Chapter Three: International Market Entry Strategies

Dear students after finishing this chapter, you should understand:

 Identify the various factors affecting selection of entry modes in international market
 Discuss the alternatives of international market and their advantages and disadvantages
4.1 Modes of Entry in International market
There are various formats of entering into international market. It ranges from the simplest export to
foreign direct investment which is more complex and risky to enter in foreign market. The risk of
entering in international market comes from the capital requirement to enter, the control it provides to
operation of parent firm and the political risks we discussed in political environment are some to
mention.
The firm can either export the product from home market to international market or the firm might
invest in foreign market on facility, raw material, and other factor of production and make the product
and offer to the foreign market.
We can divide entry modes into three broad category, these are:
1. Export
2. Contract based
3. Non Contract based
Exporting
Firms have two alternatives in exporting products to international market these are: direct and, indirect
exporting. In indirect involvement firms participate in international businesses through an intermediary.
In direct exporting firms are in interrelationships with foreign customers and markets. Firms use own
exporting when there is no domestic or foreign middleman between the producer and end customer.
There are various reasons for firms to just take other alternatives than exporting. Let us see some
reasons that might force for looking beyond exporting.
 Overcoming trade barriers
 Reducing tariffs by having local content
 Reducing transport and production costs
 Utilizing more favorable production conditions
 Being closer to your market reduce transportation cost
 Better market credibility
 Achieving better market penetration
 Reaching more markets
Exporting strategies benefits
 The rapidity of international market entry, and not required investment in establishing
operations in the host country
 Offers for a firm a low risk and simple way to begin its international process and meet the
demand and challenges.
 Exporting is usually small company and management commitment.
Disadvantages of Exporting

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  High cost of transportation and possible tariffs placed on incoming goods.
 The exporter has less control over the marketing and distribution of its products in the target
country
 The distributor takes part of the profits either in the form of pay or adding extra to the price.
Contract based
Contractual entry modes are long-term non-equity associations between an international company and
entity in a foreign target country. The primarily difference between a contractual entry mode and an
export entry is that contractual entry modes are vehicles for the transfer of knowledge and skills.
Contractual entry modes are distinguished from the entry modes that need investment, because there is
no equity investment by the international company. There exist many different contractual entry modes,
such as licensing, franchising, and numerous contract based entry modes.

In the case of foreign direct investment, companies face two basic decisions: (1) How much to own of
the investment (all or part), (2) whether to set up new investment from scratch or acquire an existing
company .Investment entry modes involve ownership by an international company of manufacturing
plants or other production units in the target country. Ownership and the control of the affiliate may be
either fully or partly owned. In partly owned affiliates, or joint ventures, the ownership and control are
shared between the parent company and one or more local partners. Combinations between contractual
entry modes with export or investment modes are usual in among the international companies.

a. Licensing
Licensing is a form of contractual agreement in which the licensor permits the licensee to use its
intellectual property (such as patents, trademarks, copyrights, technology, technical know-how,
marketing skill or some other specific skill) in lieu of royalty. The monetary benefit to the licensor is
the royalty or fees which licensee pays. In many countries, such fees or royalties are regulated by the
government; it does not exceed five per cent of the sales in many developing countries. A licensing
agreement may also be one of cross licensing, wherein there is a mutual exchange of knowledge and /or
patents. In cross-licensing, a cash payment may or may not, be involved.

Licensing agreements have potential for companies of all sizes. Licensing agreements can harness the
production and financial strength of well-established companies to the innovative flair of small and
medium-sized organizations. A license is a formal agreement between two parties where the licensor
gives something of value to the licensee in exchange for certain undertakings and payments for the
licensee.
The advantages of licensing
 The risk of expropriation decreases because the licensee is a local company that can provide
leverage against government action.
 Provide a method by which foreign markets can be tested without major involvement of capital
or company commitment.
 The evasion of import barriers that increase the cost (tariffs) or limit the quantity (quotas) of
exports on the target market.
 Licensing is a lower political risk than with an equity investment.
 Expand returns based on previous innovations

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 Disadvantages of Licensing
 The licensor’s lack of control over the marketing plan and program in the target country.
 Licensing entry mode includes most limited amount of foreign market participation and does not in
any way guarantee a basis for future expansion.
 Licensing contains also the risk that in exchange of royalty, the licensor may create its own
competitor not only in the market for which the agreement was made but for third country markets
as well; income from licensing arrangement as compared to that from exporting to, or investing in,
the target country is a low.
 Create some inflexibility, if a firm wants to move to a different ownership arrangement.

