What gives a firm tight control for coordinating a globally dispersed value chain?

chapter 13 Entering Foreign Markets

LEARNING OBJECTIVES

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.

opening case JCB in India

JCB, the venerable British manufacturer of construction equipment, has long been a relatively small player in a global market that is dominated by the likes of Caterpillar and Komatsu, but there is one exception to this, India. While the company is present in 150 countries, of the 51,600 machines it sold globally in 2010, some 21,000 were in India. India now generates one-third of JCB's $4.45 billion in annual sales. For JCB, India is truly the jewel in the crown.

The story of JCB in India dates back to 1979 when the company entered into a joint venture with Escorts, an Indian engineering conglomerate, to manufacture backhoe loaders for sale in India. Escorts held a majority 60 percent stake in the venture and JCB 40 percent. The joint venture was a first for JCB, which historically had exported as much as two-thirds of its production from Britain to a wide range of nations. However, high tariff barriers made direct exports to India difficult.

JCB would probably have preferred to go it alone in India, but government regulations at the time required foreign investors to create joint ventures with local companies. JCB believed the Indian construction market was ripe for growth and could become very large. The company's managers believed that it was better to get a foothold in the nation, thereby gaining an advantage over global competitors, rather than wait until the growth potential was realized.

By the end of the 1990s, the joint venture was selling some 2,000 backhoes in India and had an 80 percent share of the Indian market. After years of deregulation, the Indian economy was booming. However, JCB felt that the joint venture limited its ability to expand. For one thing, much of JCB's global success was based on the utilization of leading-edge manufacturing technologies and relentless product innovation, but the company was very hesitant about transferring this know-how to a venture where it did not have a majority stake and therefore lacked control. The last thing JCB wanted was for these valuable technologies to leak out of the joint venture into Escorts, which was one of the largest manufacturers of tractors in India and might conceivably become a direct competitor in the future. Moreover, JCB was unwilling to make the investment in India required to take the joint venture to the next level unless it could capture more of the long-run returns.

In 1999, JCB took advantage of changes in government regulations to renegotiate the terms of the venture with Escorts, purchasing 20 percent of its partner's equity to give JCB majority control. In 2003, JCB took this to its logical end when it responded to further relaxation of government regulations on foreign investment to purchase all of Escorts' remaining equity, transforming the joint venture into a wholly owned subsidiary.

Having gained full control, in early 2005 JCB increased its investment in India, announcing it would build a second factory in Pune that it would use to serve the Indian market. In 2007, in what represented a bold bet on future demand in the Indian market in the face of a global economic slowdown, JCB embarked on a major overhaul and expansion of its original India factory in Ballabgarh. To sell the additional Indian output, JCB rapidly expanded its dealer network, doubling the number of outlets in six years to reach 400 by 2011. The company also localized production for more than 80 percent of the parts used in its best-selling backhoe loader. This was done both to keep costs low and to make sure dealers had immediate access to spare parts. The strategy worked; between 2001 and 2011, JCB's Indian revenues increased 10-fold, and the company is now the leading manufacturer of backhoes in the country.•

  Sources: P. Marsh, “Partnerships Feel the Indian Heat,” Financial Times, June 22, 2006, p. 11; P. Marsh, “JCB Targets Asia to Spread Production,” Financial Times, March 16, 2005, p. 26; D. Jones, “Profits Jump at JCB,” Daily Post, June 20, 2006, p. 21; R. Bentley, “Still Optimistic about Asia,” Asian Business Review, October 1, 1999, p. 1; “JCB Launches India-Specific Heavy Duty Crane,” The Hindu, October 18, 2008; and P. M. Thomas, “JCB Hits Pay Dirt in India,” Forbes.com, December 6, 2011.

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. For example, as discussed in the opening case, JCB was an early entrant into India's market for heavy construction equipment. This commitment was a strategic bet on the long-term growth potential of the market—a bet that turned out to be correct. Leveraging its early-mover advantage, by 2011 JCB was the largest heavy construction equipment manufacturer in India.

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 ventures with a host-country firm, setting up a new wholly owned subsidiary in a host country to serve its market, and acquiring an established enterprise in the host nation to serve that market. Each of these options has advantages and disadvantages. The magnitude of the advantages and disadvantages associated with each entry mode is determined 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. In the case of JCB, its initial choice of entry mode, a joint venture with an Indian company, was dictated by circumstances at the time (Indian government regulations made a joint venture the only practical alternative).

