A greenfield venture may be too slow to establish a sizable presence when

After you have read this chapter you should be able to:

1 Explain the three basic decisions that firms contemplating foreign expansion must make: which markets to enter, when to enter those markets, and on what scale.

2 Compare and contrast the different modes that firms use to enter foreign markets. 3 Identify the factors that influence a firm’s choice of entry mode.

4 Recognize the pros and cons of acquisitions versus greenfield ventures as an entry strategy.

L E

A R

N IN

G O

B J E

C T

IV E

S

part 5 Competing in a Global Marketplace

hiL37217_ch12_416-441.indd Page 416 27/07/10 5:31 PM user-f471hiL37217_ch12_416-441.indd Page 416 27/07/10 5:31 PM user-f471 /Volumes/208/MHSF185/amo34390_disk1of1/0073534390/amo34390_pagefiles/Volumes/208/MHSF185/amo34390_disk1of1/0073534390/amo34390_pagefile

General Motors in China

Entering Foreign Markets

12 c h a p t e r

opening case

T he late 2000s were not kind to General Motors. Hurt by a deep recession in the United States, and plunging vehicle sales, GM capped off a decade where it had progressively lost market share to foreign rivals such as Toyota by entering Chapter 11 bankruptcy. Between 1980, when it dominated the U.S. market, and 2009, when it entered bankruptcy protection, GM saw its U.S. market share slip from 44 percent to just 19 percent. The troubled company emerged from bankruptcy a few months later a smaller enterprise with fewer brands, and yet going forward some believe that the new GM could be a much more profitable enterprise. One major reason for this optimism was the success of its joint ventures in China. GM entered China in 1997 with a $1.6 billion investment to establish a joint venture with the state-owned Shanghai Automotive Industry Corp. (SAIC) to build Buick sedans. At the time, the Chinese market was tiny (less than 400,000 cars were sold in 1996), but GM was attracted by the enormous potential in a country of over 1 billion people that was experiencing rapid eco- nomic growth. GM forecast that by the late 2000s some 3 million cars a year might be sold in China. While it explicitly recognized that it had much to learn about the Chinese market, and would probably lose money for years to come, GM executives believed that it was crucial for them to establish a beachhead and to team with SAIC (one of the early leaders in China’s emerging automobile industry) before its global rivals did. The decision to enter a joint venture was not a hard one. Not only did GM lack knowledge and connections in China, but also Chinese government regulations made it all but impossible for a for- eign automaker to go it alone in the country. While GM was not alone in investing in China—many of the world’s major auto- mobile companies entered into some kind of Chinese joint venture during this time period—it was among the largest investors. Only Volkswagen, whose man- agement shared GM’s view, made similar-sized investments. Other compa- nies adopted a more cautious approach, investing smaller amounts and setting more limited goals.

hiL37217_ch12_416-441.indd Page 417 7/26/10 10:05 PM userhiL37217_ch12_416-441.indd Page 417 7/26/10 10:05 PM user /Users/user/Desktop/Users/user/Desktop

418 Part Five Competing in a Global Marketplace

By 2007 GM had expanded the range of its partnership with SAIC to in- clude vehicles sold under the names of Chevrolet, Cadillac, and Wuling. The two companies had also established the Pan-Asian Technical Automotive center to design cars and components not just for China but also for other Asian markets. At this point it was already clear that both the Chinese market and the joint venture were exceeding GM’s initial expectations. The venture was profitable, selling more than 900,000 cars and light trucks in 2007, an 18 percent increase over 2006 and placing it second only to Volkswagen in the market among foreign nameplates. Equally impressive, some 8 million cars and light trucks were sold in China in 2007, making China the second-largest car market in the world, ahead of Japan and behind the United States. Much of the venture’s success could be attributed to its strategy of de- signing vehicles explicitly for the Chinese market. For example, together with SAIC it produced a tiny minivan, the Wuling Sunshine. The van costs $3,700, has a 0.8-liter engine, a top speed of 60 mph, and weighs less than 1,000 kilograms—a far cry from the heavy SUVs GM was known for in the United States. For China, the vehicle was perfect, and some 460,000 were sold in 2007, making it the best seller in the light-truck sector. It is the future, however, that has people excited. In 2008 and 2009, while the U.S. and European automobile markets slumped, China’s market regis- tered strong growth. In 2009 some 13.8 million vehicles were sold in the country, surpassing the United States to become the largest automobile mar- ket in the world. GM and its local partners sold a record 1.8 million vehicles in 2009, a 67 percent increase over 2008. At this point, there were 40 cars for every 1,000 people in China, compared to 765 for every 1000 in the United States, suggesting that China could see rapid growth for years to come. • Sources: S. Schifferes, “Cracking China’s Car Market,” BBC News , May 17, 2007; N. Madden, “Led by Buick, Carmaker Learning Fine Points of Regional China Tastes,” Automotive News , September 15, 2008, pp. 186–90; and “GM Posts Record Sales in China,” Toronto Star , January 5, 2010, p. B4.

