Chapter 2

Modes of Entering International Business

2.1 Factors affecting the selection of entry mode are as follows:

1) External Factors:
a. Market Size:
Market size of the market is one of the key factors an international marketer has to
keep in mind when selecting an entry mode. Countries with a large market size justify
the modes of entry with long-term commitment requiring higher level of investment,
such as wholly owned subsidiaries or equity participation.
b. Market Growth:
Most of the large, established markets, such as the US, Europe, and Japan, has more
or less reached a point of saturation for consumer goods such as automobiles,
consumer electronics. Therefore, the growth of markets in these countries is showing
a declining trend. Therefore, from the perspective of long-term growth, firms invest
more resources in markets with high growth potential.
c. Government Regulations:
The selection of a market entry mode is to a great extent affected by the legislative
framework of the overseas market. The governments of most of the Gulf countries
have made it mandatory for foreign firms to have a local partner. For example, the
UAE is a lucrative market for Indian firms but most firms operate there with a local
partner.
d. Level of Competition:
Presence of competitors and their level of involvement in an overseas market is
another crucial factor in deciding on an entry mode so as to effectively respond to
 competitive market forces. This is one of the major reasons behind auto companies
setting up their operations in India and other emerging markets so as to effectively
respond to global competition.
e. Physical Infrastructure:
The level of development of physical infrastructure such as roads, railways,
telecommunications, financial institutions, and marketing channels is a pre-condition
for a company to commit more resources to an overseas market. The level of
infrastructure development (both physical and institutional) has been responsible for
major investments in Singapore, Dubai, and Hong Kong. As a result, these places
have developed as international marketing hubs in the Asian region.
f. Level of Risk:
From the point of view of entry mode selection, a firm should evaluate the
following risks:
 Political Risk:
Political instability and turmoil dissuades firms from committing more resources to a
market.
 Economic Risk:
Economic risk may arise due to volatility of exchange rates of the target market’s
currency, upheavals in balance of payments situations that may affect the cost of other
inputs for production, and marketing activities in foreign markets. International
companies find it difficult to manage their operations in markets wherein the inflation
rate is extremely high.
 Operational Risk:
In case the marketing system in an overseas country is similar to that of the firm’s
home country, the firm has a better understanding of operational problems in the
foreign market in question.
g. Production and Shipping Costs:
Markets with substantial cost of shipping as in the case of low-value high-volume
goods may increase the logistics cost.
h. Lower Cost of Production:
It may also be one of the key factors in firms deciding to establish manufacturing
operations in foreign countries.
2) Internal Factors:
a. Company Objectives:
Companies operating in domestic markets with limited aspirations generally enter
foreign markets as a result of a reactive approach to international marketing
opportunities. In such cases, companies receive unsolicited orders from
acquaintances, firms, and relatives based abroad, and they attempt to fulfill these
export orders.
b. Availability of Company Resources:
Venturing into international markets needs substantial commitment of financial and
human resources and therefore choice of an entry mode depends upon the financial
strength of a firm. It may be observed that Indian firms with good financial strength
have entered international markets by way of wholly owned subsidiaries or equity
participation.
c. Level of Commitment:
In view of the market potential, the willingness of the company to commit resources
in a particular market also determines the entry mode choice. Companies need to
evaluate various investment alternatives for allocating scarce resources. However, the
commitment of resources in a particular market also depends upon the way the
company is willing to perceive and respond to competitive forces.
d. International Experience:
A company well exposed to the dynamics of the international marketing environment
would be at ease when making a decision regarding entering into international
markets with a highly intensive mode of entry such as Joint ventures and wholly
owned subsidiaries.
e. Flexibility:
Companies should also keep in mind exit barriers when entering international
markets. A market which presently appears attractive may not necessarily continue to
be so, say over the next 10 years. It could be due to changes in the political and legal
structure, changes in the customer preferences, emergence of new market segments,
or changes in the competitive intensity of the market.
 2.2 Modes of Entering International Business
Decision Factors

Companies deciding to enter the foreign markets, face the dilemma while deciding the
method of entry into a given overseas location.