Basic Entry Decisions

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.

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

WHICH FOREIGN MARKETS?

The 196 nation-states in the world do not all hold the same profit potential for a firm contemplating foreign expansion. 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. Chapters 2 and 3 looked in detail at the economic and political factors that influence the potential attractiveness of a foreign market. The attractiveness of a country as a potential market for an international business depends on balancing the benefits, costs, and risks associated with doing business in that country.

Chapters 2 and 3 also noted that the long-run economic benefits of doing business in a country are a function of factors such as the size of the market (in terms of demographics), the present wealth (purchasing power) of consumers in that market, and the likely future wealth of consumers, which depends on 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 relatively poor, are growing so rapidly that they are attractive targets for inward investment (hence, JCB's decision to make major additional investments in India in 2005 and 2007; see the opening case). Alternatively, weak growth in Indonesia implies that this populous nation is a far less attractive target for inward investment. As we saw in Chapters 2 and 3, likely future economic growth rates appear to be a function of a free market system and a country's capacity for growth (which may be greater in less developed nations). Also, 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 Chapters 2 and 3 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.

Another important factor is the value an international business can create in a foreign 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 product 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 international 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 operations in recent years, primarily by focusing on emerging markets that lack strong indigenous competitors (see the accompanying Management Focus). Similarly, when JCB entered India in 1979, the indigenous competitors were small and lacked technological know-how (see opening case).

ANOTHER PERSPECTIVE Timing Is Everything—Why Mahindra's Pick Up Truck Foray in the U.S. Failed

Recently, five automobile dealers from the USA filed a lawsuit accusing India's largest manufacturer of utility vehicles, Mahindra & Mahindra (M&M), of fraud, misrepresentation, and conspiracy. In 2004 bolstered by its success in selling tractors in the U.S., M&M chalked out plans to become India's first automobile manufacturer to sell utility vehicles in the U.S. First, M&M had decided to build the Euro V diesel engine to enter the U.S. market, but most of the R&D Team got dismantled shortly after the major plans hit the drawing board. This was a huge product technology challenge for the company. Secondly, the pick-up truck which made good business sense in 2006 was perhaps the worst product in 2010. The mid SUV segment in the North American market alone, in 2006 saw volumes of 1.3 million units. In 2009 the segment had crashed to 217,000 units. Mahindra is an unknown brand competing in a niche which was under tremendous fire at the time and everybody was buying crossovers. It therefore became a recipe for disaster.

  Source: http://forbesindia.com/blog/business-strategy/why-mahindras-pick-up-truck-foray-in-the-us-failed/.

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 established 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 2011, Tesco was the market leader in Hungary, with some 115 hypermarkets and 90 smaller stores. In 1995, Tesco acquired 31 stores in Poland from Stavia; a year later, it added 13 stores purchased 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 750 stores in Thailand by 2011. 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 discussions 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. By 2011, Tesco had more than 100 stores in China serving some 4 million customers every week.

In 2007, 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 concept (branded as “Fresh and Easy” in the United States). Already running in five countries, Tesco Express stores are smaller, high-quality neighborhood grocery outlets that feature a large selection of prepared and healthy foods. Tesco initially entered the West Coast market, investing some £250 million per year. By 2011, there were 164 Fresh and Easy stores in America, the majority in southern California. Although some question the wisdom of this move—and the company is still losing money in the United States as of 2011—others point out that in the United Kingdom, Tesco has consistently outperformed the Asda chain that is owned by Walmart. Also, the Tesco Express format is not offered by anyone else in the United States.

As a result of these moves, by 2011 Tesco generated record sales of £23.6 billion outside of the United Kingdom (its UK annual revenues were £47.3 billion). The addition of international stores has helped make Tesco the third largest company in the global grocery market behind Walmart and Carrefour of France. Of the three, however, Tesco may be the most successful internationally. By 2011, all of its foreign ventures except the U.S. operation were making money.

In explaining the company's success, Tesco's managers have detailed a number of important factors. First, the company 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 up with good companies that have a deep understanding of the markets in which they are participating but that lack Tesco's financial strength and retailing capabilities. Consequently, both Tesco and its partners have brought useful assets to the venture, increasing the probability of success. As the venture becomes established, Tesco has typically increased its ownership stake in its partner. By 2011, Tesco owned 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.

