, and economic environments.

To better ensure that it will not make embarrassing blunders, an inexperienced exporter might also want to engage the services of a

freight forwarder

—a specialist in export-related activities such as customs clearing, tariff schedules, and shipping and insurance fees. Freight forwarders also can pack shipments for export and take responsibility for getting a shipment from the port of export to the port of import.

freight forwarder

Specialist in export-related activities such as customs clearing, tariff schedules, and shipping and insurance fees

Quick Study

1. Briefly describe each of the four steps involved in building an export strategy.

2. How does
direct exporting
differ from
indirect exporting
?

3. Compare and contrast
export management companies
and
export trading companies
.

Barter, or trueque, became a way of life in Argentina when the nation’s economy was mired in a seemingly endless recession. Here, residents of Buenos Aires, Argentina, barter goods using “Ticket Trueque,” or “Barter Vouchers” in English. In this market near Buenos Aires, you can swap music CDs, films on DVD, clothing, fruit, plumbing supplies, and vegetables. Local newspapers run ads for such things as apartments, cars, and washing machines, all offered on a barter basis.

Source: © Reuters/Rickey Rogers/CORBIS. All Rights Reserved.

Countertrade

Companies are sometimes unable to import merchandise in exchange for financial payment. The reason is that the government of the importer’s nation either lacks the hard currency to pay for imports, or it intentionally restricts the convertibility of its currency. Fortunately, there is a way for firms to trade by using either a small amount of hard currency or even none at all. Selling goods or services that are paid for, in whole or part, with other goods or services is called
countertrade
. Although countertrade often requires an extensive network of international contacts, even smaller companies can take advantage of its benefits.

countertrade

Practice of selling goods or services that are paid for, in whole or part, with other goods or services

Nations that have long used countertrade are found mostly in Africa, Asia, Eastern Europe, and the Middle East. A lack of adequate hard currency often forced those nations to use countertrade to exchange oil for passenger aircraft and military equipment. Today, because of insufficient hard currency, developing and emerging markets frequently rely on countertrade to import goods. The greater involvement of firms from industrialized nations in those markets is expanding the use of countertrade.

Types of Countertrade

There are several different types of countertrade:

barter

, counterpurchase,

offset

,

switch trading

, and

buyback

. Let’s take a brief look at each of these.

■
Barter
is the exchange of goods or services directly for other goods or services without the use of money. It is the oldest known form of countertrade.

barter

Exchange of goods or services directly for other goods or services without the use of money

■
Counterpurchase
is the sale of goods or services to a country by a company that promises to make a future purchase of a specific product from that country. This type of agreement is designed to allow the country to earn back some of the currency that it paid for the original imports.

counterpurchase

Sale of goods or services to a country by a company that promises to make a future purchase of a specific product from the country

■
Offset
is an agreement that a company will offset a hard-currency sale to a nation by making a hard-currency purchase of an unspecified product from that nation in the future. It differs from a counterpurchase in that this type of agreement does not specify the type of product that must be purchased, just the amount that will be spent. Such an arrangement gives a business greater freedom in fulfilling its end of a countertrade deal.

offset

Agreement that a company will offset a hard-currency sale to a nation by making a hard-currency purchase of an unspecified product from that nation in the future

■
Switch trading
is countertrade whereby one company sells to another its obligation to make a purchase in a given country. For example, in return for market access, a firm that wants to enter a target market might promise to buy a product for which it has no use. The company then sells this purchase obligation to a large trading company that makes the purchase itself because it has a use for the merchandise. If the trading company has no use for the merchandise, it can arrange for yet another buyer who needs the product to make the purchase.

switch trading

Practice in which 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. This practice usually typifies long-term relationships between the companies involved.

buyback

Export of industrial equipment in return for products produced by that equipment

Thus countertrade can provide access to markets that are otherwise off-limits because of a lack of hard currency. It can also cause headaches. Much countertrade involves commodity and agricultural products such as oil, wheat, or corn—products whose prices on world markets tend to fluctuate a good deal. A problem arises when the price of a bartered product falls on world markets between the time that a deal is arranged and the time at which one party tries to sell the product. Fluctuating prices generate the same type of risk that is encountered in currency markets. Managers might be able to hedge some of this risk on commodity futures markets similar to how they hedge against currency fluctuations in currency markets (see Chapter 9).

Export/Import Financing

International trade poses risks for both exporters and importers. Exporters run the risk of not receiving payment after their products are delivered. Importers fear that delivery might not occur once payment is made for a shipment. Accordingly, a number of export/import financing methods are designed to reduce the risk to which exporters and importers are exposed. These include

advance payment

,

documentary collection

,

letter of credit

, and

open account

. Let’s take a closer look at each of these methods and the risk each holds for exporters and importers.

Advance Payment

Export/import financing in which an importer pays an exporter for merchandise before it is shipped

is called
advance payment
. This method of payment is common when two parties are unfamiliar with each other, the transaction is relatively small, or the buyer is unable to obtain credit because of a poor credit rating at banks. Payment normally takes the form of a wire transfer of money from the bank account of the importer directly to that of the exporter. Although prior payment eliminates the risk of nonpayment for exporters, it creates the complementary risk of nonshipment for importers—importers might pay for goods but never receive them. Thus advance payment is the most favorable method for exporters but the least favorable for importers (see Figure 13.2).

advance payment
Export/import financing in which an importer pays an exporter for merchandise before it is shipped

Documentary Collection

Export/import financing in which a bank acts as an intermediary without accepting financial risk

is called
documentary collection
. This payment method is commonly used when there is an ongoing business relationship between two parties. The documentary collection process can be broken into three main stages and nine smaller steps (see Figure 13.3).

documentary collection
Export/import financing in which a bank acts as an intermediary without accepting financial risk

1. Before shipping merchandise, the exporter (with its banker’s assistance) draws up a

draft (bill of exchange)

—a document ordering the importer to pay the exporter a specified sum of money at a specified time. A sight draft requires the importer to pay when goods are delivered. A time draft extends the period of time (typically 30, 60, or 90 days) following delivery by which the importer must pay for the goods. (When inscribed “accepted” by an importer, a time draft becomes a negotiable instrument that can be traded among financial institutions.)

draft (bill of exchange)

Document ordering an importer to pay an exporter a specified sum of money at a specified time

2. Following creation of the draft, the exporter delivers the merchandise to a transportation company for shipment to the importer. The exporter then delivers to its banker a set of documents that includes the draft, a packing list of items shipped, and a

bill of lading

—a contract between the exporter and shipper that specifies merchandise destination and shipping costs. The bill of lading is proof that the exporter has shipped the merchandise. An international ocean shipment requires an inland bill of lading to get the shipment to the exporter’s border and an ocean bill of lading for water transport to the importer nation. An international air shipment requires an air way bill that covers the entire international journey.

bill of lading

Contract between an exporter and a shipper that specifies merchandise destination and shipping costs

3. After receiving appropriate documents from the exporter, the exporter’s bank sends the documents to the importer’s bank. After the importer fulfills the terms stated on the draft and pays its own bank, the bank issues the bill of lading (which becomes title to the merchandise) to the importer.

FIGURE 13.2 Risk of Alternative Export/Import Financing Methods

FIGURE 13.3 Documentary Collection Process

Documentary collection reduces the importer’s risk of nonshipment because the packing list details the contents of the shipment and the bill of lading is proof that the merchandise was shipped. The exporter’s risk of nonpayment is increased because, although the exporter retains title to the goods until the merchandise is accepted, the importer does not pay until all necessary documents have been received. Although importers have the option of refusing the draft (and, therefore, the merchandise), this action is unlikely. Refusing the draft—despite all terms of the agreement being fulfilled—would make the importer’s bank unlikely to do business with the importer in the future.