Analyzing the following decision factors can reduce this dilemma: -

1. Ownership Advantages:
Ownership advantages are those designed by a company by owning resources. These
benefits provide competitive advantage to the company over its competitors.

Eg…Tata Iron and Steel Company (TISCO) Ltd., owned its iron ore mines and coal
mines. This ownership grants the advantage of low cost producer to the company.

2. Location Advantages
Certain location factors grant benefit to the company when the manufacturing facilities
are located in the host country rather than in the home country. These location factors
include:

 Customer Needs, Preferences and Tastes

 Logistic Requirements
 Cheap Land Acquisition Cost
 Cheap Labor etc
3. Internationalization Advantages
Internationalization advantages are those benefits that a company gets by manufacturing
goods or rendering services in the host country by itself rather than through contract
arrangements with the companies in the host country.

Sometimes the cost of negotiating, monitoring and enforcing an agreement with the host
country's company would be difficult and costly. In such cases the company enters the
international markets through direct investment.

Companies with low cash reserves normally prefer licensing mode rather than foreign
direct investment (FDI)
However, the software companies prefer licensing and franchising mode as they have to
respond quickly to the market needs.
 Modes of entry
I. Exporting
Exporting is the simplest and widely used mode of entering foreign markets. It is the
marketing and selling of domestically produced goods in another country. It is a
traditional and well established method of reaching foreign markets.

Since it does not require that the goods be produced in the target country, no investment
in foreign facilities is required. Most of the costs associated with exporting take form of
marketing expenses.

The advantages of exporting include:

a. Need for Limited Finance :

If the company selects a company in the host country to distribute, the company can
enter international market with no or less financial resources.

b. Less Risk:
Exporting involves less risk as the company understands the culture, customer and the
market of the host country gradually.

c. Motivation for Exporting:

Motivations for exporting are proactive and reactive.

Proactive motivations are opportunities available in the host country.

Reactive motivations are those efforts taken by the company to export the product to a
foreign country due to the decline in demand for its product in the home country.

Forms of exporting
1. Indirect Exporting:
Indirect exporting is exporting the products either in their original form or in the
modified form to a foreign country through another domestic company.

Various publishers of India including Himalaya Publishing House, sell their products,
i.e., books to UBS publishers of India, which in turn exports these books to various
foreign countries.
2. Direct Exporting:
Direct exporting is selling the products in a foreign country directly through its
distribution arrangements or through a host country's company.

Baskin Robbins initially exported its ice-cream to Russia in 1990 and later opened 74
outlets with Russian partners. Finally in 1995 it established its ice cream plant in
Moscow."

3. Intracorporate Transfers:
Intracorporate transfers are selling of products by a company to its affiliated company in
host country (another country). Selling of products by Hindustan Lever in India to
Unilever in USA. This transaction is treated as exports in India and imports in USA.

Factors to be considered:

The company, while exporting, should consider the following factors:

 Government policies like export policies, import policies, export financing, foreign
exchange etc.
 Marketing factors like image, distribution networks, responsiveness to the customer,
customer awareness and customer preferences.
 Logistical consideration: These factors include physical distribution costs,
warehousing costs, packaging, transporting, inventory carrying costs.
 Distribution Issues: These include own distribution networks, networks of host
county's companies. Japanese companies like Sony, Minolta and Hitachi rely On the
distribution networks Of' their subsidiaries in the host country.

Export Intermediaries:

Export intermediaries perform a variety of functions and enable tile small companies to
export their goods to foreign countries. Their functions include: handling transportation,
documentation, taking ownership of foreign-bound goods, assuming total responsibility
for exporting and financing.
 Types of export intermediaries include:

 Export management companies act as export department of the exporting firm (its
client).These companies act as commission agents for exports or they take title to the
goods.
 Cooperative Society: The domestic companies desire to export the goods form a co-
operative society, which undertakes the exporting operations of its members.
 International Trading Company: This company is engaged in directly exporting
and importing. It buys the goods from the domestic companies and exports. Therefore,
the companies can export their goods by selling them to the international trading
company.
 Manufacturers' Agents: They work on a commission basis. They solicit domestic
orders for foreign manufacturers.
 Manufacturers' Export Agents: These agents also work on a commission basis.
They sell the domestic manufacturers' products in the foreign markets and act as their
foreign sales department.
 Export and Import Brokers: The brokers bridge the gap between exporters and
importers and bring these two parties together.
 Freight Forwarders: Freight forwarders help the domestic manufacturers in
exporting their goods by performing various functions like physical transportation of
goods, arranging customs documents and arranging transportation services.