Introduction This chapter is concerned with two closely related topics: (1) the decision of which foreign markets to enter, when to enter them, and on what scale; and (2) the choice of entry mode. Any firm contemplating foreign expansion must first struggle with the issue of which foreign markets to enter and the timing and scale of entry. The choice of which markets to enter should be driven by an assessment of relative long-run growth and profit potential. The choice of mode for entering a foreign market is another major issue with which international businesses must wrestle. The various modes for serving foreign markets are exporting, licensing or franchising to host-country firms, establishing joint ven- tures with a host-country firm, setting up a new wholly owned subsidiary in a host

hiL37217_ch12_416-441.indd Page 418 7/26/10 10:05 PM userhiL37217_ch12_416-441.indd Page 418 7/26/10 10:05 PM user /Users/user/Desktop/Users/user/Desktop

Chapter Twelve Entering Foreign Markets 419

country to serve its market, or acquiring an established enterprise in the host nation to serve that market. Each of these options has advantages and disadvantages. The mag- nitude of the advantages and disadvantages associated with each entry mode is deter- mined by a number of factors, including transport costs, trade barriers, political risks, economic risks, business risks, costs, and firm strategy. The optimal entry mode varies by situation, depending on these factors. Thus, whereas some firms may best serve a given market by exporting, other firms may better serve the market by setting up a new wholly owned subsidiary or by acquiring an established enterprise. As discussed in the opening case, in 1997 GM decided to enter China on a sig- nificant scale. It’s choice of entry mode, a joint venture with Shanghai Automotive Industry Corp., was dictated by circumstances at the time (Chinese government regu- lations made a joint venture the only practical alternative). GM was attracted to the market by the promise of rapid future growth. The growth exceeded GM’s expecta- tions, and the company reaped the rewards of making the right strategic choice under considerable uncertainty. Although GM as a whole did not fair well in the late 2000s (it had to seek bankruptcy protection in 2009), its success in China was the glittering jewel in an otherwise dismal picture, demonstrating just how important it can be for a company to get its foreign market entry strategy right.

Basic Entry Decisions A firm contemplating foreign expansion must make three basic decisions: which mar- kets to enter, when to enter those markets, and on what scale. 1

WHICH FOREIGN MARKETS? The world has more than 200 nation-states. They do not all hold the same profit potential for a firm contemplating foreign ex- pansion. Ultimately, the choice must be based on an assessment of a nation’s long-run profit potential. This potential is a function of several factors, many of which we have studied in earlier chapters. In Chapter 2, we looked in detail at the economic and political factors that influence the potential attractiveness of a foreign market. There we noted that the attractiveness of a country as a potential market for an interna- tional business depends on balancing the benefits, costs, and risks associated with doing business in that country. Chapter 2 also noted that the long-run economic benefits of doing business in a country are a func- tion of factors such as the size of the market (in terms of demographics), the present wealth (pur- chasing power) of consumers in that market, and the likely future wealth of consumers, which de- pends upon economic growth rates. While some markets are very large when measured by number of consumers (e.g., China, India, and Indonesia), one must also look at living standards and economic growth. On this basis, China and India, while rela- tively poor, are growing so rapidly that they are at- tractive targets for inward investment (hence GM’s decision to invest in China in 1997; see the opening case). Alternatively, weak growth in Indonesia im- plies that this populous nation is a far less attractive target for inward investment. As we saw in Chapter 2, likely future economic growth rates appear to be a function of a free market system and a country’s

LEARNING OBJECTIVE 1 Explain the three basic

decisions that firms contemplating foreign expansion must make:

which markets to enter, when to enter those

markets, and on what scale.