Letter of Credit

Export/import financing in which the importer’s bank issues a document stating that the bank will pay the exporter when the exporter fulfills the terms of the document

is called
letter of credit
. A letter of credit is typically used when an importer’s credit rating is questionable, when the exporter needs a letter of credit to obtain financing, and when a market’s regulations require it.

letter of credit
Export/import financing in which the importer’s bank issues a document stating that the bank will pay the exporter when the exporter fulfills the terms of the document

Before a bank issues a letter of credit, it checks on the importer’s financial condition. Banks normally issue letters of credit only after an importer has deposited on account a sum equal in value to that of the imported merchandise. The bank is still required to pay the exporter, but the deposit protects the bank if the importer fails to pay for the merchandise. Banks will sometimes waive this requirement for their most reputable clients.

There are several types of letters of credit:

■ An irrevocable letter of credit allows the bank issuing the letter to modify its terms only after obtaining the approval of both exporter and importer.

■ A revocable letter of credit can be modified by the issuing bank without obtaining approval from either the exporter or the importer.

■ A confirmed letter of credit is guaranteed by both the exporter’s bank in the country of export and the importer’s bank in the country of import.

The le tter of credit process for payment of exports is shown in Figure 13.4. After the issuance of a letter of credit, the importer’s bank informs the exporter (through the exporter’s bank) that a letter of credit exists and that it may now ship the merchandise. The exporter then delivers a set of documents (according to the terms of the letter) to its own bank. These documents typically include an invoice, customs forms, a packing list, and a bill of lading. The exporter’s bank ensures that the documents are in order and pays the exporter.

FIGURE 13.4 Letter of Credit Process

When the importer’s bank is satisfied that the terms of the letter have been met, it pays the exporter’s bank. At that point, the importer’s bank is responsible for collecting payment from the importer. Letters of credit are popular among traders because banks assume most of the risks. The letter of credit reduces the importer’s risk of nonshipment (as compared with advance payment) because the importer receives proof of shipment before making payment. Although the exporter’s risk of nonpayment is slightly increased, it is a more secure form of payment for exporters because the nonpayment risk is accepted by the importer’s bank when it issues payment to the exporter’s bank.

Open Account

Export/import financing in which an exporter ships merchandise and later bills the importer for its value

is called
open account
. Because some receivables may not be collected, exporters should reserve shipping on open account only for their most trusted customers. This payment method is often used when the parties are very familiar with each other or for sales between two subsidiaries within an international company. The exporter simply invoices the importer (as in many domestic transactions), stating the amount and date due. This method reduces the risk of nonshipment faced by the importer under the advance payment method.

open account
Export/import financing in which an exporter ships merchandise and later bills the importer for its value

By the same token, the open account method increases the risk of nonpayment for the exporter. Thus open account is the least favorable for exporters but the most favorable for importers. For some insights on how small exporters can increase the probability of getting paid for a shipment, see the Entrepreneur’s Toolkit titled, “Collecting International Debts.”

ENTREPRENEUR’S TOOLKIT Collecting International Debts

What is the point of working hard to make an international sale if the buyer does not pay? There are seldom easy answers when an exporter is stuck without payment. Here are several pointers on what small businesses can do to reduce the likelihood of not receiving payment.

■ Knowledge of the market you are exporting to is your first and best defense. Understanding its culture, the language spoken, and its legal system is ideal. You should also understand if there is typically a payment lag for business debts and customary debt collection procedures.

■ Be aware of which countries are commonly a problem when it comes to debt collection. Regularly consult the many free sources of information available on the Internet to learn which countries are problems. Avoid doing business with them and seek markets elsewhere.

■ Essential to preventing later collection problems is both parties clearly understanding the payment terms in your export sales agreement. Also be sure the buyer knows precisely when payment is to be issued.

■ Do not wait too long to begin collecting a past due account. Exporters who delay will likely never receive payment. Begin with firmly worded communications via phone, fax, e-mail, and letter.

■ Consult an international trade attorney or hire an international debt collection agency if necessary. If you are encouraged to accept arbitration as a way to resolve the issue, this often poses your best chance of seeing at least partial payment.

Quick Study

1. Why do companies engage in
countertrade
? List each of its five types.

2. What are the four main methods of export/import financing?

3. Describe the various risks that each financing method poses for exporters and importers.

Contractual Entry Modes

The products of some companies simply cannot be traded in open markets because they are intangible. Thus a company cannot use importing, exporting, or countertrade to exploit opportunities in a target market. Fortunately, there are other options for this type of company. A company can use a variety of contracts—

licensing

,

franchising

,
management contracts
, and turnkey projects—to market highly specialized assets and skills in markets beyond its nations’ borders.

Licensing

Companies sometimes grant other firms the right to use an asset that is essential to the production of a finished product.
Licensing
is a contractual entry mode in which a company that owns intangible property (the licensor) grants another firm (the licensee) the right to use that property for a specified period of time. Licensors typically receive royalty payments based on a percentage of the licensee’s sales revenue generated by the licensed property. The licensors might also receive a one-time fee to cover the cost of transferring the property to the licensee. Commonly licensed intangible property includes patents, copyrights, special formulas and designs, trademarks, and brand names. Thus licensing often involves granting companies the right to use process technologies inherent to the production of a particular good.

licensing

Practice by which one company owning intangible property (the licensor) grants another firm (the licensee) the right to use that property for a specified period of time

Here are a few examples of successful licensing agreements:

■ Novell (United States) licensed its software to three Hong Kong universities that installed it as the campus-wide standard.

■ Hitachi (Japan) licensed from Duales System Deutschland (Germany) technology to be used in the recycling of plastics in Japan.

■ Hewlett-Packard (United States) licensed from Canon (Japan) a printer engine for use in its monochrome laser printers.

An exclusive license grants a company the exclusive rights to produce and market a property, or products made from that property, in a specific geographic region. The region can be the licensee’s home country or may extend to worldwide markets. A nonexclusive license grants a company the right to use a property but does not grant it sole access to a market. A licensor can grant several or more companies the right to use a property in the same region.

Cross licensing
occurs when companies use licensing agreements to exchange intangible property with one another. For example, Fujitsu (www.fujitsu.com) of Japan signed a five-year cross-licensing agreement with Texas Instruments (www.ti.com) of the United States. The agreement allowed each company to use the other’s technology in the production of its own goods—thus lowering R&D costs. It was a very extensive arrangement, covering all but a few semiconductor patents owned by each company. Because asset values are seldom exactly equal, cross licensing also typically involves royalty payments from one party to the other.

cross licensing

Practice by which companies use licensing agreements to exchange intangible property with one another

Advantages of Licensing

There are several advantages to using licensing as an entry mode into new markets. First, licensors can use licensing to finance their international expansion. Most licensing agreements require licensees to contribute equipment and investment financing, whether by building special production facilities or by using existing excess capacity. Access to such resources can be a great advantage to a licensor who wants to expand but lacks the capital and managerial resources to do so. And because it need not spend time constructing and starting up its own new facilities, the licensor earns revenues sooner than it would otherwise.

Second, licensing can be a less risky method of international expansion for a licensor than other entry modes. Whereas some markets are risky because of social or political unrest, others defy accurate market research for a variety of reasons. Licensing helps shield the licensor from the increased risk of operating its own local production facilities in markets that are unstable or hard to assess accurately.

Third, licensing can help reduce the likelihood that a licensor’s product will appear on the black market. The side streets of large cities in many emerging markets are dotted with tabletop vendors eager to sell bootleg versions of computer software, Hollywood films, and recordings of internationally popular musicians. Producers can, to some extent, foil bootleggers by licensing local companies to market their products at locally competitive prices. Royalties will be lower than the profits generated by sales at higher international prices, but lower profits are better than no profits at all—which is what owners get from bootleg versions of their products.

