CHAPTER 12

THE STRATEGY OF INTERNATIONAL

BUSINESS

At the end of the unit, the students must have:

OBJECTIVES

1. Discussed the different strategies used by companies operating in different countries.

2. Proposed strategies that companies can use to be more competitive.

To compete more effectively in a global economy, managers must consider: the benefits of expanding into
foreign markets, which strategies to pursue in foreign markets, the value of collaboration with global competitors, and
the advantages of strategic alliances.

A firm’s strategy can be defined as the actions that managers take to attain the goals of the firm. For most
firms, the preeminent goal is to maximize the value of the firm for its owners, its shareholders. To maximize the value of
a firm, managers must pursue strategies that increase the profitability of the enterprise and its rate of profit growth
over time. To increase profitability and to ensure growth, firms can add value, lower costs, sell more in existing markets,
and expand internationally.

VALUE CREATION
Value creation is the primary aim of any business entity. Creating value for customers helps sell products and
services, while creating value for shareholders, in the form of increases in stock price, insures the future availability of
investment capital to fund operations. The two basic strategies for creating value are: differentiation and low cost.

STRATEGIC POSITIONING
To maximize profitability, a firm must:
o Pick a position on the efficiency frontier that is viable (enough demand to support the choice)
o Configure internal operations to support the position
o Have the right organization structure in place to execute the strategy

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THE FIRM AS A VALUE CHAIN
A firm’s operations are like a value chain composed of a series of distinct value creation activities. All of these
activities must be managed effectively and be consistent with firm strategy.

PRIMARY ACTIVTIES
These involve creating the product, marketing and delivering the product to buyers, and providing support and
after-sale service to the buyers of the product.

SUPPORT ACTIVITIES
These involve providing the inputs that allow the primary activities of production and marketing to occur.

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GLOBAL EXPANSION AND PROFITS
Firms that operate internationally can
o Expand the market for their domestic product offerings by selling those products in international
markets
o Realize location economies by dispersing individual value creation activities to locations around the
globe where they can be performed most efficiently and effectively
o Realize greater cost economies from experience effects by serving an expanded global market from a
central location, thereby reducing the costs of value creation
o Earn a greater return by leveraging any valuable skills developed in foreign operations and transferring
them to other entities within the firm’s global network of operations

LEVERAGING PRODUCTS AND COMPETENCIES

To increase growth, a firm can sell products or services developed at home in foreign markets. Success depends
on the type of goods and services, and the firm’s core competencies (skills within the firm that competitors cannot
easily match or imitate- exist in any value creation activity). These core competencies enable the firm to reduce the
costs of value creation and create perceived value so that premium pricing is possible.

LOCATION ECONOMIES
Multinationals that take advantage of location economies create a global web of value creation activities. Under
this strategy, different stages of the value chain are dispersed to those locations around the globe where perceived
value is maximized or where the costs of value creation are minimized.

EXPERIENCE CURVE
The systematic reductions in production costs that have been observed to occur over the life of a product. A
product’s production costs decline by some quantity about each time cumulative output doubles. Learning effects are
cost savings that come from learning by doing. Labor productivity increases when individuals learn the most efficient
ways to perform particular tasks and management learns how to manage the new operation more efficiently.

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EXPERIENCE EFFECTS
Economies of scale refer to the reductions in unit cost achieved by producing a large volume of a product.
Sources of economies of scale include: the ability to spread fixed costs over a large volume, the ability of large firms to
employ increasingly specialized equipment or personnel to utilize production facilities more intensively, and the ability
to increase bargaining power with suppliers. Serving a global market from a single location is consistent with moving
down the experience curve and establishing a low-cost position.

LEVERAGING SUBSIDIARY SKILLS

To help increase firm value, managers should:
o Recognize that valuable skills can be developed anywhere within the firm’s global network (not just at the
corporate center)
o Use incentive systems to encourage local employees to acquire new skills
o Develop a process to identify when new skills have been created
o Act as facilitators to transfer valuable skills within the firm

COMPETITIVE PRESSURES
There are two competitive pressures: pressures for cost reductions and pressures to be locally responsive.