Another Per spect i ve

Thailand’s Homebuilder Enters Foreign Markets As a child in Thailand, Thongma Vijitpongpun helped his father sell soup to day laborers, balancing twin hampers on a shoulder pole and learning the first rule of good busi- ness: deliver quality at an affordable price. Today Thongma’s business, Pruksa Real Estate, uses mass-production tech- niques to build quality, affordable housing for low- and middle-income families. Pruksa’s process has been so successful—with recent annual revenues pegged at $569 million—that the company intends to expand to other Asian countries where the need for low-cost housing is great. First on Pruksa’s list are India, Vietnam, and the Maldives, with China, Indonesia, and the Philippines to fol- low. (Brian Mertens, “Biggest Thai Home Builder Moving Abroad to Expand Company,” Forbes.com, February 8, 2010, www.forbes.com)

hiL37217_ch12_416-441.indd Page 419 7/26/10 10:05 PM userhiL37217_ch12_416-441.indd Page 419 7/26/10 10:05 PM user /Users/user/Desktop/Users/user/Desktop

420 Part Five Competing in a Global Marketplace

capacity for growth (which may be greater in less developed nations). We also argued in Chapter 2 that the costs and risks associated with doing business in a foreign country are typically lower in economically advanced and politically stable democratic nations, and they are greater in less developed and politically unstable nations. The discussion in Chapter 2 suggests that, other things being equal, the benefit– cost–risk trade-off is likely to be most favorable in politically stable developed and developing nations that have free market systems, and where there is not a dramatic upsurge in either inflation rates or private-sector debt. The trade-off is likely to be least favorable in politically unstable developing nations that operate with a mixed or command economy or in developing nations where speculative financial bubbles have led to excess borrowing (see Chapter 2 for further details). Another important factor is the value an international business can create in a for- eign market. This depends on the suitability of its product offering to that market and the nature of indigenous competition. 2 If the international business can offer a prod- uct that has not been widely available in that market and that satisfies an unmet need, the value of that product to consumers is likely to be much greater than if the interna- tional business simply offers the same type of product that indigenous competitors and other foreign entrants are already offering. Greater value translates into an ability to charge higher prices and/or to build sales volume more rapidly. By considering such factors, a firm can rank countries in terms of their attractiveness and long-run profit potential. Preference is then given to entering markets that rank highly. For example, Tesco, the large British grocery chain, has been aggressively expanding its foreign op- erations in recent years, primarily by focusing on emerging markets that lack strong indigenous competitors (see the accompanying Management Focus). Similarly, when GM entered China in 1997 the indigenous competitors were small and lacked techno- logical know-how (see opening case).

TIMING OF ENTRY Once attractive markets have been identified, it is impor- tant to consider the timing of entry. We say that entry is early when an international business enters a foreign market before other foreign firms and late when it enters after other international businesses have already established themselves. The advan- tages frequently associated with entering a market early are commonly known as first- mover advantages. 3 One first-mover advantage is the ability to preempt rivals and capture demand by establishing a strong brand name. This desire has driven the rapid expansion by Tesco into developing nations (see the Management Focus). A second advantage is the ability to build sales volume in that country and ride down the experi- ence curve ahead of rivals, giving the early entrant a cost advantage over later entrants. One could argue that this factor motivated GM to enter the Chinese automobile mar- ket in 1997 when it was still tiny (it is now the world’s largest; see the opening case). This cost advantage may enable the early entrant to cut prices below that of later en- trants, thereby driving them out of the market. A third advantage is the ability of early entrants to create switching costs that tie customers into their products or services. Such switching costs make it difficult for later entrants to win business. There can also be disadvantages associated with entering a foreign market before other international businesses. These are often referred to as first-mover disadvan- tages. 4 These disadvantages may give rise to pioneering costs, costs that an early entrant has to bear that a later entrant can avoid. Pioneering costs arise when the busi- ness system in a foreign country is so different from that in a firm’s home market that the enterprise has to devote considerable effort, time, and expense to learning the rules of the game. Pioneering costs include the costs of business failure if the firm, due to its ignorance of the foreign environment, makes major mistakes. A certain liability is associated with being a foreigner, and this liability is greater for foreign firms that

Timing of Entry Entry is early when a firm

enters a foreign market before other foreign

firms and late when a firm enters after other

international businesses have established

themselves.

