Chapter 12

Entering Foreign
Markets
 Introduction
Question: How can firms enter foreign markets?

• Firms can enter foreign markets through

– exporting
– licensing or franchising to host country firms
– a joint venture with a host country firm
– a wholly owned subsidiary in the host country to
serve that market

• The advantages and disadvantages of each entry mode

is determined by
– transport costs and trade barriers
– political and economic risks
– firm strategy
 Basic Entry Decisions
Question: What are the basic entry decisions for firms
expanding internationally?

• A firm expanding internationally must decide

– which markets to enter
– when to enter them and on what scale
– how to enter them (the choice of entry mode)
 Which Foreign Markets?
• Firms need to assess the long run profit potential of each
market
• The most favorable markets are politically stable
developed and developing nations with free market
systems, low inflation, and low private sector debt
• The less desirable markets are politically unstable
developing nations with mixed or command economies,
or developing nations where speculative financial
bubbles have led to excess borrowing
• Success firms usually offer products that have not been
widely available in the market and that satisfy an unmet
need
 Timing of Entry
• After a firm identifies which market to enter, it must
determine the timing of entry

• Entry is early when an international business enters a

foreign market before other foreign firms

• Entry is late when a firm enters after other international

businesses have already established themselves in the
market
 Timing of Entry
• Firms entering a market early can gain first mover
advantages including
– the ability to pre-empt rivals and capture demand by
establishing a strong brand name
– the ability to build up sales volume in that country and
ride down the experience curve ahead of rivals and
gain a cost advantage over later entrants
– the ability to create switching costs that tie customers
into their products or services making it difficult for
later entrants to win business
 Timing of Entry
• First mover disadvantages are the disadvantages
associated with entering a foreign market before other
international businesses

• These may result in pioneering costs (costs that an early

entrant has to bear that a later entrant can avoid) such
as
– the costs of business failure if the firm, due to its
ignorance of the foreign environment, makes some
major mistakes
– the costs of promoting and establishing a product
offering, including the cost of educating the
customers
 Scale of Entry
and Strategic Commitments
• Firms that enter foreign markets on a significant scale
make a major strategic commitment that changes the
competitive playing field
– This involves decisions that have a long term impact
and are difficult to reverse

• Small-scale entry can be attractive because it allows the

firm to learn about a foreign market, but at the same time
it limits the firm’s exposure to that market
 Summary
• There are no “right” decisions with foreign market entry,
just decisions that are associated with different levels of
risk and reward

• Firms in developing countries can learn from the

experiences of firms in developed countries
 Entry Modes
Question: What is the best way to enter a foreign market?

• Firms can enter foreign market through

1. Exporting
2. Turnkey projects
3. Licensing
4. Franchising
5. Joint ventures
6. Wholly owned subsidiaries

• Each mode has advantages and disadvantages

 Exporting
1. Exporting is often the first method firms use to enter
foreign market
• Exporting is attractive because
– it is relatively low cost
– firms may achieve experience curve economies

• Exporting is not attractive when

– lower-cost manufacturing locations exist
– transport costs are high
– tariff barriers are high
– foreign agents fail to in the exporter’s best interest
 Turnkey Projects
2. Turnkey projects involve a contractor that agrees to
handle every detail of the project for a foreign client,
including the training of operating personnel

• At completion of the contract, the foreign client is

handed the "key" to a plant that is ready for full operation
 Turnkey Projects
Turnkey projects are attractive because
– They allow firms to earn great economic returns from
the know-how required to assemble and run a
technologically complex process
– They are less risky in countries where the political
and economic environment is such that a longer-term
investment might expose the firm to unacceptable
political and/or economic risk

• Turnkey projects are not attractive when

– The firm's process technology is a source of
competitive advantage
 Licensing
3. Licensing is an arrangement whereby a licensor grants the rights to
intangible property to another entity (the licensee) for a specified
time period, and in return, the licensor receives a royalty fee from
the licensee
– Intangible property includes patents, inventions, formulas,
processes, designs, copyrights, and trademarks
• Licensing is attractive when
– The firm does not have to bear the development costs and risks
associated with opening a foreign market
– The firm avoids barriers to investment
– It allows a firm with intangible property that might have business
applications, but which doesn’t want to develop those
applications itself, to capitalize on market opportunities
 Licensing
• Licensing is unattractive when
– the firm doesn’t have the tight control over
manufacturing, marketing, and strategy necessary to
realize experience curve and location economies
– the firm’s ability to coordinate strategic moves across
countries by using profits earned in one country to
support competitive attacks in another is
compromised