  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; Tesco's annual reports, archived at www.tesco.com; and P. Sonne, “Tesco Set to Push Ahead in the United States,” The Wall Street Journal, October 6, 2010, p. 19.

TIMING OF ENTRY

Once attractive markets have been identified, it is important to consider the timing of entry. 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 advantages 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 experience curve ahead of rivals, giving the early entrant a cost advantage over later entrants. One could argue that this factor motivated JCB to enter the Indian market in 1979 when it was still tiny (it is now among the world's largest; see the opening case). This cost advantage may enable the early entrant to cut prices below that of later entrants, 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.

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.

There can also be disadvantages associated with entering a foreign market before other international businesses. These are often referred to as first-mover disadvantages.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 business 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 enter a national market early.5 Research seems to confirm that the probability of survival 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.

First-Mover Disadvantages

Disadvantages associated with entering a foreign market before other international businesses.

Pioneering Costs

Costs an early entrant bears that later entrants avoid, such as the time and effort in learning the rules, failure due to ignorance, and the liability of being a foreigner.

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 education 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 capitalized 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 business 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 significant resources. Entering a market on a large scale 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 associated 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. This will have several effects. On the positive side, it will make it easier for the company to attract customers and distributors (such as insurance agents). The scale of entry gives both customers and distributors reasons 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 a reason to pause; now they will 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 may 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 unambiguously 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.

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 decisions that are associated with different levels of risk and reward. Entering a large developing 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 advantages that will bolster its long-run position in that market.9 This was what JCB hoped to do when it entered India in 1979, and as of 2012 it seemed as if JCB had captured a significant first-mover advantage (see opening case). In contrast, entering developed nations such as Australia or Canada after other international 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 multinationals 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 effectively 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 differentiating itself from early movers in global markets, the firm from the developing nation may still be able to build a strong international business presence. A good example of how this can work is given in the accompanying Management Focus, which looks at how Jollibee, a Philippines-based fast-food chain, has started to build a global presence in a market dominated by U.S. multinationals such as McDonald's and KFC.

Being the first to enter a developing nation such as China is risky, but potentially rewarding.

MANAGEMENT FOCUS The Jollibee Phenomenon—A Philippine Multinational

Jollibee is one of the Philippines' phenomenal business success stories. Jollibee, which stands for “Jolly Bee,” began operations in 1975 as a two-branch ice cream parlor. It later expanded its menu to include hot sandwiches and other meals. Encouraged by early success, Jollibee Foods Corporation was incorporated in 1978, with a network that had grown to seven outlets. In 1981, when Jollibee had 11 stores, McDonald's began to open stores in Manila. Many observers thought Jollibee would have difficulty competing against McDonald's. However, Jollibee saw this as an opportunity to learn from a very successful global competitor. Jollibee benchmarked its performance against that of McDonald's and started to adopt operational systems similar to those used at McDonald's to control its quality, cost, and service at the store level. This helped Jollibee to improve its performance.

As it came to better understand McDonald's business model, Jollibee began to look for a weakness in McDonald's global strategy. Jollibee executives concluded that McDonald's fare was too standardized for many locals and that the local firm could gain share by tailoring its menu to local tastes. Jollibee's hamburgers were set apart by a secret mix of spices blended into the ground beef to make the burgers sweeter than those produced by McDonald's, appealing more to Philippine tastes. It also offered local fare, including various rice dishes, pineapple burgers, and banana langka and peach mango pies for desserts. By pursuing this strategy, Jollibee maintained a leadership position over the global giant. By 2012, Jollibee had more than 740 stores in the Philippines, a market share of more than 60 percent, and revenues in excess of $600 million. McDonald's, in contrast, had about 250 stores.

Jollibee may be heading your way! Unlike many fast-food chains that have their roots within the United States, the Jollibee chain originated in the Philippines using McDonald's as a role model.