First-Mover Advantages

Advantages accruing to the first to enter a market.

First-Mover Disadvantages

Disadvantages associated with entering

a foreign market before other international

businesses.

Pioneering Costs Costs that an early

entrant has to bear that a later entrant can avoid,

such as the time and effort in learning the rules, failure due to ignorance, and the

liability of being a foreigner.

hiL37217_ch12_416-441.indd Page 420 7/26/10 10:05 PM userhiL37217_ch12_416-441.indd Page 420 7/26/10 10:05 PM user /Users/user/Desktop/Users/user/Desktop

Chapter Twelve Entering Foreign Markets 421

Management FOCUS

Tesco’s International Growth Strategy

Tesco is the largest grocery retailer in the United Kingdom, with a 25 percent share of the local market. In its home market, the company’s strengths are reputed to come from strong competencies in marketing and store site selection, logistics and inventory management, and its own label product offerings. By the early 1990s, these competencies had already given the company a leading position in the United Kingdom. The company was generating strong free cash flows, and senior management had to decide how to use that cash. One strategy they settled on was overseas expansion. As they looked at international markets, they soon concluded the best opportunities were not in estab- lished markets, such as those in North America and Western Europe, where strong local competitors already existed, but in the emerging markets of Eastern Europe and Asia where there were few capable competitors but strong underlying growth trends. Tesco’s first international foray was into Hungary in 1994, when it acquired an initial 51 percent stake in Global, a 43-store, state-owned grocery chain. By 2004, Tesco was the market leader in Hungary, with some 60 stores and a 14 percent market share. In 1995, Tesco acquired 31 stores in Poland from Stavia; a year later it added 13 stores pur- chased from Kmart in the Czech Republic and Slovakia; and the following year it entered the Republic of Ireland. Tesco’s Asian expansion began in 1998 in Thailand when it purchased 75 percent of Lotus, a local food retailer with 13 stores. Building on that base, Tesco had 64 stores in Thailand by 2004. In 1999, the company entered South Korea when it partnered with Samsung to develop a chain of hypermarkets. This was followed by entry into Taiwan in 2000, Malaysia in 2002, and China in 2004. The move into China came after three years of careful research and dis- cussions with potential partners. Like many other Western companies, Tesco was attracted to the Chinese market by its large size and rapid growth. In the end, Tesco settled on a 50/50 joint venture with Hymall, a hypermarket chain that is controlled by Ting Hsin, a Taiwanese group, which had been operating in China for six years. Currently, Hymall has 25 stores in China, and it plans to open another 10 each year. Ting Hsin is a well-capitalized enterprise in its own right, and it will match Tesco’s investments, reducing the risks Tesco faces in China. As a result of these moves, by 2007 Tesco had more than 800 stores outside the United Kingdom, which generated £7.6 billion in annual revenues. In the United Kingdom, Tesco had some 1,900 stores, generating £30 billion. The