• There is the potential for loss of proprietary (or

intangible) technology or property
– To reduce this risk, firms can use cross-licensing
agreements or link the agreement with the decision
to form a joint venture
 Franchising
4. Franchising is a form of licensing in which the franchisor
sells intangible property to the franchisee, and requires
the franchisee agree to abide by strict rules as to how it
does business

• Franchising is attractive because

– firms avoid many costs and risks of opening up a
foreign market

• Franchising is unattractive because

– It may inhibit the firm's ability to take profits out of one
country to support competitive attacks in another
– the geographic distance of the firm from its foreign
franchisees can make poor quality difficult for the
franchisor to detect
 Joint Ventures
5. Joint ventures involve the establishment of a firm that is
jointly owned by two or more otherwise independent
firms

• Joint ventures are attractive because

– a firm can benefit from a local partner's knowledge of
the host country's competitive conditions, culture,
language, political systems, and business systems
– the costs and risks of opening a foreign market are
shared with the partner
– they can help firms avoid the risk of nationalization or
other adverse government interference
 Joint Ventures
• Joint ventures can be unattractive because
– the firm risks giving control of its technology to its
partner
– the firm may not have the tight control over
subsidiaries that it might need to realize experience
curve or location economies
– shared ownership can lead to conflicts and battles for
control if goals and objectives differ or change over
time
 Wholly Owned Subsidiaries
6. Wholly owned subsidiaries involve 100 percent
ownership of the stock of the subsidiary

• Firms establishing a wholly owned subsidiary can

– set up a new operation in that country
– acquire an established firm
 Wholly Owned Subsidiaries
• Wholly owned subsidiaries are attractive because
– they reduce the risk of losing control over core
competencies
– they gives the firm the tight control over operations in
different countries that is necessary for engaging in
global strategic coordination
– they may be required if a firm is trying to realize
location and experience curve economies

• Wholly owned subsidiaries are unattractive because

firms bear the full costs and risks of setting up overseas
operations
 Selecting an Entry Mode
Question: How should a firm choose a specific entry
mode?

• All entry modes have advantages and disadvantages

• The optimal choice of entry mode involves trade-offs

 Core Competencies and Entry
Mode
• The optimal entry mode depends to some degree on the
nature of a firm’s core competencies

• Core competencies can involve

1. technological know-how
2. management know-how
 Core Competencies and Entry
Mode
1. Technological Know-How
• When competitive advantage is based on proprietary
technological know-how, firms should avoid licensing
and joint venture arrangements in order to minimize the
risk of losing control over the technology

• However, if a technological advantage is only transitory,

or the firm can establish its technology as the dominant
design in the industry, then licensing may be attractive
 Core Competencies and Entry
Mode
2. Management Know-How
• The competitive advantage of many service firms is
based upon management know-how
– International trademark laws are generally effective
for protecting trademarks

• Since the risk of losing control over management skills to

franchisees or joint venture partners is not high, the
benefits from getting greater use of brand names is
significant
 Pressures for Cost Reductions
and Entry Mode
• Firms facing strong pressures for cost reductions are
likely to pursue some combination of exporting and
wholly owned subsidiaries

• This will allow the firms to achieve location and scale

economies as well as retain some degree of control over
worldwide product manufacturing and distribution
 Greenfield or Acquisition?
Question: Should a firm establish a wholly owned
subsidiary in a country by building a subsidiary from the
ground up (greenfield strategy), or by acquiring an
established enterprise in the target market (acquisition
strategy)?

• The number of cross border acquisitions are increasing

• Over the last decade, 50-80 percent of all FDI inflows

have been mergers and acquisitions
 Pros and Cons of Acquisitions
• Acquisitions
– are quick to execute
– enable firms to preempt their competitors
– can be less risky than green-field ventures

• However, many acquisitions are not successful

 Pros and Cons of Acquisitions
Question: Why do acquisitions fail?

• Acquisitions fail when

– the firm overpays for the assets of the acquired firm
– there is a clash between the cultures of the acquiring
and acquired firm
– attempts to realize synergies by integrating the
operations of the acquired and acquiring entities run
into roadblocks and take much longer than forecast
– there is inadequate pre-acquisition screening
 Pros and Cons of Acquisitions
Question: How can firms reduce the problems associated
with acquisitions?

• Firms can reduce the problems associated with

acquisitions
– through careful screening of the firm to be acquired
– by moving rapidly once the firm is acquired to
implement an integration plan
 Pros and Cons of
Greenfield Ventures
• Question: Why are greenfield ventures attractive?

• Greenfield ventures are attractive because they allow the

firm to build the kind of subsidiary company that it wants

• However, greenfield ventures

– are slower to establish
– are risky because they have no proven track record
– can be problematic if a competitor enters via
acquisition and quickly builds market share