Pressures for Cost Reductions

Pressures for cost reductions are greatest:
o In industries producing commodity type products that fill universal needs - needs that exist when
the tastes and preferences of consumers in different nations are similar if not identical
o When major competitors are based in low cost locations
o Where there is persistent excess capacity
o Where consumers are powerful and face low switching costs

To respond to these pressures, firms need to lower the costs of value creation.

Pressures for Local Responsiveness

1. Differences in consumer tastes and preferences
2. Differences in infrastructure and traditional practices
3. Differences in distribution channels
4. Host government demands

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CHOOSING A STRATEGY

GLOBAL STANDARDIZATION STRATEGY

This focuses on increasing profitability and profit growth by reaping the cost reductions that come from
economies of scale, learning effects, and location economies. The goal is to pursue a low-cost strategy on a global scale.
This makes sense when there are strong pressures for cost reductions and demands for local responsiveness are
minimal.

LOCALIZATION STRATEGY
This focuses on increasing profitability by customizing the firm’s goods or services so that they provide a good
match to tastes and preferences in different national markets. This makes sense when there are substantial differences
across nations with regard to consumer tastes and preferences, and where cost pressures are not too intense.

TRANSNATIONAL STRATEGY
This tries to simultaneously:
o Achieve low costs through location economies, economies of scale, and learning effects
o Differentiate the product offering across geographic markets to account for local differences
o Foster a multidirectional flow of skills between different subsidiaries

This makes sense when there are both high cost pressures and high pressures for local responsiveness.

INTERNATIONAL STRATEGY
This involves taking products first produced for the domestic market and then selling them internationally with
only minimal local customization. This makes sense when there are low cost pressures and low pressures for local
responsiveness.

THE EVOLUTION OF STRATEGY

An international strategy may not be viable in the long term. Localization may give a firm a competitive edge,
but if the firm is simultaneously facing aggressive competitors, the company will also have to reduce its cost structures.
The choice of strategy is not static. As competition increases, international and localization strategies become less
viable. To survive, firms may need to shift to a global standardization strategy or a transnational strategy in advance of

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competitors.

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 CHAPTER 13
THE ORGANIZATION OF INTERNATIONAL
BUSINESS
OBJECTIVES

At the end of the unit, the students must have:

1. Explained how organization can be matched to strategy to improve the performance of an
international business.
2. Evaluated what is required for an international business to change its organization so that it
better matches its strategy.

ORGANIZATION ARCHITECTURE
This refers to the totality of a firm’s organization - formal organizational structure, control systems and
incentives, organizational culture, processes, and people.

Organization Architecture

CONTROLS
These are the metrics used to measure the performance of subunits and make judgments about how
well the subunits are run.

INCENTIVES
These are the devices used to reward appropriate managerial behavior.

PROCESSES
These refer to the manner in which decisions are made and work is performed.

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 ORGANIZATIONAL CULTURE
This is composed of the norms and value systems that are shared among the employees.

PEOPLE
They are the employees and the strategy used to recruit, compensate, and retain those individuals in
terms of their skills, values, and orientation.

So, to attain superior performance and earn a high return on capital, a firm’s strategy must make sense given
market conditions:
o The operations of the firm must support the firm’s strategy-the elements of the organizational
architecture must be internally consistent
o The organizational architecture of the firm must match the firm’s operations and strategy
o If market conditions shift, so must the firm’s strategy, operations, and organization-the strategy and
architecture must be consistent with each other, and consistent with competitive conditions

Strategic Fit

ORGANIZATIONAL STRUCTURE
This refers to the formal division of the organization into subunits. The location of decision-making
responsibilities within that structure is either centralized or decentralized. Organizational structure refers to the
establishment of integrating mechanisms to coordinate the activities of subunits including cross functional teams and or
pan-regional committees.