Finally, licensees can benefit by using licensing as a method of upgrading existing production technologies. For example, manufacturers of plastics and other synthetic materials in the Philippines attempted to meet the high standards demanded by the local subsidiaries of Japanese electronics and office equipment producers. To do this, D&L Industries of the Philippines upgraded its manufacturing process by licensing materials technology from Nippon Pigment of Japan.

Disadvantages of Licensing

There also are important disadvantages to using licensing. First, it can restrict a licensor’s future activities. Suppose a licensee is granted the exclusive right to use an asset but fails to produce the sort of results that a licensor expected. Because the license agreement is exclusive, the licensor cannot simply begin selling directly in that particular market to meet demand itself or contract with another licensee. A good product and lucrative market, therefore, do not guarantee success for a producer entering a market through licensing.

The automobile industry relies on franchising to exploit international opportunities. Franchising allows German carmaker, Volkswagen, to maintain strict control over its Chinese dealerships. In this way, Volkswagen ensures that dealerships meet company guidelines on matters such as sales, service, and financing. Volkswagen is the leading carmaker in China with around 20 percent of the passenger car market. Can you think of other industries that employ franchising?

Source: Getty Images.

Second, licensing might reduce the global consistency of the quality and marketing of a licensor’s product in different national markets. A licensor might find the development of a coherent global brand image an elusive goal if each of its national licensees is allowed to operate in any manner it chooses. Promoting a global image might later require considerable amounts of time and money to change the misconceptions of buyers in the various licensed markets.

Third, licensing might amount to a company “lending” strategically important property to its future competitors. This is an especially dangerous situation when a company licenses assets on which its competitive advantage is based. Licensing agreements are often made for several years and perhaps even a decade or more. During this time, licensees often become highly competent at producing and marketing the licensor’s product. When the agreement expires, the licensor might find that its former licensee is capable of producing and marketing a better version of its own product. Licensing contracts can (and should) restrict licensees from competing in the future with products based strictly on licensed property. But enforcement of such provisions works only for identical or nearly identical products, not when substantial improvements are made.

Franchising

Franchising
is a contractual entry mode in which one company (the franchiser) supplies another (the franchisee) with intangible property and other assistance over an extended period. Franchisers typically receive compensation as flat fees, royalty payments, or both. The most popular franchises are those with widely recognized brand names, such as Mercedes (www.mercedes.com), McDonald’s (www.mcdonalds.com), and Starbucks (www.starbucks.com). In fact, the brand name or trademark of a company is normally the single most important item desired by the franchisee. This is why smaller companies with lesser known brand names and trademarks have greater difficulty locating interested franchisees.

franchising

Practice by which one company (the franchiser) supplies another (the franchisee) with intangible property and other assistance over an extended period

Franchising differs from licensing in several ways. First, franchising gives a company greater control over the sale of its product in a target market. Franchisees must often meet strict guidelines on product quality, day-to-day management duties, and marketing promotions. Second, although licensing is fairly common in manufacturing industries, franchising is primarily used in service industries such as auto dealerships, entertainment, lodging, restaurants, and business services. Third, although licensing normally involves a one-time transfer of property, franchising requires ongoing assistance from the franchiser. In addition to the initial transfer of property, franchisers typically offer startup capital, management training, location advice, and advertising assistance to their franchisees.

Some examples of the kinds of companies involved in international franchising include:

■ Ozemail (Australia) awarded Magictel (Hong Kong) a franchise to operate its Internet phone and fax service in Hong Kong.

■ Jean-Louis David (France) awarded franchises to more than 200 hairdressing salons in Italy.

■ Brooks Brothers (United States) awarded Dickson Concepts (Hong Kong) a franchise to operate Brooks Brothers stores across Southeast Asia.

Companies based in the United States dominate the world of international franchising. U.S. companies perfected the practice of franchising in their large, homogeneous domestic market having low barriers to interstate trade and investment. Yet franchising is growing in the European Union, with the advent of a single currency and a unified set of franchise laws. Many European managers with comfortable early-retirement packages have discovered franchising to be an appealing second career. Franchising across much of Europe is expected to grow for the foreseeable future.2

Despite projections for robust growth, European franchise managers often misunderstand the franchising concept. One example is when Holiday Inn’s franchise expansion in Spain was moving more slowly than expected. According to the company’s development director in Spain, Holiday Inn found that it needed to convince local managers that Holiday Inn did not want to “take control” of their hotels.3 In some eastern European countries, local managers do not understand why they must continue to pay royalties to brand and trademark owners. Franchise expansion in eastern European markets also suffers from a lack of local capital, high interest rates, high taxes, bureaucratic obstacles, restrictive laws, and corruption.4

Advantages of Franchising

There are several important advantages of franchising. First, franchisers can use franchising as a low-cost, low-risk entry mode into new markets. Companies following global strategies rely on consistent products and common themes in worldwide markets. Franchising allows them to maintain consistency by replicating the processes for standardized products in each target market. Many franchisers, however, will make small modifications in products and promotional messages when marketing specifically to local buyers.

Second, franchising is an entry mode that allows for rapid geographic expansion. Firms often gain a competitive advantage by being first in seizing a market opportunity. For example, Microtel Inns & Suites (www.microtelinn.com) of Atlanta, Georgia, is using franchising to fuel its international expansion. Microtel is boldly entering Argentina and Uruguay and eyeing opportunities in Brazil and Western Europe. Rooms cost around $75 per night and target business travelers who cannot afford $200 per night.5

Finally, franchisers can benefit from the cultural knowledge and know-how of local managers. This helps lower the risk of business failure in unfamiliar markets and can create a competitive advantage.

Disadvantages of Franchising

Franchising can also pose problems for both franchisers and franchisees. First, franchisers may find it cumbersome to manage a large number of franchisees in a variety of national markets. A major concern is that product quality and promotional messages among franchisees will not be consistent from one market to another. One way to ensure greater control is by establishing in each market a so-called master franchisee, which is responsible for monitoring the operations of individual franchisees.

Second, franchisees can experience a loss of organizational flexibility in franchising agreements. Franchise contracts can restrict their strategic and tactical options, and they may even be forced to promote products owned by the franchiser’s other divisions. For years PepsiCo (www.pepsico.com) owned the well-known restaurant chains Pizza Hut, Taco Bell, and KFC. As part of their franchise agreements with PepsiCo, restaurant owners were required to sell only PepsiCo beverages to their customers. Many franchisees worldwide were displeased with such restrictions on their product offerings and were relieved when PepsiCo spun off the restaurant chains.

Management Contracts

Under the stipulations of a

management contract

, one company supplies another with managerial expertise for a specific period of time. The supplier of expertise is normally compensated with either a lump-sum payment or a continuing fee based on sales volume. Such contracts are commonly found in the public utilities sectors of developed and emerging markets. Two types of knowledge can be transferred through management contracts—the specialized knowledge of technical managers and the business-management skills of general managers.

management contract

Practice by which one company supplies another with managerial expertise for a specific period of time

Two examples of management contracts include:

■ DBS Asia (Thailand) awarded a management contract to Favorlangh Communication (Taiwan) to set up and run a company supplying digital television programming in Taiwan.

■ Lyonnaise de Eaux (France) and RWE Aqua (Germany) agreed to manage drinking-water quality and client billing and to maintain the water infrastructure for the city of Budapest, Hungary, for 25 years.

Advantages of Management Contracts

Management contracts can benefit organizations and countries. First, a firm can award a management contract to another company and thereby exploit an international business opportunity without having to place a great deal of its own physical assets at risk. Financial capital can then be reserved for other promising investment projects that would otherwise not be funded.

Second, governments can award companies management contracts to operate and upgrade public utilities, particularly when a nation is short of investment financing. That is why the government of Kazakhstan contracted with a group of international companies called ABB Power Grid Consortium to manage its national electricity-grid system for 25 years. Under the terms of the contract, the consortium paid past wages owed to workers by the government and is to invest more than $200 million during the first three years of the agreement. The Kazakhstan government had neither the cash flow to pay the workers nor the funds to make badly needed improvements.