In the mid-1980s, Jollibee had gained enough confidence to expand internationally. Its initial ventures were into neighboring Asian countries such as Indonesia, where it pursued the strategy of localizing the menu to better match local tastes, thereby differentiating itself from McDonald's. In 1987, Jollibee entered the Middle East, where a large contingent of expatriate Filipino workers provided a ready-made market for the company. The strategy of focusing on expatriates worked so well that in the late 1990s, Jollibee decided to enter another foreign market where there was a large Filipino population—the United States. Between 1999 and 2012, Jollibee opened 25 stores in the United States, 20 of which are in California. Even though many believe the U.S. fast-food market is saturated, the stores have performed well. While the initial clientele was strongly biased toward the expatriate Filipino community, where Jollibee's brand awareness is high, non-Filipinos are increasingly coming to the restaurant. In the San Francisco store, which has been open the longest, more than half the customers are now non-Filipino. Today, Jollibee has 75 international stores that operate under the Jollibee name and a potentially bright future as a niche player in a market that has historically been dominated by U.S. multinationals.

Recently Jollibee has focused its attentions on two international markets, mainland China and India. It has more than 100 stores in China, which operate under the Yonghe brand name (and serve Chinese-style fast food). While it does not yet have a presence in India, the company is reported to be considering acquiring an Indian fast-food chain, although as with so many enterprises, Jollibee has slowed its expansion strategy in the wake of the 2008–2009 global financial crisis.

  Sources: “Jollibee Battles Burger Giants in US Market,” Philippine Daily Inquirer, July 13, 2000; M. Ballon, “Jollibee Struggling to Expand in U.S.,” Los Angeles Times, September 16, 2002, p. C1; J. Hookway, “Burgers and Beer,” Far Eastern Economic Review, December 2003, pp. 72–74; S. E. Lockyer, “Coming to America,” Nation's Restaurant News, February 14, 2005, pp. 33–35; Erik de la Cruz, “Jollibee to Open 120 New Stores This Year, Plans India,” Inquirer Money, July 5, 2006 (www.business.inquirer.net); and www.jollibee.com.ph.

• QUICK STUDY

What factors determine the choice of which foreign market to enter?

What factors influence the timing of entry into a foreign market?

What factors determine the scale of entry into a foreign market?

ANOTHER PERSPECTIVE Made in Poland: Healthy Exports Despite Trade Gap

Contrary to many developed economies currently experiencing widening deficits, Poland's trade gap is not seen as reflecting a lack of competitiveness, or weak export growth. In 2011, total Polish exports denominated in złoty grew by 15.3 percent year-on-year to zł.554.77 billion, on the back of a weak złoty and strong German exports in the first half of the year. The strength of Germany's exports, and therefore the state of the global economy, is key for Polish companies since many components and raw materials used in German exports are sourced from Poland. Around 40 percent of Polish automotive components, for example, are sent to Germany, according to the European Automobile Manufacturers' Association. That figure appears even more significant considering that roughly 98 percent of the Polish car industry's output is exported. Luckily for Poland, German exports were healthy in the first half of last year, meaning producers in that country filed large numbers of orders with Polish suppliers. A weakened złoty, which fell by roughly 15 percent against the euro in H2 2011, also aided Polish exporters by making Polish products more price-competitive for those buying in euro. The importance of Germany to Poland's exporters is underlined by trade data for 2011, which show that 26.1 percent of all Polish exports headed to Germany. In second place was the UK, where just 6.4 percent of Polish exports were sent.

  Source: www.wbj.pl/article-58674-made-in-poland-healthy-exports-despite-trade-gap.html.

Entry Modes

Once a firm decides to enter a foreign market, the question arises as to the best mode of entry. Firms can use six different modes to enter foreign markets: exporting, turnkey projects, licensing, franchising, establishing joint ventures with a host-country firm, or setting up a new wholly owned subsidiary in the host country. Each entry mode has advantages and disadvantages. Managers need to consider these carefully when deciding which to use.11

EXPORTING

Many manufacturing firms begin their global expansion as exporters and only later switch to another mode for serving a foreign market. We take a close look at the mechanics of exporting in Chapter 14. Here, we focus onw the advantages and disadvantages of exporting as an entry mode.

Advantages

LEARNING OBJECTIVE 2

Compare and contrast the different modes that firms use to enter foreign markets.

Exporting 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 (see Chapter 12). By manufacturing the product in a centralized location and exporting it to other national markets, the firm may realize substantial scale economies from its global sales volume. This is how Sony came to dominate the global TV market, how Matsushita came to dominate the VCR market, how many Japanese automakers made inroads into the U.S. market, and how South Korean firms such as Samsung gained market share in computer memory chips.