addition of international stores has helped to make Tesco the fourth-largest company in the global grocery market behind Walmart, Carrefour of France, and Ahold of Holland. Of the four, however, Tesco may be the most successful internationally. By 2005, all of its foreign ventures were making money. In explaining the company’s success, Tesco’s managers have detailed a number of important factors. First, the com- pany devotes considerable attention to transferring its core capabilities in retailing to its new ventures. At the same time, it does not send in an army of expatriate managers to run local operations, preferring to hire local managers and support them with a few operational experts from the United Kingdom. Second, the company believes that its partnering strategy in Asia has been a great asset. Tesco has teamed with good companies that have a deep under- standing of the markets in which they are participating but that lack Tesco’s financial strength and retailing capa- bilities. Consequently, both Tesco and its partners have brought useful assets to the venture, which have increased the probability of success. As the venture becomes estab- lished, Tesco has typically increased its ownership stake in its partner. Thus, under current plans, by 2011 Tesco will own 99 percent of Homeplus, its South Korean hypermarket chain. When the venture was established, Tesco owned 51 percent. Third, the company has focused on markets with good growth potential but that lack strong indigenous competitors, which provides Tesco with ripe ground for expansion. In 2006, Tesco took its international expansion strategy to the next level when it announced it would enter the crowded U.S. grocery market with its Tesco Express con- cept. Currently running in five countries, Tesco Express stores are smaller, high-quality neighborhood grocery out- lets that feature a large selection of prepared and healthy foods. Tesco will initially enter on the West Coast, investing some £250 million per year, with breakeven expected in the second year of operation. Although some question the wisdom of this move, others point out that in the United Kingdom Tesco has consistently outperformed the ASDA chain, which is owned by Walmart. Also, the Tesco Express format is not something found in the United States.

Sources: P. N. Child, “Taking Tesco Global,” The McKenzie Quarterly, no. 3 (2002); H. Keers, “Global Tesco Sets Out Its Stall in China,” Daily Telegraph, July 15, 2004, p. 31; K. Burgess, “Tesco Spends Pounds 140m on Chinese Partnership,” Financial Times, July 15, 2004, p. 22; J. McTaggart, “Industry Awaits Tesco Invasion,” Progressive Grocer , March 1, 2006, pp. 8–10; and Tesco’s annual reports, archived at www.tesco.com.

hiL37217_ch12_416-441.indd Page 421 7/26/10 10:05 PM userhiL37217_ch12_416-441.indd Page 421 7/26/10 10:05 PM user /Users/user/Desktop/Users/user/Desktop

422 Part Five Competing in a Global Marketplace

enter a national market early. 5 Research seems to confirm that the probability of sur- vival increases if an international business enters a national market after several other foreign firms have already done so. 6 The late entrant may benefit by observing and learning from the mistakes made by early entrants. Pioneering costs also include the costs of promoting and establishing a product offering, including the costs of educating customers. These can be significant when the product being promoted is unfamiliar to local consumers. In contrast, later entrants may be able to ride on an early entrant’s investments in learning and customer educa- tion by watching how the early entrant proceeded in the market, by avoiding costly mistakes made by the early entrant, and by exploiting the market potential created by the early entrant’s investments in customer education. For example, KFC introduced the Chinese to American-style fast food, but a later entrant, McDonald’s, has capital- ized on the market in China. An early entrant may be put at a severe disadvantage, relative to a later entrant, if regulations change in a way that diminishes the value of an early entrant’s investments. This is a serious risk in many developing nations where the rules that govern business practices are still evolving. Early entrants can find themselves at a disadvantage if a subsequent change in regulations invalidates prior assumptions about the best busi- ness model for operating in that country.

SCALE OF ENTRY AND STRATEGIC COMMITMENTS Another issue that an international business needs to consider when contemplating market entry is the scale of entry. Entering a market on a large scale involves the commitment of sig- nificant resources and implies rapid entry. Consider the entry of the Dutch insurance company ING into the U.S. insurance market in 1999. ING had to spend several billion dollars to acquire its U.S. operations. Not all firms have the resources necessary to enter on a large scale, and even some large firms prefer to enter foreign markets on a small scale and then build slowly as they become more familiar with the market. The consequences of entering on a significant scale—entering rapidly—are associ- ated with the value of the resulting strategic commitments. 7 A strategic commitment has a long-term impact and is difficult to reverse. Deciding to enter a foreign market on a significant scale is a major strategic commitment. Strategic commitments, such as rapid large-scale market entry, can have an important influence on the nature of competition in a market. For example, by entering the U.S. financial services market on a significant scale, ING signaled its commitment to the market. Such a move has several effects. On the positive side, it makes it easier for the company to attract customers and distributors (such as insurance agents). The scale of entry gives both customers and distributors rea- sons for believing that ING will remain in the market for the long run. The scale of entry may also give other foreign institutions considering entry into the United States pause; now they would have to compete not only against indigenous institutions in the United States, but also against an aggressive and successful European institution. On the negative side, by committing itself heavily to the United States, ING would have fewer resources available to support expansion in other desirable markets, such as Japan. The commitment to the United States limits the company’s strategic flexibility. As suggested by the ING example, significant strategic commitments are neither un- ambiguously good nor bad. Rather, they tend to change the competitive playing field and unleash a number of changes, some of which may be desirable and some of which will not be. It is important for a firm to think through the implications of large-scale entry into a market and act accordingly. Of particular relevance is trying to identify how actual and potential competitors might react to large-scale entry into a market. Also, the large-scale entrant is more likely than the small-scale entrant to be able to capture first-mover advantages associated with demand preemption, scale economies, and switching costs.