II. Licensing
In this mode of entry, the domestic manufacturer leases the right to use its intellectual
property, i.e., technology, work methods, patents, copy rights, brand names, trademarks
etc. to a manufacturer in a foreign country for a fee."

Here the manufacturer in the domestic country is called 'licensor' and the manufacturer in
the foreign country is called `licensee.'

Licensing is a popular method of entering foreign markets. The cost of entering foreign
markets through this mode is less costly. The domestic company need not invest any
capital as it has already developed intellectual property. As such, the domestic company
earns revenue without additional investment.
 Basic issues in international licensing:

o Boundaries of the Agreements: The companies should clearly define the boundaries of
agreements. They determine which rights and privileges are being conveyed in the
agreement.
Eg Pepsi-Cola granted license to Heineken of Netherlands with exclusive rights of
producing and selling Pepsi-Cola in Netherlands. Under this agreement the boundaries
are

(i) Heineken should not export Pepsi-Cola to any other country,

(ii) Pepsi supplies concentrated cola syrup and Heineken adds carbonated water to
produce beverage and
(iii) Pepsi can grant license to other companies in Netherlands to produce other
products of' Pepsi like Potato chips.
o Determination of Royalty: The most important factor in deciding the license is the
amount of royalty. It is needless to mention that the licensor expects high rate of royalty
while licensee would be unwilling to pay much royalty. However, both the parties
negotiate for a fair royalty for both the sides in order to implement the contract
o Determining; Rights, Privileges and Constraints: Another important factor, in
granting license is determining clearly and specifically the rights, privileges and
constraints.
For example, if the Indian licensee of Aiwa TV uses interior input in order to reduce
price, boost up sales and profit, the image of the Japanese licensor would be damaged.

o Dispute Settlement Mechanism: The licensee and licensor should clearly mention the
mechanism to settle the disputes as disputes are hound to crop up. This is because,
settlement of disputes in courts is costly, time consuming and hinders business interests.
o Agreement Duration: The two parties of the agreement specify the duration of the
agreement. Licensing cannot he a short-term strategy. Hence, the duration of the
licensing should not be of the short-term. It would always be appropriate to have long
duration of the licensing.
Eg Tokyo Disneyland demanded on a 100-year licensing agreement With The Walt
Disney Company.
 Advantages and disadvantages of licensing

Advantages

1. Licensing mode carries relatively low investment on the part of licensor

2. Licensing mode carries low financial risk to the licensor.
3. Licensor can investigate the foreign market without much efforts on his part.
4. Licensee gets the benefits with less investment on research and development.
5. Licensee escapes himself from the risk of product failure. For example, Nintendo
game designers have the relatively safety of knowing millions of game system units.
Disadvantages

1. Licensing agreements reduce the market opportunities for both the licensor and
licensee. Eg. Pepsi-cola cannot enter Netherlands and Heineken cannot sell Coca-
cola.
2. Both the parties have the responsibilities to maintain the product quality and
promoting the product. Therefore, one party can affect the other through their
improper acts.
3. Costly and tedious litigation may crop up and hurt both the parties and the market.
4. There is scope for misunderstanding between the parties despite the effectiveness of
the agreement. The best example is Oleg Cassini and Jovan.
5. There is a problem of leakage of the trade secrets of the licensor.
6. The licensee may develop his reputation.
7. The licensee may sell the product outside the agreed territory and after the expiry of
the contract.

III. Franchising
Franchising is a form of licensing. The franchisor can exercise more control over the
franchised compared to that in licensing.

Under this agreement the franchisee pays fee to the franchisor. The franchisor provides
the following services to the franchisee:

 Trade marks
 Operating systems
 Product reputations
 Continuous support systems like advertising, employee training, reservation
services, and quality assurance programmes etc.