Exporting

Sale of products produced in one country to residents of another country.

Disadvantages

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 (i.e., if the firm can realize location economies by moving production elsewhere). Thus, particularly for firms pursuing global or transnational strategies, it may be preferable to manufacture where the mix of factor conditions is most favorable from a value creation perspective and to export to the rest of the world from that location. This is not so much an argument against exporting as an argument against exporting from the firm's home country. Many U.S. electronics firms have moved some of their manufacturing to the Far East because of the availability of low-cost, highly skilled labor there. They then export from that location to the rest of the world, including the United States.

A second drawback to exporting is that high transport costs can make exporting uneconomical, particularly for bulk products. One way of getting around this is to manufacture bulk products regionally. This strategy enables the firm to realize some economies from large-scale production and at the same time to limit its transport costs. For example, many multinational chemical firms manufacture their products regionally, serving several countries from one facility.

Another drawback is that tariff barriers can make exporting uneconomical. Similarly, the threat of tariff barriers by the host-country government can make it very risky. A fourth drawback to exporting arises when a firm delegates its marketing, sales, and service in each country where it does business to another company. This is a common approach for manufacturing firms that are just beginning to expand internationally. The other company may be a local agent, or it may be another multinational with extensive international distribution operations. Local agents often carry the products of competing firms and so have divided loyalties. In such cases, the local agent may not do as good a job as the firm would if it managed its marketing itself. Similar problems can occur when another multinational takes on distribution.

The way around such problems is to set up wholly owned subsidiaries in foreign nations to handle local marketing, sales, and service. By doing this, the firm can exercise tight control over marketing and sales in the country while reaping the cost advantages of manufacturing the product in a single location, or a few choice locations.

TURNKEY PROJECTS

Firms that specialize in the design, construction, and start-up of turnkey plants are common in some industries. In a turnkey project, the contractor 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—hence, the term turnkey. This is a means of exporting process technology to other countries. Turnkey projects are most common in the chemical, pharmaceutical, petroleum-refining, and metal-refining industries, all of which use complex, expensive production technologies.

Turnkey Project

A project in which a firm agrees to set up an operating plant for a foreign client and hand over the “key” when the plant is fully operational.

Advantages

The know-how required to assemble and run a technologically complex process, such as refining petroleum or steel, is a valuable asset. Turnkey projects are a way of earning great economic returns from that asset. The strategy is particularly useful where FDI is limited by host-government regulations. For example, the governments of many oil-rich countries have set out to build their own petroleum-refining industries, so they restrict FDI in their oil-refining sectors. But because many of these countries lack petroleum-refining technology, they gain it by entering into turnkey projects with foreign firms that have the technology. Such deals are often attractive to the selling firm because without them, they would have no way to earn a return on their valuable know-how in that country. A turnkey strategy can also be less risky than conventional FDI. In a country with unstable political and economic environments, a longer-term investment might expose the firm to unacceptable political and/or economic risks (e.g., the risk of nationalization or of economic collapse).

Disadvantages

Three main drawbacks are associated with a turnkey strategy. First, the firm that enters into a turnkey deal will have no long-term interest in the foreign country. This can be a disadvantage if that country subsequently proves to be a major market for the output of the process that has been exported. One way around this is to take a minority equity interest in the operation. Second, the firm that enters into a turnkey project with a foreign enterprise may inadvertently create a competitor. For example, many of the Western firms that sold oil-refining technology to firms in Saudi Arabia, Kuwait, and other Gulf states now find themselves competing with these firms in the world oil market. Third, 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

A licensing agreement 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.12 Intangible property includes patents, inventions, formulas, processes, designs, copyrights, and trademarks. For example, to enter the Japanese market, Xerox, inventor of the photocopier, established a joint venture with Fuji Photo that is known as Fuji Xerox. Xerox then licensed its xerographic know-how to Fuji Xerox. In return, Fuji Xerox paid Xerox a royalty fee equal to 5 percent of the net sales revenue that Fuji Xerox earned from the sales of photocopiers based on Xerox's patented know-how. In the Fuji Xerox case, the license was originally granted for 10 years, and it has been renegotiated and extended several times since. The licensing agreement between Xerox and Fuji Xerox also limited Fuji Xerox's direct sales to the Asian Pacific region (although Fuji Xerox does supply Xerox with photocopiers that are sold in North America under the Xerox label).13