b. Franchising
Franchising is a form of licensing in which a parent company (the franchiser) grants another
independent entity (the franchisee) the right to do business in a prescribed manner. This right can take
the form of selling the franchisor’s products, ‘using its name, production and marketing techniques, or
general business approach. One of the common forms of I franchising involves the franchisor supplying
an important ingredient (part, material etc.) for the finished product, like the Coca Cola supplying the
syrup to the bottlers. Usually franchising involves a combination
of many of the elements mentioned above. The major forms of franchising are manufacturer-retailer
systems (such as automobile dealership), manufacturer wholesaler systems (such as soft drink
companies), and service firm-retailer systems (such as lodging services and fast food outlets).
Franchising is a form of licensing that markets product and ‘know-how’ together, in a way that is
attractive to others as an investment. When franchiser sells the concept, it has set standards to ensure
consistency of the product, service delivery, branding and marketing. A franchise allows a rapid
internationalization of the product, as the capital costs are normally borne by the Franchisee.

c. Contract Manufacturing
In contract manufacturing, a company doing international marketing contracts with firms in foreign
countries to manufacture or assemble the products while retaining the responsibility of marketing the
product Contract manufacturing is having your product or part of your product made by another firm
under a contract arrangement. Your relationship with the manufacturer is essentially a customer
supplier one, except that the product or component is made to your own specifications, rather than
being a standard item. In many cases you might supply a mould or detailed manufacturing. The sale and
marketing of the finished product remain your responsibility, not the manufacturers. Sometimes
contract manufacturer of components also includes final assembly and packaging of the product, as well
as delivery to the point of distribution or sale.

d. Strategic alliances
A strategic alliance is a specific form of collaboration between two or more companies. Strategic
alliances with stronger overseas partners can provide a means of overcoming the problems of small size
and lack of resources faced by some companies. The term strategic alliance can mean many things. All
organizations are not strong in all function of business. To offset their shortcoming they collaborate
with other firms. It can apply to virtually any form of collaboration between two or more firms, for the
following activities:
 Design contracts  Technology transfer agreements

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  Joint product development  Distribution agreements
 Purchasing agreements  Marketing collaboration
A strategic alliance might be entered into for a one-off activity, or it might focus on just one part of a
business, or its objective might be new products jointly developed for a particular market. Generally,
each company involved in the strategic alliance will benefit by working together. The arrangement they
enter into may not be as formal as a joint venture agreement. Alliances are usually consummated with a
written contract, often with agreed termination points, and do not result in the creation of an
independent business organization.
Characteristics of a Strategic Alliance
 Usually a non-equity, loosely structured relationship
 Each partner retains its business independence
 The alliance can be between companies competitors
 The relative size of the partners is not a significant factor
 Each partner must contribute distinctive “core strengths” e.g. technology
Benefits of strategic alliance:
 Increased leverage  Potential for conflict
 Risk sharing  A small company risks being subsumed
 Opportunities for growth by a larger partner
 Greater responsiveness  Strategic priorities change over time
 Disadvantages of a Strategic Alliance  Payment difficulties
 High commitment – time, money, people  Political risk in the country where the
 Difficulty of identifying a compatible strategic alliance is based
partner

e. Turnkey Projects:
A project in which contractor handles every detail of the project for a foreign client, including the
training of operating personnel, and then hands over the foreign clients the “key” to a plant that is ready
for operation. (Setting up a new plant ready for operation). Turnkey projects are most common in the
chemical, pharmaceutical, petroleum refining and metal refining industries, all of which use complex,
expensive production technologies.
Advantages:
 This is the best way of earning greater economic returns from that asset.
 Obtain returns from know-how about a complex process.
 Government restrictions may limit other options therefore; this strategy is best in case where
FDI is limited by government.
 Lower risk if unstable economic/political situation in country

Disadvantages:
 The firm that enters into the turnkey deal will have no long-term interest in the foreign country.
 Less potential to profit from success of plant.
 Creating a competitor by transferring the technical know-how to a foreign firm.
 Give away technological know-how to potential competitor