Third, governments use management contracts to develop the skills of local workers and managers. ESB International (www.esb.ie) of Ireland signed a three-year contract not only to manage and operate a power plant in Ghana, Africa, but also to train local personnel in the skills needed to manage it at some point in the future.

Disadvantages of Management Contracts

Unfortunately, management contracts also pose two disadvantages for suppliers of expertise. First of all, although management contracts reduce the exposure of physical assets in another country, the same is not true for the supplier’s personnel; political or social turmoil can threaten managers’ lives.

Second, suppliers of expertise may end up nurturing a formidable new competitor in the local market. After learning how to conduct certain operations, the party that had originally needed assistance may be capable of competing on its own. Firms must weigh the financial returns from a management contract against the potential future problems caused by a newly launched competitor.

Turnkey Projects

When one company designs, constructs, and tests a production facility for a client, the agreement is called a

turnkey (build–operate–transfer) project

. The term turnkey project is derived from the understanding that the client, who normally pays a flat fee for the project, is expected to do nothing more than simply “turn a key” to get the facility operating. The company awarded a turnkey project completely prepares the facility for its client.

turnkey (build–operate–transfer) project

Practice by which one company designs, constructs, and tests a production facility for a client firm

Similar to management contracts, turnkey projects tend to be large-scale and often involve government agencies. But unlike management contracts, turnkey projects transfer special process technologies or production-facility designs to the client. They typically involve the construction of power plants, airports, seaports, telecommunication systems, and petrochemical facilities that are then turned over to the client. Under a management contract, the supplier of a service retains the asset—the managerial expertise.

Two examples of international turnkey projects include:

■ Telecommunications Consultants India constructed telecom networks in both Madagascar and Ghana—two turnkey projects worth a combined total of $28 million.

■ Lubei Group (China) agreed with the government of Belarus to join in the construction of a facility for processing a fertilizer byproduct into cement.

Advantages of Turnkey Projects

Turnkey projects provide benefits to providers and recipients. First, turnkey projects permit firms to specialize in their core competencies and to exploit opportunities that they could not undertake alone. Exxon Mobil (www.exxonmobil.com) awarded a turnkey project to PT McDermott Indonesia (www.mcdermott.com) and Toyo Engineering (toyo-eng.co.jp) of Japan to build a liquid natural gas plant on the Indonesian island of Sumatra. The providers are responsible for constructing an offshore production platform, laying a 100-kilometer underwater pipeline, and building an on-land liquid natural gas refinery. The $316 million project is feasible only because each company contributes unique expertise to the design, construction, and testing of the facilities.

A turnkey project is a venture in which one organization designs, builds, and tests a facility for another, which then merely “turns the key” to get things underway. The liquefied natural gas plant shown here on Bonny Island, Nigeria, was built by a global consortium of engineering firms from France, Italy, and Japan. The turnkey contract included construction of the gas plant, its transmission system, and the residential area. What other types of operations are appropriate for a turnkey project?

Source: © George Steinmetz/CORBIS. All Rights Reserved.

Second, turnkey projects allow governments to obtain designs for infrastructure projects from the world’s leading companies. For instance, Turkey’s government enlisted two separate consortiums of international firms to build four hydroelectric dams on its Coruh River. The dams combine the design and technological expertise of each company in the two consortiums. The Turkish government also awarded a turnkey project to Ericsson (www.ericsson.com) of Sweden to expand the country’s mobile telecommunication system.

Disadvantages of Turnkey Projects

Among the disadvantages of turnkey projects is the fact that a company may be awarded a project for political reasons rather than for technological know-how. Because turnkey projects are often of high monetary value and awarded by government agencies, the process of awarding them can be highly politicized. When the selection process is not entirely open, companies with the best political connections often win contracts, usually at inflated prices—the costs of which are typically passed on to local taxpayers.

Second, like management contracts, turnkey projects can create future competitors. A newly created local competitor could become a major supplier in its own domestic market and perhaps even in other markets where the supplier operates. Therefore, companies try to avoid projects in which there is danger of transferring their core competencies to others.

Quick Study

1. Identify the advantages and disadvantages of
licensing
for the licensor and the licensee.

2. Describe how
franchising
differs from licensing. What are its main benefits and drawbacks?

3. When is a
management contract
useful? Identify two types of knowledge it is used to transfer.

4. What is a turnkey project? Describe its main advantages and disadvantages.

Investment Entry Modes

Investment entry modes entail direct investment in plant and equipment in a country coupled with ongoing involvement in the local operation. Entry modes in this category take a company’s commitment in a market to a higher level. Let’s now explore three common forms of investment entry:
wholly owned subsidiaries
,
joint ventures
, and
strategic alliances
.

Wholly Owned Subsidiaries

As the term suggests, a

wholly owned subsidiary

is a facility entirely owned and controlled by a single parent company. Companies can establish a wholly owned subsidiary either by forming a new company and constructing entirely new facilities (such as factories, offices, and equipment) or by purchasing an existing company and internalizing its facilities. Whether an international subsidiary is purchased or newly created depends to a large extent on its proposed operations. When a parent company designs a subsidiary to manufacture the latest high-tech products, it typically must build new facilities. The major drawback of creation from the ground up is the time it takes to construct new facilities, hire and train employees, and launch production.

wholly owned subsidiary

Facility entirely owned and controlled by a single parent company

Conversely, finding an existing local company capable of performing marketing and sales will be easier because special technologies are typically not needed. By purchasing the existing marketing and sales operations of an existing firm in the target market, the parent can have the subsidiary operating relatively quickly. Buying an existing company’s operations in the target market is a particularly good strategy when the company to be acquired has a valuable trademark, brand name, or process technology.

Advantages of Wholly Owned Subsidiaries

There are two main advantages to entering a market using a wholly owned subsidiary. First, managers have complete control over day-to-day operations in the target market and access to valuable technologies, processes, and other intangible properties within the subsidiary. Complete control also decreases the chance that competitors will gain access to a company’s competitive advantage, which is particularly important if it is technology-based. Managers also retain complete control over the subsidiary’s output and prices. Unlike licensors and franchisers, the parent company also receives all profits generated by the subsidiary.

Second, a wholly owned subsidiary is a good mode of entry when a company wants to coordinate the activities of all its national subsidiaries. Companies using global strategies view each of their national markets as one part of an interconnected global market. Thus the ability to exercise complete control over a wholly owned subsidiary makes this entry mode attractive to companies that are pursuing global strategies.

Disadvantages of Wholly Owned Subsidiaries

Wholly owned subsidiaries also present two primary disadvantages. First, they can be expensive undertakings because companies must typically finance investments internally or raise funds in financial markets. Obtaining the necessary funds can be difficult for small and medium-sized companies, but relatively easy for the largest companies.

Second, risk exposure is high because a wholly owned subsidiary requires substantial company resources. One source of risk is political or social uncertainty or outright instability in the target market. Such risks can place both physical assets and personnel in serious jeopardy. The sole owner of a wholly owned subsidiary also accepts the risk that buyers will reject the company’s product. Parent companies can reduce this risk by gaining a better understanding of consumers prior to entering the target market.

Joint Ventures

Under certain circumstances, companies prefer to share ownership of an operation rather than take complete ownership. A separate company that is created and jointly owned by two or more independent entities to achieve a common business objective is called a

joint venture

. Joint venture partners can be privately owned companies, government agencies, or government-owned companies. Each party may contribute anything valued by its partners, including managerial talent, marketing expertise, market access, production technologies, financial capital, and superior knowledge or techniques of research and development.

joint venture

Separate company that is created and jointly owned by two or more independent entities to achieve a common business objective

Examples of joint ventures include:

■ A joint venture between Suzuki Motor Corporation (Japan) and the government of India to manufacture a small-engine car specifically for the Indian market

■ A joint venture between a group of Indian companies and a Russian partner to produce television sets in Russia for the local market

■ Biltrite Corporation (United States) and Shenzhen Petrochemical (China) created a shoe-soling factory as a joint venture in China to supply international shoe manufacturers located in China

Joint Venture Configurations

As we see in Figure 13.5, there are four main joint venture configurations.6 Although we illustrate each of these as consisting of just two partners, each configuration can also apply to ventures of several or more partners.