Organizational structure has three dimensions

VERTICAL refers to the location of decision-making responsibilities within

DIFFERENTIATION a structure

HORIZONTAL refers to the formal division of the organization into subunits

DIFFERENTIATION

INTEGRATING
mechanisms for coordinating subunits
MECHANISMS

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 Vertical differentiation determines where decision-making power is concentrated. Centralized decision making
facilitates coordination, ensures decisions are consistent with the organization’s objectives, gives managers the means
to bring about organizational change, and avoids duplication of activities. On the other hand, decentralized decision
making relieves the burden of centralized decision making, has been shown to motivate individuals, permits greater
flexibility, can result to better decisions, and can increase control.

Horizontal differentiation refers to how the firm divides into subunits. It is usually based on function, type of
business, or geographical area. Most firms begin with no formal structure, but as they grow, split into functions
reflecting the firm’s value creation activities – functional structure. Functions are coordinated and controlled by top
management, decision making is centralized, and product line diversification requires further horizontal differentiation.

A typical Functional Structure

Firms may switch to a product divisional structure 10074/

When firms expand internationally, they often group all of their international activities into an international

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division. Over time, manufacturing may shift to foreign markets. Firms with a functional structure at home would
replicate the functional structure in the foreign market while firms with a divisional structure would replicate the
divisional structure in the foreign market. In either case, there is the potential for conflict and coordination problems
between domestic and foreign operations.

International Division Structure

Firms that continue to expand will move to either a worldwide product division structure - adopted by firms that
are reasonably diversified. This allows for worldwide coordination of value creation activities of each product division,
helps realize location and experience curve economies, facilitates the transfer of core competencies, and does not allow
for local responsiveness.

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 Worldwide Product Division Structure

Or, it may move to a worldwide area structure which is favored by firms with low degree of diversification and a
domestic structure based on function. This divides the world into autonomous geographic areas, decentralizes
operational authority, and facilitates local responsiveness. It can result in a fragmentation of the organization and is
consistent with a localization strategy.

Worldwide Area Structure

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How does organizational structure change over time?

The global matrix structure tries to minimize the limitations of the worldwide area structure and the worldwide
product divisional structure. This allows for differentiation along two dimensions: product division and geographic area.
This also allows for dual decision making: product division and geographic area have equal responsibility for operating
decisions. However, it can be bureaucratic and slow, it can result in conflict between areas and product divisions, and
can result in finger-pointing between divisions when something goes wrong.

Global Matrix Structure

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INTEGRATING MECHANISMS
Regardless of the type of structure, firms need a mechanism to integrate subunits
– need for coordination is lowest in firms with a localization strategy and highest in transnational
firms
– coordination can be complicated by differences in subunit orientation and goals
– simplest formal integrating mechanism is direct contact between subunit managers, followed by
liaisons
– temporary or permanent teams composed of individuals from each subunit is the next level of
formal integration
– the matrix structure allows for all roles to be integrating roles

Formal Integrating Mechanisms

Firms with a high need for integration have been experimenting with an informal integrating mechanism:
knowledge networks that are supported by an organization culture that values teamwork and cross-unit cooperation. A
knowledge network - network for transmitting information within an organization that is based not on informal
contacts between managers and on distributed information systems. This is a non-bureaucratic conduit for
knowledge flows and for it to work it must embrace as many managers as possible and managers must adhere to a
common set of norms and values that override differing subunit orientations.

A Simple Management Network

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CONTROL SYSTEMS AND INCENTIVES
A major task of a firm's leadership is to control the various subunits of the firm-whether they be defined on the
basis of function, product division, or geographic area-to ensure their actions are consistent with the firm's overall
strategic and financial objectives. Firms achieve this with various control and incentive systems.

TYPES OF CONTROL SYSTEMS

 control by personal contact with subordinates

PERSONAL CONTROLS
 most widely used in small firms

 control through a system of rules and procedures that

directs the actions of subunits
BUREAUCRATIC
CONTROLS  The most important bureaucratic controls in subunits
within multinational firms are budgets and capital
spending rules

 involve setting goals for subunits to achieve and

expressing those goals in terms of relatively objective
OUTPUT CONTROLS
performance metrics such as profitability, productivity,
growth, market share, and quality.

CULTURAL CONTROLS  exist when employees "buy into" the norms and value
systems of the firm.