Basic issues in franchising

1. The franchisor has been successful in his home country. McDonnell was successful in
USA due to the popular menu and fast and efficient services.
2. The factors for the success of the McDonald are later transferred to other countries.
3. The franchiser may have the experience in franchising in the home country before
going for international franchising.
4. Foreign investors should come forward for introducing the product on franchising
basis.

Franchising agreements: The franchising agreement should contain important

items as follows: -

1. Franchisee has to pay a fixed amount and royalty based on the sales to the franchisor.
2. Franchisee should agree to adhere to follow the franchisor's requirements like
appearance, financial reporting, operating procedures, customer service etc."
3. Franchisor helps the franchisee in establishing the manufacturing facilities, services
facilities. provides expertise, advertising, corporate image etc.
4. Franchisor allows the franchisee some degree of flexibility in order to meet the local
taste-, and preferences. McDonald restaurants in Germany sell beer also and
McDonald restaurants in France sell wine also.

Advantages and disadvantages of franchising

Advantages
For Franchisors
1. Expansion: Franchising is one of the only means available to access investment capital
without the need to give up control in the process.
2. Legal considerations: The franchisor is relieved of many of the routine duties necessary
to start a new outlet, such as obtaining the necessary licenses and permits.
3. Operational considerations: Franchisees are said to have a greater incentive than direct
employees to operate their businesses successfully because they have a direct stake in the
operation.
For franchisees
1. Quick start: As practiced in retailing, franchising offers franchisees the advantage of
starting up a new business quickly based on a proven trademark and formula of doing
business.
2. Expansion: With the help of the expertise provided by the franchisers the franchisees are
able to take their franchise business to that level which they wouldn't have had been able
to without the expert guidance of their franchisors.
3. Training: Franchisors often offer franchisees significant training, which is not available
for free to individuals starting their own business.

DISADVANTAGES
For Franchisors
1. Limited pool of viable franchisees: In any city or region there will be only a limited
pool of people who have both the resources and the desire to set up a franchise in a
certain industry, compared to the pool of individuals who would be able to competently
manage a directly-owned outlet.
2. Control: Successful franchising necessitates a much more careful vetting process when
evaluating the limited number of potential franchisees than would be required to hire a
direct employee.
An incompetent manager of a directly-owned outlet can easily be replaced, while
regardless of the local laws and agreements in place removing an incompetent franchisee
is much more difficult.
For franchisees
1. Control: the franchisee is required to follow the system and get approval for changes
from the franchisor.
2. Price: Starting and operating a franchise business carries expenses. In choosing to adopt
the standards set by the franchisor, the franchisee often has no further choice as to
signage, shop fitting, uniforms etc. The franchisee may not be allowed to source less
 expensive alternatives. Added to that is the franchise fee and ongoing royalties and
advertising contributions.
3. Conflicts: The franchisor/franchisee relationship can easily cause conflict if either side is
incompetent (or acting in bad faith).

IV. Special modes

Some companies cannot make long-term investments or long-term contracts to enter
markets. Therefore, they may use specialized strategies. These specialized strategies
include: -

a. Contract Manufacturing
Some companies outsource their part of or entire production and concentrate on
marketing operations. This practice is called the contract manufacturing or outsourcing.

Eg. Nike has contracted with a number of factories in south-east Asia to produce its
athletic footwear and it concentrates on marketing. Bata also contracted with a number of
cobblers in India to produce its footwear and concentrate on marketing.

Advantages

1. International business can focus on the part of the value chain where it has distinctive
-
competence.
2. It 'reduces the cost of production as the host country's companies with their relative
cost advantage produce at low cost.
3. Small and medium industrial units in the host country can also develop as most of the
production activities take in these units.
4. The international company gets the location advantages, generated by the host
country's production.

Disadvantages
1. Host country's companies may take up the marketing activities also, hindering the
interest of the international company.
2. Host county's companies may not strictly adhere to the production design, quality
standards etc. These factors result in quality problems, design problem and other
surprises.
 3. The poor working countries in the host country's companies affect the company's,
image. For example, Nike has suffered a string of blows to its public image, because
of reports of unsafe and harsh working conditions in Vietnamese factories churning
our Nike footware.

b. Management Contracts
The companies with low level technology and managerial expertise may seek tile
assistance of a foreign company. Then the foreign company may agree to provide
technical assistance and managerial expertise. This agreement between these two
companies is called the management contract.