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Non Contract based
a. Joint Venture
A joint venture is the long-term commitment of funds, facilities and services by two or more legally
separate interests, to a combined enterprise for their mutual benefits. A joint venture need not be a
separate legal entity or company. The essential feature of a joint ownership venture is that the
ownership and management are shared between a foreign firm and a local firm.
The Benefits of a Joint Venture
Advantages:
 Benefit from local firm’s knowledge about the host country’s competitive Conditions, culture,
language, political systems and business systems.
 shared costs/risks of development of product
 political constraints on other options by host government will be minimized

The Disadvantages of a Joint Venture

 Potentially high capital cost required to establish JV
 It might take much time to get profit
 Difficult to get out of quickly if a partner find the venture infeasible later
 Working in a different legal and Cultural system might be source of conflict among partners
 Political risks in the country where the joint venture is based

Investment in Existing Ventures

Not all joint ventures need involve the creation of a separate manufacturing or business entity. A
common procedure is to purchase or exchange equity with an overseas company which retains its own
indigenous management and identity.

b. Wholly Owned Subsidiaries:

In wholly owned subsidiary, the firm owns 100 percent of the stock. Establishing a wholly owned
subsidiary in a foreign market can be done in two ways. The firm can either set up a new operation in
host country or it can acquire an established firm and use that firm to promote its products in the
country’s market. It is form of entering into foreign market through foreign direct investment. There are
two alternatives acquisition and green investment for wholly owned subsidiary.

Acquisitions
Acquisition is transferring the local company to foreign owner. In this the foreign company invest in
local firm for 100 percent ownership on the existing facility.
Advantages of Acquisitions
 It may provide a resource that is scarce (human or managerial skill) in the target country
 rapid access to new markets
 Is a good method for a firm to gain market specific experience quickly.
 Favorable in situations with less need for strategic flexibility and when the transaction is used
to maintain economies of scale or scope.
Disadvantages of Acquisitions
 Costs and multiple risks come with an acquisition entry mode.

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  Firms that uses equity based entry mode have a higher rate of growth than export mode when
foreign risk is higher.
 Complex international negotiations, the problems dealing with the legal and regulatory
requirements in the target firm’s country, and problems of merging the new firm into the
acquiring firm.
 High financial commitment, and thus demands more stable political and commercial climate
than those with a smaller financial commitments.

Greenfield investments
Greenfield investment is investing from scratch. The company entering in international market will buy
land, construct building and hire people to run the business.

Advantages of the Greenfield investment

 The firm is the maintained control over the technology, marketing, and distribution of its
products.
 High returns can be generated especially by firms with strong intangible capabilities that are
possible to generate through a Greenfield investment.
 Setting up from scratch the production site comes due to the latest production technologies and
opportunity to build the site to match the company’s exact production requirements. This is
usually only true for firms exploiting the low cost locations.
The disadvantages of the Greenfield investment
 Are usually often complex establishing process and potential high costs.
 Establishing new wholly owned subsidiary takes a lot of time, and thus is not appropriate for
rapid entering in foreign markets.
 Establishing the Greenfield investment needs also the greatest contribution of know-how of all
the international market entry alternatives.

4.2 Factors Influencing To the Entry Mode Choice

Factors influencing in entry mode decisions can be divided for external and internal factors. External
factors include target country market factors, target country environmental factors, target country
production factors and home country factors. Internal factors affecting in the entry mode decision are
company product factors and company resource factors

Target country market factors

Market factors in target country consist of general business environment and competitive Structure of
local companies. The size of the target market has an important influence on the entry mode. Small
markets support entry modes that have low break-even sales volumes, like indirect or agent exporting,
licensing, and some contractual arrangements. Markets with high sales potential are possible for entry
modes with substantial break-even sales volumes.

Competitive structure is another important dimension in the target markets. Usually most favorable
markets are markets, in which competitor are many non-dominant companies. If there are large
companies which are dominant the best alternative might be equity investment in production. In target
markets where competition is tough for export and investment modes, the company may end up to

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licensing or other contractual modes. Availability and quality of the local marketing infrastructure can
be considered as a third of influencing factor of target country markets. The lack of good global agents
or distribution may be, for instance, the reason why exporting company ends up to the subsidiary entry
mode.
Target country production factors
If cost of production is low in the target country it encourages some form of local production and high
cost would force against local manufacturing. Target country production costs are related to the quality,
quantity and cost of raw materials, labor, energy and other factors of production. Other relevant host
country factors include the availability of raw materials and skilled labor. It is possible that costs drive
up if the necessary raw materials or labors are too costly to access, or the risks are too high. In the host
country, there might be factors that could inhibit the firm’s ability to transfer resources.

