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Modes of Entry Into International Markets
Critically discuss the various modes of entry for which an organisation can internationalise their operations. Is there one mode that is preferred above others?
International expansion is one of the key strategic devices available to any firm looking to grow its operations. However, once the decision to internationalise has been arrived at, organizations have at their disposal numerous options in terms of mode of entry. Each of these strategies offers advantages and drawbacks in regards to the opportunity for the firm to realise transaction savings, enhanced market access and returns, and improved level of control (Sitken and Bowen, 2010). This paper critically appraises the key choices available to businesses seeking to expand globally. Following an empirical comparison of the costs and benefits of these approaches, and drawing on the key theoretical framework in the international business literature (OLI eclectic paradigm), the paper seeks to identify whether one mode of entry is preferred above others.
In examining both the international business literature and the empirical movements of internationalising firms, it is clear that the number of options open to globally expanding businesses is myriad (Hennart, 2001). It is worthwhile, therefore to provide an overview of the principal benefits and drawbacks of those options. Table 1 demonstrates that in making their decision, internationalising firms must balance a number of possible gains and losses.
Table 1: Key modes of entry to foreign markets, costs and benefits
Mode of entry
|Exporting an existing product or service||Transaction costs may be high. Trade and tariff barriers may exist||Firm may realise economies of location and experience|
|International franchising or licensing||Limited control over overseas product/service quality.
Limited capacity for international strategic coordination
|Relatively low risk since the business model has already been tested in a market.|
|Turnkey contracts||Long term market presence is limited||Opportunity to realise process technology returns in economies with limited experience of Foreign Direct Investment|
|Horizontal acquisition||Relatively high risk, particularly in relation to cultural differences||Capacity for international strategic coordination
Firms can realise economies of experience and location. Technology/patents are protected
|Joint Ventures/Strategic alliances||Firm loses control over quality and technology.||Costs of development and other risks are shared with the collaborative partner.
Internationalising firm can access the localised knowledge of its partner.
In the modern globalised economy, the most popular international activity of producing firms is exporting (Buckley, 2009). Although there is some scholarly debate regarding the extent to which exporting activity can truly be deemed ‘internationalisation’ (Cantwell, 1992), sending goods abroad for sale in overseas markets seems to be the preferred way for businesses to enter foreign markets, and it can often provide a foretaste or capability building for those seeking physical international expansion at some point in the future (Chang, 1995).
This mode of entry is particularly useful for businesses that are lacking in financial and other resources necessary for physical location overseas, and for this reason, it is a particularly popular internationalisation activity of small and medium-sized enterprises (SMEs) (Lu and Beamish, 2006; Coviello and McAuley, 1999). For these firms, as well as their larger counterparts, the key benefit of exporting home-produced goods is often that the costs of setting up a new, wholly owned plant abroad – which are often substantial, and subject to significant regulation – can be avoided (Welch, Benito and Petersen, 2007). Firms that take a longer-term strategic view and have access to the necessary resources, do, however, often find that the costs of production are cheaper overseas, particularly if the internationalising firm is based in the West and relocates to the Far East or Indian subcontinent (Argawal and Ramaswami, 2002). Nevertheless, exporting firms can realise substantial economies of both location and experience through the boost to their global sales volume offered by a new exporting activity. In spite of the opportunity to reduce costs in this way, there are other costs associated with exporting. The firm will likely face trade barriers that vary depending on the laws and regulations governing the target market; these are usually in the form of tariffs, but may take other forms, such as caps (Hill, 2010). Incurring such costs will increase the expense associated with exporting.
Extensive government regulation – such as the import tariffs just mentioned – can hinder the level of Foreign Direct Investment (FDI) attracted to an economy, and in these instances, it is often preferable for the home firm to involve itself in what is known as a turnkey contract, rather than in exporting activity (Hill, 2010). Turnkey contracts refer to projects in which two or more firms provide resources to establish a production facility. Typically, such contracts are entered into when the home firm possesses specific knowledge relating to the production of the good, but a collaborating partner, or contractor is needed to input the technological capital, market knowledge or some other resource specific to the host nation (Sitkin and Bowen, 2010). The ability to bypass trade barriers is thus the major benefit of these collaborative projects; furthermore, the internationalising firm has access to the expertise of the host partner. Despite these advantages, there are some drawbacks to this mode of entry. In allowing the host firm access to its own capabilities, the internationalising firm may inadvertently be creating a competitor once the contract comes to a conclusion (Sitkin and Bowen, 2010).
To combat this drawback, a longer-term partnership may be necessary, and the key devices for these are licenses and franchising agreements (Hill, 2010). While these two methods of foreign entry are distinct in terms of contractual format, they do share commonalities in terms of nature, and as such, are considered together here. A licensing arrangement is an agreement through which the firm in the host country is granted the rights to produce or offer a product in return for payments of a regular royalty. Franchising involves a similar agreement, although the terms of the contract are often shorter, and the arrangement typically involves a service instead of a product. As with turnkey projects and exporting arrangements, such agreements enable the internationalising business to avoid the risks and costs associated with the physical establishment of a plant in an overseas market (Doherty, 2007). This also enables the business to gain a foothold in several international markets simultaneously, so that this mode of entry is particularly attractive for businesses seeking to expand quickly (Sitkin and Bowen, 2010). On the other hand, by extending the license to produce its product or offer its services to an overseas, unrelated firm, the host company correspondingly relinquishes control of its strategic development, marketing and sales activities, and, importantly, reputation. This is a crucial disadvantage for retail and other service-oriented companies in particular, for their customers are unable to cognitively perceive ownership differences among franchised entities and typically demand the same level of service from all branches operating under identical titular umbrellas (Doherty, 2007).