FORWARD INTEGRATION JOINT VENTURE

Figure 13.5(a) outlines a joint venture characterized by forward integration. In this type of joint venture, the parties choose to invest together in downstream business activities—activities farther along in the “value system” that are normally performed by others. For instance, two household appliance manufacturers opening a retail outlet in a developing country would be a joint venture characterized by forward integration. The two companies now perform activities normally performed by retailers farther along in the product’s journey to buyers.

BACKWARD INTEGRATION JOINT VENTURE

Figure 13.5(b) outlines a joint venture characterized by backward integration. In other words, the joint venture signals a move by each company into upstream business activities—activities earlier in the value system that are normally performed by others. Such a configuration would result if two steel manufacturers formed a joint venture to mine iron ore. The companies now engage in an activity that is normally performed by mining companies.

FIGURE 13.5 Alternative Joint Venture Configurations

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.

BUYBACK JOINT VENTURE

Figure 13.5(c) outlines a joint venture whose input is provided by, and whose output is absorbed by, each of its partners. A
buyback joint venture
is formed when each partner requires the same component in its production process. It might be formed when a production facility of a certain minimum size is needed to achieve economies of scale, but neither partner alone enjoys enough demand to warrant building it. However, by combining resources the partners can construct a facility that serves their needs while achieving savings from economies of scale production. For instance, this was one reason behind the $500 million joint venture between Chrysler (www.chrysler.com) and BMW (www.bmw.com) to build small-car engines in Latin America. Each party benefited from the economies of scale offered by the plant’s annual production capacity of 400,000 engines—a volume that neither company could absorb alone.

MULTISTAGE JOINT VENTURE

Figure 13.5(d) outlines a joint venture that features downstream integration by one partner and upstream integration by another. A multistage joint venture often results when one company produces a good or service required by another. For example, a sporting goods manufacturer might join with a sporting goods retailer to establish a distribution company designed to bypass inefficient local distributors in a developing country.

Advantages of Joint Ventures

Joint ventures offer several important advantages to companies going international. Above all, companies rely on joint ventures to reduce risk. Generally, a joint venture exposes fewer of a partner’s assets to risk than would a wholly owned subsidiary—each partner risks only its own contribution. That is why a joint venture entry might be a wise choice when market entry requires a large investment or when there is significant political or social instability in the target market. Similarly, a company can use a joint venture to learn about a local business environment prior to launching a wholly owned subsidiary. In fact, many joint ventures are ultimately bought outright by one of the partners after it gains sufficient expertise in the local market.

Second, companies can use joint ventures to penetrate international markets that are otherwise off-limits. Some governments either require nondomestic companies to share ownership with local companies or provide incentives for them to do so. Such requirements are most common among governments of developing countries. The goal is to improve the competitiveness of local companies by having them team up with and learn from international partner(s).

Third, a company can gain access to another company’s international distribution network through the use of a joint venture. The joint venture between Caterpillar (www.caterpillar.com) of the United States and Mitsubishi Heavy Industries (www.mitsubishi.com) of Japan was designed to improve the competitiveness of each against a common rival, Komatsu (www.komatsu.com) of Japan. While Caterpillar gained access to Mitsubishi’s distribution system in Japan, Mitsubishi got access to Caterpillar’s global distribution network—helping it to compete more effectively internationally.

Finally, companies form international joint ventures for defensive reasons. Entering a joint venture with a local government or government-controlled company gives the government a direct stake in the venture’s success. In turn, the local government will be less likely to interfere if it means that the venture’s performance will suffer. This same strategy can also be used to create a more “local” image when feelings of nationalism are running strong in a target country.

Disadvantages of Joint Ventures

Among its disadvantages, joint venture ownership can result in conflict between partners. Conflict is perhaps most common when management is shared equally—that is, when each partner supplies top managers in what is commonly known as a “50–50 joint venture.” Because neither partner’s managers have the final say on decisions, managerial paralysis can result, causing problems such as delays in responding to changing market conditions. Conflict can also arise from disagreements over how future investments and profits are to be shared. Parties can reduce the likelihood of conflict and indecision by establishing unequal ownership, whereby one partner maintains 51 percent ownership of the voting stock and has the final say on decisions. A multiparty joint venture (commonly referred to as a consortium) can also feature unequal ownership. For example, ownership of a four-party joint venture could be distributed 20–20–20–40, with the 40 percent owner having the final say on decisions.

Second, loss of control over a joint venture’s operations can also result when the local government is a partner in the joint venture. This situation occurs most often in industries considered culturally sensitive or important to national security, such as broadcasting, infrastructure, and defense. Thus a joint venture’s profitability could suffer because of local government motives based on cultural preservation or security.

Strategic Alliances

Sometimes companies who are willing to cooperate with one another do not want to go so far as to create a separate jointly owned company. A relationship whereby two or more entities cooperate (but do not form a separate company) to achieve the strategic goals of each is called a

strategic alliance

. Similar to joint ventures, strategic alliances can be formed for relatively short periods or for many years, depending on the goals of the participants. Strategic alliances can be established between a company and its suppliers, its buyers, and even its competitors. In forming such alliances, sometimes each partner purchases a portion of the other’s stock. In this way, each company has a direct stake in its partner’s future performance. This decreases the likelihood that one partner will try to take advantage of the other.

strategic alliance

Relationship whereby two or more entities cooperate (but do not form a separate company) to achieve the strategic goals of each

Examples of strategic alliances include:

■ An alliance between Siemens (Germany) and Hewlett-Packard (United States) to create and market devices used to control telecommunications systems

■ A strategic alliance between Nippon Life Group (Japan) and Putnam Investments (United States) to permit Putnam to develop investment products and manage assets for Nippon

Advantages of Strategic Alliances

Strategic alliances offer several important advantages to companies. First, companies use strategic alliances to share the cost of an international investment project. For example, many firms are developing new products that not only integrate the latest technologies but also shorten the life spans of existing products. In turn, the shorter life span is reducing the number of years during which a company can recoup its investment. Thus many companies are cooperating to share the costs of developing new products. For example, Toshiba (www.toshiba.com) of Japan, Siemens (www.siemens.com) of Germany, and IBM (www.ibm.com) of the United States shared the $1 billion cost of developing a facility near Nagoya, Japan, to manufacture small, efficient computer memory chips.

Second, companies use strategic alliances to tap into competitors’ specific strengths. Some alliances formed between Internet portals and technology companies are designed to do just that. For example, an Internet portal provides access to a large, global audience through its Web site, while the technology company supplies its know-how in delivering, say, music over the Internet. Meeting the goal of the alliance—marketing music over the Web—requires the competencies of both partners.

Finally, companies turn to strategic alliances for many of the same reasons that they turn to joint ventures. Some businesses use strategic alliances to gain access to a partner’s channels of distribution in a target market. Other firms use them to reduce exposure to the same kinds of risks from which joint ventures provide protection.

Disadvantages of Strategic Alliances

Perhaps the most important disadvantage of a strategic alliance is that it can create a future local or even global competitor. For example, one partner might be using the alliance to test a market and prepare the launch of a wholly owned subsidiary. By declining to cooperate with others in the area of its core competency, a company can reduce the likelihood of creating a competitor that would threaten its main area of business. Likewise, a company can insist on contractual clauses that constrain partners from competing against it with certain products or in certain geographic regions. Companies are also careful to protect special research programs, production techniques, and marketing practices that are not committed to the alliance. Naturally, managers must weigh the potential for encouraging new competition against the benefits of international cooperation.