Incentives refer to the devices used to reward appropriate employee behavior. Incentives are usually closely
tied to performance metrics used for output controls. It should vary depending on the employee and the nature of the
work being performed. Incentives should promote cooperation between managers in sub-units and should reflect
national differences in institutions and culture. It is important for managers to recognize that incentive systems can
have unintended consequences.

Performance ambiguity exists when the causes of a sub-unit’s poor performance are not clear. It is common
when a sub-unit’s performance is dependent on the performance of other subunits. Performance ambiguity is lowest in
firms with a localization strategy and higher in international firms. It is still higher in firms with a global standardization
strategy and highest in transnational firms.

The link between control, incentives, and strategy is summarized in the following table

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ORGANIZATIONAL CULTURE
An organization's culture comes from several sources. First, there seems to be wide agreement that founders or
important leaders can have a profound impact on an organization's culture, often imprinting their own values on the
culture. Another important influence on organizational culture is the broader social culture of the nation where the firm
was founded. A third influence on organizational culture is the history of the enterprise, which over time may come to
shape the values of the organization.

Managers in companies with a “strong” culture share a relatively consistent set of values and norms that have a
clear impact on the way work is performed. A “strong” culture is not always good. It may not lead to high performance
and could be beneficial at one point, but not at another. Companies with adaptive cultures have the highest
performance.

A SYNTHESIS OF STRATEGY, STRUCTURE, AND CONTROL SYSTEMS

For a firm to succeed, the firm’s strategy must be consistent with the environment in which the firm operates
and the firm’s organization architecture must be consistent with its strategy.

ORGANIZATIONAL CHANGE
Organizational change is the movement of an organization from one state of affairs to another. A change in the
environment often requires change within the organization operating within that environment. Multinational firms
periodically have to alter their architecture so that it conforms
to the changes in the environment in which they are competing and the strategy they are pursuing.

To implement organization change

1. Unfreeze the organization through shock therapy
– requires taking bold actions like plant closures or dramatic structural reorganizations
2. Move the organization to a new state through proactive change in architecture
– requires a substantial and quick change in organizational architecture so that it matches the
desired new strategic posture
3. Refreeze the organization in its new state
– requires that employees be socialized into the new way of doing things

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 Organizations are difficult to change. Within most organizations are strong inertia forces. These forces come
from a number of sources. One source of inertia is the existing distribution of power and influence within an
organization. Another source of organizational inertia is the existing culture, as expressed in norms and value systems.
Organizational inertia might also derive from senior managers' preconceptions about the appropriate business model or
paradigm. Institutional constraints might also act as a source of inertia.

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 CHAPTER 14
ENTRY Strategy and strategic
alliances
OBJECTIVES

At the end of the unit, the students must have:

1. Explained the different entry modes.
2. Discussed the pros and cons of strategic alliances.
3. Compared and contrasted greenfield venture and acquisition.

BASIC ENTRY DECISIONS

Firms expanding internationally must decide
1. Which markets to enter
2. When to enter them and on what scale
3. Which entry mode to use
a. Exporting
b. licensing or franchising to a company in the host nation
c. establishing a joint venture with a local company
d. establishing a new wholly owned subsidiary
e. acquiring an established enterprise

Several factors affect the choice of entry mode including

o transport costs
o trade barriers
o political risks
o economic risks
o costs
o firm strategy

The optimal mode varies by situation – what makes sense for one company might not make sense for another.

WHICH FOREIGN MARKETS TO ENTER

The choice of foreign markets will depend on their long-run profit potential. The favorable markets are the ones
with the following characteristics:
o are politically stable
o have free market systems
o have relatively low inflation rates
o have low private sector debt

Markets are also more attractive when the product in question is not widely available and satisfies an unmet

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need. The less desirable markets are the ones that:
o are politically unstable
o have mixed or command economies
o have excessive levels of borrowing

WHEN TO ENTER A FOREIGN MARKET

Once attractive markets are identified, the firm must consider the timing of entry. Entry is early when the firm
enters a foreign market before other foreign firms. On the other hand, entry is late when the firm enters the market
after firms have already established themselves in the market.

Why enter a foreign market early?