Eg. Delta, Air France and KLM often provide technical and managerial assistance to the
small airlines companies owned by the Governments.

Advantages

1. Foreign company earns additional income without any additional investment,

risks and obligations.

2. Hilton Hotels provided these seivices to other hotels without additional

investment and earned additional income..
3. This arrangement and additional income allows the company to enhance its
image in the investors and mobilise the funds for expansion.
4. Management contract helps the companies to enter other business areas in the
host country.
5. The companies can act as dealer for the business of, the host country’s business
in the home country.

Disadvantages
1. Sometimes the companies allow the companies in the host country even to use
their trademarks and brand name. The host country's companies spoil the brand
name, if they do not keep up the quality of the product service.
2. The host country’s companies may leak the secrets of technology
c. Turnkey Project
A turnkey project is a contract under which a firm agrees to fully design, construct and
equip a manufacturing/business/service facility and turn the project over to the
purchaser when it is ready for operation for remuneration.

The forms of remuneration include: -

1. A fixed price (firm plans to implement the project below this price)
2. Payment on cost plus basis (i.e., total cost incurred plus profit)
International turnkey projects include nuclear power plants, air ports, oil refinery,
national highways, railway lines etc. Hence, they are large and multiyear projects.
International companies involved in such projects include: Bechtel, Brown and Root,
Hyundai Group, Friedrich Krupp, etc.

The companies normally approach the host country's Governments or International

Finance, Corporation, Export-Import Bank of USA and the like for financial assistance
as the turnkey projects require huge finances.

V. Foreign direct investment without alliances (Greenfields strategy)

Companies which enter the international markets through foreign direct investment (FDI)
invest their money, establish manufacturing and marketing , facilities through ownership
and control.

Foreign firm needs to control the operations when -

1. It has foreign firm's need to control the operations when it has subsidiaries to achieve
strategic synergies.
2. The technology, manufacturing expertise, intellectual property rights have
potentialities and their full utilization needs planned exploitation.

Advantages

1. Mostly, the customers of the host country prefer to the products produced in their
country like -'Be American, Buy American, 'Be Indian. Buy Indian.'. In such cases
FDI helps the company to gain market through this mode rather than other modes.
 2. Purchase managers of most of the companies prefer to buy local production in order
to ensure certainty of supply, faster services, quality dependability and better
communication with the supplier.
3. The company can produce based on the local environment and changing preferences
of the customers.

Disadvantages
1. FDI exposes the company (to a fullest extent) to the host country's political and
economic risks.
2. FDI also exposes the company to the exchange rate fluctuations.
3. Some countries discourage the entry of foreign companies through FDI in order to
protect the domestic industry.
4. Changing Government policies of the host country may create uncertainties to the
company.
5. Host country Governments, sometimes, ban the acquisition of local companies by
foreign companies.
The Greenfield strategy

The term Greenfield refers to starting with a virgin green site and then building.
Greenfield strategy is starting of the operations of a company from scratch in a foreign
market. The company conducts the market survey, selects the location, buys or leases
land, creates facilities, erects the machinery, remits or transfers the human resources and
starts the operations and marketing activities.

Advantages
1. The company selects the best location from all viewpoints.
2. The company can avail the incentives, rebates and concessions offered by the host
governments including local governments.
3. The company can have latest models of the buildings, machinery and equipment
technology.
4. The company can, also have its own policies and styles of human resources
management.
5. The company can have its gestation period to understand and adjust to the new culture
of the host country. Thus it can avoid the cultural shock.
 Disadvantages

1. This strategy results in a longer gestation period as the successful implementation

takes time and patience.
2. Some companies may not get the land in the location of its choice.
3. The company has to follow the rules and regulations imposed by the host country's
Government in case of construction of the factory buildings.
4. Host country's Government may impose conditions that the company should recruit
local people and train them, if necessary, to meet the company’s requirement.