As in the case of joint ventures, conflict can arise and eventually undermine cooperation. Alliance contracts are drawn up to cover as many contingencies as possible, but communication and cultural differences can still arise. When serious problems crop up, dissolution of the alliance may be the only option.

Selecting Partners for Cooperation

Every company’s goals and strategies are influenced by both its competitive strengths and the challenges it faces in the marketplace. Because the goals and strategies of any two companies are never exactly alike, cooperation can be difficult. Moreover, ventures and alliances often last many years, perhaps even indefinitely. Therefore, partner selection is a crucial ingredient for success. The following discussion focuses on partner selection in joint ventures and strategic alliances. Yet many of the same points also apply to contractual entry modes such as licensing and franchising, for which choosing the right partner is also important.

Every partner must be firmly committed to the goals of the cooperative arrangement. Many companies engage in cooperative forms of business, but the reasons behind each party’s participation are never identical. Sometimes, a company stops contributing to a cooperative arrangement once it achieves its own objectives. Detailing the precise duties and contributions of each party to an international cooperative arrangement through prior negotiations can go a long way toward ensuring continued cooperation. For some key considerations in negotiating international agreements, see the Global Manager’s Briefcase titled, “Negotiating Market Entry.”

Although the importance of locating a trustworthy partner seems obvious, cooperation should be approached with caution. Companies can have hidden reasons for cooperating. Sometimes they try to acquire more from cooperation than their partners realize. If a hidden agenda is discovered during the course of cooperation, trust can break down—in which case the cooperative arrangement is virtually destroyed. Because trust is so important, firms naturally prefer partners with whom they have had a favorable working relationship in the past. However, such arrangements are much easier for large multinationals than for small and medium-sized companies with little international experience and few international contacts.

Each party’s managers must be comfortable working with people of other cultures and traveling to (even perhaps living in) other national cultures. As a result, cooperation will go more smoothly and the transition—both in work life and personal life—will be easier for managers who are sent to work for a joint venture. Each partner’s managers should also be comfortable working with, and within, one another’s corporate culture. For example, although some companies encourage the participation of subordinates in decision making, others do not. Such differences often reflect differences in national culture, and when managers possess cultural understanding, adjustment and cooperation are likely to run more smoothly.

GLOBAL MANAGER’S BRIEFCASE: Negotiating Market Entry

Global business managers must negotiate the terms of many deals. A cooperative atmosphere between potential partners depends on both parties viewing contract negotiations as a success. Managers should be aware of the negotiation process and influential factors. The process normally occurs in four stages.

■
Stage 1: Preparation.
Negotiators must have a clear vision of what the company wants to achieve. Negotiation will vary depending on whether the proposed business arrangement is a one-time deal or just the first phase of a lengthy partnership.

■
Stage 2: Opening Positions.
Discussions begin as each side states its opening position, which is each side’s most favorable terms. Positions might emerge gradually to leave negotiators room to maneuver.

■
Stage 3: Hard Bargaining.
The relative power of each party is key in the outcome of negotiations. Direct conflict is likely at this stage, and culture plays a role. For example, Chinese negotiators will likely try to avoid conflict and may call off talks if conflict erupts.

■
Stage 4: Agreement and Follow-up.
Negotiations reaching this stage are a success. Whereas Western negotiators view signing contracts as the end of negotiations, most Asian negotiators see contracts as the start of a flexible relationship.

Two key elements influence international business negotiations:

■
Cultural Elements.
Negotiating styles differ from culture to culture. Successful negotiations in Asian cultures mean protecting the other party from losing face (being embarrassed or shamed) and meeting the other party halfway. Yet negotiators in Western cultures typically hope to gain many concessions with little concern for embarrassing the other party.

■
Political and Legal Elements.
Negotiators may have political motives. A rigid public position might be taken to show the company or government officials back home that they are working in the company’s or nation’s interest. Also, consumer groups and labor unions might lobby government officials to ensure that a proposed agreement benefits them.

Above all, a suitable partner must have something valuable to offer. Firms should avoid cooperation simply because they are approached by another company. Rather, managers must be certain that they are getting a fair return on their cooperative efforts. And they should evaluate the benefits of a potential international cooperative arrangement just as they would any other investment opportunity.

Strategic Factors in Selecting an Entry Mode

The choice of entry mode has many important strategic implications for a company’s future operations.7 Because enormous investments in time and money can go into determining an entry mode, the choice must be made carefully. Several key factors that influence a company’s international entry mode selection are the cultural environment, political and legal environments, market size, production and shipping costs, and international experience. Let’s now explore each of these factors.

Cultural Environment

As we saw in Chapter 2, the dimensions of culture—values, beliefs, customs, languages, religions—can differ greatly from one nation to another. In such cases, managers can be less confident in their ability to manage operations in the host country. They can be concerned about the potential not only for communication problems but also for interpersonal difficulties. As a result, managers may avoid investment entry modes in favor of exporting or a contractual mode. On the other hand, cultural similarity encourages confidence and thus the likelihood of investment. Likewise, the importance of cultural differences diminishes when managers are knowledgeable about the culture of the target market.

Political and Legal Environments

As mentioned earlier in this chapter, political instability in a target market increases the risk exposure of investments. Significant political differences and levels of instability cause companies to avoid large investments and to favor entry modes that shelter assets.

A target market’s legal system also influences the choice of entry mode. Certain import regulations, such as high tariffs or low quota limits, can encourage investment. A company that produces locally avoids tariffs that increase product cost; it also doesn’t have to worry about making it into the market below the quota (if there is one). But low tariffs and high quota limits discourage investment. Also, governments may enact laws that ban certain types of investment outright. For many years, China had banned wholly owned subsidiaries by non-Chinese companies and required that joint ventures be formed with local partners. Finally, if a market is lax in enforcing copyright and patent laws, a company may prefer to use investment entry to maintain control over its assets and marketing.

Market Size

The size of a potential market also influences the choice of entry mode. For example, rising incomes in a market encourage investment entry modes because investment allows a firm to prepare for expanding market demand and to increase its understanding of the target market. High domestic demand in China is attracting investment in joint ventures, strategic alliances, and wholly owned subsidiaries. On the other hand, if investors believe that a market is likely to remain relatively small, better options might include exporting or contractual entry.

Production and Shipping Costs

By helping to control total costs, low-cost production and shipping can give a company an advantage. Accordingly, setting up production in a market is desirable when the total cost of production there is lower than in the home market. Low-cost local production might also encourage contractual entry through licensing or franchising. If production costs are sufficiently low, the international production site might even begin supplying other markets, including the home country. An additional potential benefit of local production might be that managers could observe buyer behavior and modify products to better suit the needs of the local market. Lower production costs at home make it more appealing to export to international markets.

Companies that produce goods with high shipping costs naturally prefer local production. Contractual and investment entry modes are viable options in this case. Alternatively, exporting is feasible when products have relatively lower shipping costs. Finally, because they are subject to less price competition, products for which there are fewer substitutes or those that are discretionary items can more easily absorb higher shipping and production costs. In this case exporting is a likely selection.

International Experience

By way of summary, Figure 13.6 illustrates the control, risk, and experience relationships of each entry mode. Most companies enter the international marketplace through exporting. As companies gain international experience, they tend to select entry modes that require deeper involvement. But this means businesses must accept greater risk in return for greater control over operations and strategy. Eventually, they may explore the advantages of licensing, franchising, management contracts, and turnkey projects. After businesses become comfortable in a particular market, joint ventures, strategic alliances, and wholly owned subsidiaries become viable options.