hiL37217_ch12_416-441.indd Page 422 7/26/10 10:05 PM userhiL37217_ch12_416-441.indd Page 422 7/26/10 10:05 PM user /Users/user/Desktop/Users/user/Desktop

Chapter Twelve Entering Foreign Markets 423

The value of the commitments that flow from rapid large-scale entry into a foreign market must be balanced against the resulting risks and lack of flexibility associated with significant commitments. But strategic inflexibility can also have value. A famous example from military history illustrates the value of inflexibility. When Hernán Cortés landed in Mexico, he ordered his men to burn all but one of his ships. Cortés reasoned that by eliminating their only method of retreat, his men had no choice but to fight hard to win against the Aztecs—and ultimately they did. 8 Balanced against the value and risks of the commitments associated with large-scale entry are the benefits of a small-scale entry. Small-scale entry allows a firm to learn about a foreign market while limiting the firm’s exposure to that market. Small-scale entry is a way to gather information about a foreign market before deciding whether to enter on a significant scale and how best to enter. By giving the firm time to collect information, small-scale entry reduces the risks associated with a subsequent large-scale entry. But the lack of commitment associated with small-scale entry may make it more difficult for the small-scale entrant to build market share and to capture first-mover or early-mover advantages. The risk-averse firm that enters a foreign market on a small scale may limit its potential losses, but it may also miss the chance to capture first-mover advantages.

MARKET ENTRY SUMMARY There are no “right” decisions here, just deci- sions that are associated with different levels of risk and reward. Entering a large devel- oping nation such as China or India before most other international businesses in the firm’s industry, and entering on a large scale, will be associated with high levels of risk. In such cases, the liability of being foreign is increased by the absence of prior foreign entrants whose experience can be a useful guide. At the same time, the potential long- term rewards associated with such a strategy are great. The early large-scale entrant into a major developing nation may be able to capture significant first-mover advan- tages that will bolster its long-run position in that market. 9 This was what GM hoped to do when it entered China in 1997, and as of 2010 it seems as if GM has captured a significant first-mover, or at least early-mover, advantage (see the opening case). In contrast, entering developed nations such as Australia or Canada after other interna- tional businesses in the firm’s industry, and entering on a small scale to first learn more about those markets, will be associated with much lower levels of risk. However, the potential long-term rewards are also likely to be lower because the firm is essentially forgoing the opportunity to capture first-mover advantages and because the lack of commitment signaled by small-scale entry may limit its future growth potential. This section has been written largely from the perspective of a business based in a developed country considering entry into foreign markets. Christopher Bartlett and Sumantra Ghoshal have pointed out the ability that businesses based in developing nations have to enter foreign markets and become global players. 10 Although such firms tend to be late entrants into foreign markets, and although their resources may be limited, Bartlett and Ghoshal argue that such late movers can still succeed against well-established global competitors by pursuing appropriate strategies. In particular, Bartlett and Ghoshal argue that companies based in developing nations should use the entry of foreign multi- nationals as an opportunity to learn from these competitors by benchmarking their operations and performance against them. Furthermore, they suggest the local company may be able to find ways to differentiate itself from a foreign multinational, for example, by focusing on market niches that the multinational ignores or is unable to serve effec- tively if it has a standardized global product offering. Having improved its performance through learning and differentiated its product offering, the firm from a developing nation may then be able to pursue its own international expansion strategy. Even though the firm may be a late entrant into many countries, by benchmarking and then differenti- ating itself from early movers in global markets, the firm from the developing nation