Target country environmental factors

An environmental factor includes political, economic and socio-cultural characters. High tariffs, tight
quotas and high exit barriers effectively decrease the company interest on exporting. A target country
may encourage foreign investment by offering incentives, like tax holidays. Geographical distance has
significant effects on the transportation costs, but also available transport alternatives have vital
influence. Useful information for companies, like industry and company specific information may be
very difficult to acquire, and it may also be really expensive to obtain.

One characteristic of the target country is the country’s size in the economy perspective. Gross
domestic product is a central measure of the target country’s absolute level of performance. Other, often
dynamic, target country’s economic features are rate of investment, the growth rate of gross domestic
product, personal income, changes in the employment rate, and like. Companies planning to
internationalize should also consider the target country’s external economic relations. External
economic relations consist of the debt service burden, value of exports and imports, the balance of
payments, exchange rate behavior etc.

Social-cultural factors have also their influence on a company’s choice of entry mode. Cultural gap
between home country and target country societies may have significant meaning. Substantial cultural
distance tends to favor non-equity entry modes that limit a company’s commitment in the target
country. This is because of high cost of information acquisitions and manager’s ignorance towards
target country and also the fear of their capacity is not enough to manage production there. Cultural
distance has also an influence to the time sequence in the choice of target countries. Companies are
used to enter first countries that are culturally close to the home country. Cultural distance between the
investing firm’s home country and the host country has significant influence on the equity based entry
mode

Home country’s factors

Market, production and environmental factors in the home country have certain influence in the
company’s choice of entry mode to penetrate a target country market. The size of domestic market
affects to the need to grow the business outside country borders. Companies reaching the optimum size
with economics of scale in the small markets are attracted to exporting. Controversially, great domestic

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markets make possible to the company to grow to a large size before, if ever, it heads to the foreign
markets.

Companies in oligopolistic industries tend to imitate and follow rival domestic firms that threat the
competitive equilibrium. Therefore rival companies commonly follow when one company begins to
invest in abroad. Other important factors that have influence to the entry mode choice are home
country’s production costs and policy of the home country towards exporting and foreign investment by
domestic firms. Distance between home country and target country affects the transaction costs of
delivering the products.

Product factors
One extremely important factor for the entry mode decision is product differentiation. Undifferentiated
products have to compete on a price basis, and thus tend to be possible only through some form of local
production. In contrast, highly differentiated products, with distinct advantages over competitive
products allow sellers a significant degree of pricing discretion. Hence highly differentiated products
can absorb high unit transportation costs and high import duties, but still remain competitive in a
foreign target country. This is why high product differentiation supports export mode of entry, while
low differentiation drive a company in the direction of some form of local production.

Profit targets are on essential characteristic of the product factors. Various entry modes are probably
going to produce different levels of profit, especially quite long time horizon. This is because the
dynamics of profit generation of various modes will be extremely dissimilar. Some entry modes
generate profits almost immediately, and then may soon latter off, but the other may produce no profits
for the four or three years and pay back itself after several years. According to one research the lower
the target return rates, the more likely it is for the company to select countries that show greater long-
term prospects and promise to enhance the firm’s capabilities.

Resource and commitment factors

The size of the company affects the option it has to enter in international market. The larger companies
will have the financial, managerial resource to commit to enter in various entry mode like wholly
owned subsidiary. The better the resources are in management, capital, technology, production skills
and marketing skills, the more numerous its entry mode options are. Managers tend to make entry mode
choices based on considerations of firm-specific resources (tangible assets, superior managerial skills,
tacit know-how, and business experience) that afford their firm competitive advantage in the target
foreign market In contrast; a company with very limited resources is inhibited to use entry modes that
need for only a small resource commitment. Company’s management risk attitudes have effects on the
choice of the target country and degree of commitment. International market entry experiences might
have significant influence to the entry mode choice.

Even though resources are an influencing factor, they cannot sufficiently explain a company’s choice of
entry mode. The choice of entry mode is more about the combination of resources and willingness to
commit them to foreign market development. Thus company with high degree of commitment means
that managers will select the entry mode for a target country from a wider range of alternative modes
than managers with low commitment. Typically in companies the international commitment has grown

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along with international experience over a lengthy period of time. The commitment is heavy when key
management staff is involved in developing the international strategy.

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