Bear in mind that this evolutionary path of accepting greater risk and control with experience does not hold for every company. Whereas some firms remain fixed at one point, others skip several entry modes altogether. Advances in technology and transportation are allowing more and more small companies to leapfrog several stages at once. These relationships also vary for each company depending on its product and characteristics of the home and target markets.

Quick Study

1. What is a
wholly owned subsidiary
? Identify its advantages and disadvantages.

2. What is meant by the term
joint venture
? Identify four joint venture configurations.

3. How does a
strategic alliance
differ from a joint venture? Explain the pluses and minuses of such alliances.

4. Discuss the strategic factors to consider when selecting an entry mode.

FIGURE 13.6 Evolution of the Entry Mode Decision

Source: Franklin R. Root, Entry Strategies for International Markets (Lexington, MA: Lexington Books, 1987), pp. 8–21.

A Final Word

This chapter explained important factors in selecting entry modes and key aspects in their management. We studied the circumstances under which each entry mode is most appropriate and the advantages and disadvantages that each provides. The choice of which entry mode(s) to use in entering international markets matches a company’s international strategy. Some companies will want entry modes that give them tight control over international activities because they are pursuing a global strategy. Meanwhile, other companies might not require an entry mode with central control because they are pursuing a multinational strategy. The entry mode must also be chosen to align well with an organization’s structure.

Chapter Summary

1. Explain how companies use exporting, importing, and countertrade.

■ Exporting helps a company to expand sales, diversify sales, or gain experience and represents a low-cost, low-risk way of getting started in international business.

■ A successful export strategy involves: (1) identifying a potential market, (2) matching needs to abilities, (3) initiating meetings, and (4) committing resources.

■
Direct exporting
occurs when a company sells its products directly to buyers in a target market through local sales representatives or distributors.

■
Indirect exporting
occurs when a company sells its products to intermediaries (
agents
,
export management companies
, and
export trading companies
) who then resell to buyers in a target market.

■
Countertrade
is selling goods or services that are paid for with other goods or services; it can take the form of: (1)
barter
, (2)
counterpurchase
,(3)
offset
, (4)
switch trading
, and (5)
buyback
.

2. Explain the various means of financing export and import activities.

■ With
advance payment
an importer pays an exporter for merchandise before it is shipped.

■
Documentary collection
calls for a bank to act as an intermediary without accepting financial risk.

■ Under a
letter of credit
, the importer’s bank issues a document stating that the bank will pay the exporter when the exporter fulfills the terms of the document.

■ Several types of letters of credit are an irrevocable letter of credit, a revocable letter of credit, and a confirmed letter of credit.

■ Under
open account, an exporter ships merchandise and later bills the importer for its value.

3. Describe the different contractual entry modes that are available to companies.

■
Licensing
is a contractual entry mode in which a company that owns intangible property (the licensor) grants another firm (the licensee) the right to use that property for a specified period of time.

■
Franchising
is a contractual entry mode in which one company (the franchiser) supplies another (the franchisee) with intangible property and other assistance over an extended period.

■ A
management contract
is where one company supplies another with managerial expertise for a specific period of time and is used to transfer two types of knowledge—the specialized knowledge of technical managers and the business-management skills of general managers.

■ A
turnkey
(build–operate–transfer) project is where one company designs, constructs, and tests a production facility for a client.

4. Explain the various types of investment entry modes.

■ Investment entry modes entail the direct investment in plant and equipment in a country coupled with ongoing involvement in the local operation.

■ A
wholly owned subsidiary
is a facility entirely owned and controlled by a single parent company.

■ A separate company created and jointly owned by two or more independent entities to achieve a common business objective is called a
joint venture
.

■ Joint ventures can involve forward integration (investing in downstream activities), backward integration (investing in upstream activities), a
buyback joint venture
(input is provided by and output is absorbed by each partner), and multistage joint venture (downstream integration by one partner and upstream integration by another).

■ A
strategic alliance
is a relationship in which two or more entities cooperate (but do not form a separate company).

5. Discuss the important strategic factors in selecting an entry mode.

■ Managers are typically less confident in their ability to manage operations in unfamiliar cultures and may avoid investment entry modes in favor of exporting or a contractual mode.

■ Large political differences and high levels of instability cause companies to avoid large investments and favor entry modes that shelter assets.

■ Rising incomes encourage investment entry because investment allows a firm to prepare for expanding market demand and to increase its understanding of the target market.

■ Producing locally is desirable when the total cost of production in a market is lower than in the home market and when shipping costs are high.

■ Companies tend to make their initial foray into international markets using exporting and select entry modes that require deeper involvement as they gain international experience.

Talk It Over

1. Not all companies “go international” by first exporting, then using contracts, and then investing in other markets. How does a company’s product influence the process of going international? How (if at all) does technology, such as the Internet, affect the process of going international?

2. “Companies should use investment entry modes whenever possible because they offer the greatest control over business operations.” Do you agree or disagree with this statement? Are there times when other types of market entry offer greater control? When is investment entry a poor option?

3. In earlier chapters, we learned how governments get involved in the international flow of trade and foreign direct investment. We also learned how regional economic integration is influencing international business. Identify two market entry modes and describe how each might be affected by the actions of governments and by increasing regional integration.

Teaming Up

1. Research/Interview Project. As a team of three or four students, interview a manager of a company involved in international business. What method did the company use initially to go international? Does the company export? If so, is it a direct or an indirect exporter? How does the company receive payment for its goods? Does the company use different entry modes in different markets? What factors influenced its choice of entry mode in each case? How do managers deal with cultural differences when negotiating across cultures? Provide any other information on the company your team believes is relevant to the discussion of market entry.

2. Negotiation Project. This project is designed to introduce you to the complexity of negotiations and to help develop your negotiating skills.

Background: A western European automobile manufacturer is considering entering markets in Southeast Asia. The company wants to construct an assembly plant outside Bangkok, Thailand, to assemble its lower-priced cars. Major components would come from manufacturing plants in Brazil, Poland, and China. The cars would then be sold in emerging markets throughout Southeast Asia and the Indian subcontinent. Managers are hoping to strike a $100 million joint venture deal with the Thai government. The company would supply technology and management for the venture, and the government would contribute a minority share of financing to the venture. The company considers the government’s main contributions to be providing tax breaks (and other financial incentives) and a stable business environment in which to operate.

Financial capital is flowing into Thailand at a fair pace. The currency is strong, and inflation remains low. As with other nations in the region, investors are generally wary of the nation’s stability. The new auto assembly plant would boost the local economy, reduce unemployment, and increase local wages. But some local politicians fear the company might be interested only in exploiting the country’s relatively low-cost labor.

Activity: Break into an equal number of negotiating teams of three or four persons. Half the teams are to represent the company and the other half the government. As a group, meet for 15 minutes to develop the team’s opening position and negotiating strategy. Meet with a team from the other side and undertake 20 minutes of negotiations. After the negotiating session, spend 15 minutes comparing the progress of your negotiations with that of the other pairs of teams.

Key Terms

advance payment (p. 358)

agents (p. 355)

barter (p. 357)

bill of lading (p. 358)

buyback (p. 357)

counterpurchase (p. 357)

countertrade (p. 357)

cross licensing (p. 362)

direct exporting (p. 354)

documentary collection (p. 358)

draft (bill of exchange) (p. 358)

entry mode (p. 352)

export management company (EMC) (p. 355)

export trading company (ETC) (p. 355)

franchising (p. 363)

freight forwarder (p. 356)

indirect exporting (p. 354)

joint venture (p. 368)

letter of credit (p. 359)

licensing (p. 361)

management contract (p. 365)

offset (p. 357)

open account (p. 360)

strategic alliance (p. 370)

switch trading (p. 357)

turnkey (build–operate–transfer) project (p. 366)

wholly owned subsidiary (p. 367)

Take It to the Web

1. Video Report. Visit this book’s channel on YouTube (YouTube.com/MyIBvideos). Click on “Playlists” near the top of the page and click on the set of videos labeled “Ch 13: Selecting and Managing Entry Modes.” Watch one video from the list and summarize it in a half-page report. Reflecting on the contents of this chapter, which aspects of selecting and managing entry modes can you identify in the video? How might a company engaged in international business act on the information contained in the video?