First-mover advantages include
o the ability to preempt rivals by establishing a strong brand name
o the ability to build up sales volume and ride down the experience curve ahead of rivals
and gain a cost advantage over later entrants
o the ability to create switching costs that tie customers into products or services making
it difficult for later entrants to win business

Why enter a foreign market late?

First-mover disadvantages include
o pioneering costs - arise when the foreign business system is so different from that in
the home market that the firm must devote considerable time, effort and expense to
learning the rules of the game
o the costs of business failure if the firm, due to its ignorance of the foreign
environment, makes some major mistakes
o the costs of promoting and establishing a product offering, including the cost of
educating customers

ON WHAT SCALE SHOULD A FIRM ENTER FOREIGN MARKETS

After choosing which market to enter and the timing of entry, firms need to decide on the scale of market entry.
Firms that enter a market on a significant scale make a strategic commitment to the market. Small scale entry has the
advantage of allowing a firm to learn about a foreign market while simultaneously limiting the firm’s exposure to that
market.

There are no “right” decisions when deciding which markets to enter, and the timing and scale of entry – just
decisions that are associated with different levels of risk and reward.

WHICH ENTRY MODE TO USE

Exporting - defined as the sale of products and services in foreign countries that are sourced or made in the
home country. This has two distinct advantages: First, it avoids the often substantial costs of establishing
manufacturing operations in the host country. Second, exporting may help a firm achieve experience curve and
location economies. Exporting has a number of drawbacks. First, exporting from the firm's home base may not
be appropriate if lower-cost locations for manufacturing the product can be found abroad. A second drawback
to exporting is that high transport costs can make exporting uneconomical, particularly for bulk products. It is
also possible for agents in a foreign country not to act in exporter’s best interest.

Turnkey Projects - is a contract under which a firm agrees to fully design, construct and equip a manufacturing/

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business/ service facility and turn the project over to the purchaser when it is ready for operation for
remuneration. The contractor handles every detail of the project for a foreign client, including the training of
operating personnel. Turnkey projects are attractive because they are a way of earning economic returns from
the know-how required to assemble and run a technologically complex process and they can be less risky than
conventional FDI. Turnkey projects are unattractive because the firm has no long-term interest in the foreign
country, the firm may create a competitor, and if the firm’s process technology is a source of competitive
advantage, then selling this technology through a turnkey project is also selling competitive advantage to
potential and/or actual competitors.

Licensing - is an arrangement whereby a licensor grants the rights to intangible property to another entity (the
licensee) for a specified period, and in return, the licensor receives a royalty fee from the licensee.

Licensing is attractive for the following reasons:

o the firm avoids development costs and risks associated with opening a foreign market
o the firm avoids barriers to investment
o the firm can capitalize on market opportunities without developing those applications itself

Licensing is unattractive for the following reasons:

o the firm doesn’t have the tight control required for realizing experience curve and location
economies
o the firm’s ability to coordinate strategic moves across countries is limited
o proprietary (or intangible) assets could be lost to reduce this risk, use cross-licensing

Franchising - a form of business by which the owner (franchisor) of a product, service or method obtains
distribution through affiliated dealers (franchisees).

Franchising is attractive because

o it avoids the costs and risks of opening up a foreign market
o firms can quickly build a global presence

Franchising is unattractive because

o it inhibits the firm’s ability to take profits out of one country to support competitive attacks in
another
o the geographic distance of the firm from its franchisees can make it difficult to detect poor
quality

Joint Venture (with a host country firm) - entails establishing a firm that is jointly owned by two or more
otherwise independent firms. Establishing a joint venture with a foreign firm has long been a popular mode for
entering a new market.

Joint ventures are attractive because:

o firms benefit from a local partner’s knowledge of the local market, culture, language, political
systems, and business systems
o the costs and risks of opening a foreign market are shared
o they satisfy political considerations for market entry

Joint ventures are unattractive because

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 o the firm risks giving control of its technology to its partner
o the firm may not have the tight control to realize experience curve or location economies
o shared ownership can lead to conflicts and battles for control if goals and objectives differ or
change over time

Wholly-owned subsidiary - is a company whose entire stock is held by another

company, called the parent company. The subsidiary usually operates independently of its parent company –
with its own senior management structure, products and clients – rather than as an integrated division or unit of
the parent.