Until now, the foreign market entry modes that have been considered have been distal in terms of the relationship between the home and the host country. The remaining two methods of entry differ in that they do involve the physical establishment of the internationalising firm in the host country. A firm utilising a horizontal acquisitional strategy procures a company that already exists in its target market, typically by purchasing the firm’s shares, stocks or assets (DePamphilis, 2009). Acquisitions may be either friendly or hostile. A friendly acquisition involves the presentation of offers and counter offers among the executives of the bidding and target organization, while a hostile acquisition, known as a takeover, occurs in spite of the wishes of the target firm.
There are considerable advantages associated with an expansionary strategy pursued through acquisitions. Primarily, the internationalising firm is able to achieve economies of scales, “whereby long-run average total costs falls as the quantity of output increases” (Mankiw, 2011: p. 272). With the purchase of an existing operation comes its bundle of resources, including its technology, inventory, manpower and human capital. The addition of these assets to those already held by the home company enables the firm to boost both its output, and its efficiency, which in turn, lowers per-unit costs (Hill, 2010). The internationalising company is also, through this method, able to acquire the proprietary rights to the goods produced by the acquired firm. This serves as a unique benefit for it is likely that the products that are produced by the acquired firm are already settled in the foreign market. Thus, such an acquisition is an effective means for the internationalising firm to gain a foothold in a foreign market which is likely to be unfamiliar to them (DePamphilis, 2009). In addition, the acquiring company can develop its technical know-how through the procurement of the proprietary information, and the local human capital (for instance in operations management, research and development, or distribution) that would be otherwise difficult to come by on the open market (Hill, 2010). In business parlance, this is known as knowledge transfer and it is known to be a major driver of innovation, performance and growth (Sitkin and Bowen, 2010).
Yet mergers and acquisitions are known to be complicated, drawn out affairs (DePamphilis, 2009). As well as the resistance that is often met from shareholders, employees and, even, at times, the government, the accounting, legal and taxation requirements of acquisitions can be extremely onerous. Any firm wishing to enter a foreign market using this strategy will need to hire experts in the local regulations, which can substantially increase costs. Relatedly, appraising the value of the target firm can often prove difficult and will involve the use of lawyers, corporate intelligence investigators, accountants and other consultants. These experts are particularly necessary when the takeover is hostile (DePamphilis, 2009).
These costs are largely avoided by internationalising firms that opt instead to start a joint venture with a similarly minded entity based in the target foreign market. A joint venture is a new firm established by two or more parties (Hill, 2010), and it offers considerable advantages, principal of which is the ability of each partner to “absorb the skills of the other” (Hamel, Doz and Prahalad, 1989: p. 134). As suggested by the resource based view of the firm, (Wernerfelt, 1984), competitiveness and overall business success generally accrues to those firms that, relative to others, are able to capitalise on their resources or skills in a given market. Through a joint venture, collaborating parties are able access the resources and capital (social, financial, and human) of the other. One contemporary example of this is given by Costa Coffee China, which is a joint venture between a UK based corporation, Costa Coffee, and two Chinese firms, Yueda South Holdings and Hualian Group (Swan, 2012). In a case study offered by Swan (2012), it is theorised that Costa entered into this partnership instead of going it alone (as, for example, its American competitor, Starbucks does in China), because Costa wanted to capitalise on the knowledge of the local, embryonic coffee market held by those firms, and the opportunity for assistance in navigating the considerable red tape facing businesses in China. As with franchising, however, there is some relinquishment of control, and the success of joint ventures is inextricably linked to the ability of partners to overcome cultural differences. Indeed, it has been estimated that the failure rates of joint ventures due to cultural misunderstandings is as high as 90 per cent (Sitkin and Bowen, 2010).
To summarise then, there are a myriad of options open to businesses seeking to internationalise. But, is any one mode preferred above all others? Considered in a decontextualised way, the fact that each mode has both drawbacks and advantages (see table 1) would suggest that no one method is favourable. However, no decision is entered into in a vacuum and several theories have been advanced to predict the optimal choice for firms. Chief of these is John Dunning’s OLI Eclectic Paradigm model (Hill, 2010). In this model, mode of entry is dependent on the ownership benefits (O), location benefits (L) and internalisation benefits (I) of each option. Applied to the various options available to internationalising firms, a preferred mode of entry may indeed be identified. For instance, businesses that are less able to transfer their ownership benefits (such as their brand name) to the host nation would do well to choose a joint venture over an acquisitional strategy, while businesses that appraise few advantages to locating overseas are likely to opt for distal strategies, such as exporting, or licensing.
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