2. Web Site Report. This chapter’s opening company profile discussed Marvel’s 50/50 joint venture with Sony that oversees all licensing and merchandising for Spider-Man, as well as Sony’s animated TV series titled Spider-Man. Not mentioned in the opener is that Marvel and Sony became embroiled in a series of lawsuits and counterlawsuits. Perform an Internet search for the name of the joint venture, “Spider-Man Merchandising L. P.,” and locate stories that discuss the lawsuits and their settlement.

What reasons did Marvel give for its initial lawsuit against Sony over its activities? Do you think Marvel was justified in filing suit against Sony? Was it a ruse for Marvel to exact something out of Sony, as some believe? Do you think Sony was right to countersue as it did? What do you think was the main motivation to form the venture from the perspective of each partner?

Do you think the 50/50 split had anything to do with the joint venture’s difficulties? Why or why not? Do you think differences in organizational culture (perhaps rooted in national culture) played any role in the conflict? Do you think anything could have been done during the formation of the joint venture that would have reduced the chances of this dispute arising? Explain.

Ethical Challenges

1. You are the director of international operations for a leading clothing designer based in New York. Your firm recently formed a 50/50 joint venture with a top Latin American manufacturer. On a recent trip to the joint venture’s factory in Latin America, you uncovered discrepancies between the financial results sent to the U.S. parent company and those sent to the local parent firm. Further investigation has convinced you that the local venture’s top management is keeping two sets of accounting records to facilitate the diversion of funds to personal bank accounts. This scenario is not surprising to you, however, because it is rather common in the local country. What do you do? Do you confront your local joint venture partner directly or find another solution? Might you devise a policy that encourages the local partner to be honest in its financial reporting? If so, how do you go about doing this?

2. You own a small manufacturing firm in California and are considering entering either Australia or Hong Kong. You are unsure which country you should target and you are unclear about which entry mode is most appropriate. A recent study investigated the differences between ethical perceptions of business managers from Australia and Hong Kong. The researchers determined two factors impact the perception of ethical problems: (a) culture and (b) the particular mode of market entry (e.g., exporting, contractual, investment in subsidiaries, or joint ventures). What ethical issues do you think might arise in conjunction with the various market entry modes discussed in this chapter? How might these issues influence your entry-mode selection?

3. You are chief operating officer of a Germany-based telecommunications firm considering a joint venture inside China with a Chinese firm. The consultant you’ve hired to help you through the negotiations has just informed you that ethical concerns can arise when international companies consider a cooperative form of market entry (such as a joint venture) with a local partner. This is especially true when each partner contributes personnel to the venture because cultural perspectives cause people to see ethical decisions differently. This is of special concern to you because the venture plans to employ people from both China and Germany—which have very different cultural backgrounds. Is there anything that your two companies can do to establish ethical principles in such a situation—either before or after formation of the cooperative arrangement? Can you think of a company that succeeded in the face of such difficulties?

PRACTICING INTERNATIONAL MANAGEMENT CASE Telecom Ventures Unite the World

The world of telecommunications is changing. The era of global e-commerce is here, driven by new technologies such as broadband and wireless Internet access that make possible video telephone connections and high-speed data transmission. Annual worldwide revenues for telecommunications services total $600 billion, with international companies accounting for 20 percent of the business.

Market opportunities are opening around the world as post, telephone, and telegraph (PTT) monopolies are undergoing privatization. Since 1998 telecom deregulation has been taking place in earnest in Europe. Meanwhile, governments in developing countries are boosting investments in infrastructure improvements to increase the number of available telephone lines. The demand for telephone service is growing at a sharp pace; international telephone call volume more than doubled over a recent six-year period. The net result of these changes is the globalization of the telecommunications industry. As William Donovan, a vice president at Sea-Land Service, said recently, “I don’t want to have to talk to a bunch of different PTTs around the world. I don’t want to have to go to one carrier in one country and a second in another just because it doesn’t have a presence there.”

Several alliances and joint venture partnerships formed between companies hoping to capitalize on the changed market and business environment. France Telecom, Deutsche Telekom, and Sprint created Global One to bring international telecommunications services to multinational companies. As part of the deal, Sprint sold 10 percent of its stock to each of its French and German partners. One hurdle for the company was how to integrate the three partners’ communication networks into a unified whole. Yet start-up costs were high, and the need to communicate in three different languages created some friction among personnel. Early on, lengthy negotiations were required to reach agreement about the value each partner brought to the venture. A former Global One executive noted, “There is no trust among the partners.” Other problems included equipment and billing incompatibilities resulting from distribution agreements with telephone monopolies in individual countries. And then there were the financial losses that prompted Sprint chairman William T. Esrey to install Sprint executive Gary Forsee as CEO and president of Global One.

AT&T also depends on various partnership strategies as entry modes. WorldPartners began as an alliance of AT&T, Kokusai Denshin Denwa (KDD) of Japan, and Telecom of Singapore. The goal was to provide improved telecommunications services for companies conducting business globally. Today WorldPartners is composed of 10 companies, including Telecom New Zealand, Telestra (Australia), Hong Kong Telecom, and Unisource.

Unisource is itself a joint venture that originally included Sweden’s Telia AB, Swiss Telecom PTT, and PTT Telecom Netherlands. Later, Telefonica de España became an equal equity partner in Unisource. Unisource and AT&T then agreed to form a 60–40 joint venture known as AT&T–Unisource Communications to offer voice, data, and messaging services to businesses with European operations. AT&T would have preferred to form a joint venture with the French or German telephone companies. Yet European regulators, concerned about AT&T’s strong brand name and enormous size, refused to approve such a deal.

There was strong logic for the deal. As AT&T–Unisource CEO James Cosgrove explained from headquarters near Amsterdam in Hoofddorp, “You have to be European to play in Europe and yet you have to offer global solutions.” Despite the fact that there are five corporate parents, a sense of equality and congeniality has developed. CEO Cosgrove explains, “Working practices of two years have ironed out remarkably well. We have learned that you have to see this thing as a common operation. Otherwise too many bad compromises can be made.” The presence of Telefonica de España in the alliance was especially significant for AT&T because of the Spanish company’s strong influence in Latin America. Unfortunately, the alliance was weakened when Telefonica decided to ally itself with Concert Communications. To fill the void, AT&T and Italy’s Stet announced a new alliance that would expand communication services to Latin America as well as Europe.

The third major telecommunications alliance, Concert Communications, was formed when British Telecommunications PLC bought a 20 percent stake in MCI Communications. Again, the goal of the alliance was to offer global voice and data network services to global corporations.

Thinking Globally

1. What strengths did AT&T bring to its joint venture with Unisource?

2. Can you think of any potential complications that could arise in the AT&T–Unisource joint venture?

3. Assess the formation of Global One, Unisource, and other partnerships discussed in this case in terms of the strategic factors for selecting entry modes identified in the chapter.

Source: Barbara Martinez, “Sprint Names Its Long-distance Chief to Run Loss-Beset Global One Venture,” Wall Street Journal, February 17, 1998, p. B20; Jennifer L. Schenker and James Pressley, “European Telecom Venture with Sprint Hasn’t Become the Bully Some Feared,” Wall Street Journal, December 23, 1997, p. A11; Alan Cane, “Unisource Partners to Strengthen Ties,” Financial Times, June 4, 1997, p. 13; Gautam Naik, “Unisource Expected to Merge Operations,” Wall Street Journal, June 4, 1997, p. B6.

(Wild 350)

. .