Wholly-owned subsidiaries are attractive because

o they reduce the risk of losing control over core competencies
o they give a firm the tight control in different countries necessary for global strategic
coordination
o they may be required in order to realize location and experience curve economies

Wholly-owned subsidiaries are unattractive because the firm bears the full cost and risk of setting up overseas
operations.

WHICH ENTRY MODE IS BEST?

INFLUENCE OF CORE COMPETENCIES ON ENTRY MODE

The optimal entry mode depends on the nature of a firm’s core competencies. When competitive advantage is
based on proprietary technological know-how, avoid licensing and joint ventures unless the technological advantage is
only transitory, or can be established as the dominant design. When competitive advantage is based on management
know-how, the risk of losing control over the management skills is not high, and the benefits from getting greater use of
brand names is significant.

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INFLUENCE OF COST REDUCTION PRESSURES ON ENTRY MODE
When pressure for cost reductions is high, firms are more likely to pursue some combination of exporting and
wholly-owned subsidiaries allow the firm to achieve location and scale economies and retain some control over product
manufacturing and distribution. Firms pursuing global standardization or transnational strategies prefer wholly-owned
subsidiaries.

GREENFIELD VERSUS ACQUISITION

A greenfield venture is a form of market entry strategy with establishment of a new wholly owned subsidiary in
a foreign country by constructing its facilities from start. Through Greenfield Venture, a business enters a new market
without the help of another business which is already present there. Although the process of setting up a Greenfield
Venture, in most cases, is complex and more expensive, yet it provides maximum control to the firm. This is because the
firm develops the project from the beginning thereby building its own culture and structure.

The main advantage of a greenfield venture is that it gives the firm a greater ability to build the kind of
subsidiary company that it wants. But greenfield ventures are slower to establish. Greenfield ventures are also risky.

Acquisition strategy involves finding a methodology for the acquisition of target companies that generates value
for the acquirer. The use of an acquisition strategy can keep a management team from buying businesses for which
there is no clear path to achieving a profitable outcome. Instead of simple growth, an acquirer must understand exactly
how its acquisition strategy will generate value.

Acquisitions are attractive for the following reasons:

o they are quick to execute
o they enable firms to preempt their competitors
o they may be less risky than greenfield ventures

Acquisitions can fail when

o the acquiring firm overpays for the acquired firm
o the cultures of the acquiring and acquired firm clash
o anticipated synergies are slow and difficult to achieve
o there is inadequate pre-acquisition screening

To avoid these problems, firms should carefully screen the firm to be acquired and move rapidly to implement
an integration plan.

STRATEGIC ALLIANCES
This refer to cooperative agreements between potential or actual competitors. The number of international
strategic alliances has risen significantly in recent decades. Strategic alliances are attractive because they:
o Facilitate entry into a foreign market
o Allow firms to share the fixed costs and risks of developing new products or processes
o Bring together complementary skills and assets that neither partner could easily develop on its own
o Can help establish technological standards for the industry that will benefit the firm

The drawbacks of strategic alliances include giving competitors low-cost routes to new
technology and markets and unless a firm is careful, it can give away more in a strategic alliance than it receives.

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MAKING ALLIANCES WORK
The success of an alliance is a function of:
o Partner selection
A good partner:
 Helps the firm achieve its strategic goals and has the capabilities the firm lacks and that
it values
 Shares the firm’s vision for the purpose of the alliance
 Does not expropriate the firm’s technological know-how while giving away little in
return
o Alliance structure
A good alliance should:
 Be designed to make it difficult to transfer technology not meant to be transferred
 Have contractual safeguards to guard against the risk of opportunism by a partner
 Involve an agreement in advance to swap skills and technologies to ensure a chance for
equitable gain
 Extract a significant credible commitment from the partner in advance
o The manner in which the alliance is managed
A good alliance:
 Requires managers from both companies to build interpersonal relationships Should
promote learning from alliance partners
 Should promote the diffusion of learned knowledge throughout the organization

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