VI. Foreign direct investment with strategic alliances

Strategic alliance is a co-operative and collaborative approach to achieve the larger
goals. Strategic alliance takes different forms like licensing, franchising, contract
manufacturing, joint ventures etc. Alliance is a strategy to explore a new market which
the companies individually cannot do. For example, Xerox of USA and Fuji of Japan
collaborated to explore new markets in Europe and Pacific Rim.

Why Consider Strategic Alliances?

1. Multiply market entry alternatives and available resources for expansion into
choice international markets. 
2. Access dominant or leading foreign technology through local manufacture in the
target market. 
3. Access lucrative but otherwise closed or resistant markets through the efforts of a
foreign partner to maximize value of established relationships. 
4. Gain cost advantages through scale and locational economies (factor costs). 
5. Employ key managers experienced in cultural norms and business practices of
overseas target markets. 
6. Realize political or legal advantages via relationship with a partner enjoying
regional or national recognition.
7. Exploit multiple synergies in production, marketing, and finance. 
8. Limit exposure of own corporate assets to those actually contributed to the joint
venture.
 Modes of foreign entry through alliances: -
a. Mergers and Acquisitions
Domestic companies enter international business though mergers and acquisitions. A
domestic company selects a foreign company and merges itself with the foreign company
in order to enter international business. Alternatively, the domestic company may
purchase the foreign company and acquires its ownership and control.

Advantages

1. The company immediately gets the ownership and control over the acquired
firm's factories, employees, technology, brand names and distribution networks.
2. The company can formulate international strategy and generate more revenues.
3. If the industry already reached the stage of optimum capacity level or
overcapacity level in the host country. This strategy helps the economy of the
host country.
Disadvantages
1. Acquiring a firm in a foreign country is a complex task involving bankers, lawyers,
regulations, mergers and acquisition specialists from the two distribution networks.
2. This strategy adds no capacity to the industry.
3. Sometimes host countries imposed restrictions on acquisition of local companies by
the foreign companies.
4. Labour problems of the host country's company are also transferred to the acquired
company.

b. Joint Ventures
Two or more firms join together to create a new business entity that is legally separate
and distinct from its parents. Joint ventures are established as corporations and owned by
the funding partners in the predetermined proportions.

Eg. American Motor Corporation entered into a joint venture with Beijing Automotive
Works called Beijing Jeep to enter Chinese market by producing jeeps and other
vehicles.

Joint ventures involve shared ownership.

Advantages

1. Joint ventures provide large capital funds. Joint ventures are suitable for major
projects.
2. Joint venture spread the risk between or among, partners.
3. Different parties to the joint venture bring different kinds of skills like technical skills,
technology, human skills, expertise, marketing skills or marketing networks.
4. Joint ventures make large projects and turn key projects feasible and possible.
5. Joint ventures provide synergy due to combined efforts of varied parties.

Disadvantages
1. Joint ventures are also potential for conflicts. They result in disputes between or
among parties due to varied interests.

2. The partners delay tile decision-making once the dispute arises. Then the operations
become unresponsive and inefficient.

3. Decision-making is normally slowed down in joint ventures due to the involvement of

a number of parties.
4. Scope for collapse of a joint venture is more due to entry of competitors, changes in
the business environment in the two countries, changes in the partners' strengths etc.
5. Life cycle of a joint venture is hindered by many causes of collapse.

Life cycle of a joint venture

The first stage of the life cycle of a joint venture begins with exploratory stage. During
this stage the prospective partners start making:

 Alliances
 Project Collaborations
 Feasibility Studies
After making alliances, the growth phase of the joint venture takes place. If the interests
of the parties vary at this stage, they will lead to collapse of the joint venture in this
phase itself. If the partners work together, this phase leads to stability of the joint
ventures.
 Even in the stability stage, the joint venture may collapse. If not, the changed interests of
the parties force them to renegotiate regarding their interests and shares. If the
renegotiation is not successful, the joint venture may collapse. The reasons for collapse
include:

 Entry of new competitors

 Changes in Business Environment
 Changes in partners' strengths
 Today's partners may become tomorrow's competitors,
 Changes in partners' interests.