STARTING INTERNATIONAL OPERATIONS (Week 13 Module 10)

CHAPTER 9

Starting International Operations

OVERVIEW OF CLASS MODULE

This lesson encompasses why companies wish to move beyond exporting and importing to avail themselves of a
wide range of market entry strategies. Respectively, the five common international expansion entry modes is discussed
that includes exporting, licensing, franchising, contract manufacturing, and joint ventures.

LEARNING OBJECTIVES

By the end of this module, the students should be able to:

1. Enumerate various entry strategies used by firms to initiate international business activity;
2. Analyze indirect exporting and importing; and
3. Understand the advantages and disadvantages of licensing.

LEARNING CONTEXT

INTERNATIONAL ENTRY MODES

What is the best way to enter a new market? Should a company first establish an export base or license its products
to gain experience in a newly targeted country or region? Or does the potential associated with first-mover status justify
a bolder move such as entering an alliance, making an acquisition, or even starting a new subsidiary?

Many companies move from exporting to licensing to a higher investment strategy, in effect treating these choices
as a learning curve. Each has distinct advantages and disadvantages. In this section, we will explore the traditional
international-expansion entry modes.

These modes of entering international markets and their characteristics are shown in Table 9.1 “International-
Expansion Entry Modes”. Each mode of market entry has advantages and disadvantages. Firms need to evaluate their
options to choose the entry mode that best suits their strategy and goals.

TYPE OF ENTRY ADVANTAGES DISADVANTAGES

Low control, low local knowledge,

Exporting Fast entry, low risk potential negative environmental
impact of transportation

Less control, licensee may become a

competitor, legal and regulatory
Fast entry, low cost, low risk
Licensing and Franchising environment (IP and contract law)
must be sound

Shared costs reduce investment Higher cost than exporting, licensing,

needed, reduced risk, seen as local or franchising; integration problems
Partnering and Strategic Alliance
entity between two corporate cultures

Fast entry; known, established High cost, integration issues with home
Acquisition
operations office

Gain local market knowledge; can

High cost, high risk due to unknowns,
Greenfield Venture be seen as insider who employs
slow entry due to setup time
locals; maximum control

Table 9.1 International-Expansion Entry Modes

 Exporting
- It is the marketing and direct sale of domestically produced goods in another country. Exporting is a traditional
and well-established method of reaching foreign markets.
- It does not require that the goods be produced in the target country, no investment in foreign production
facilities is required.

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- Most of the costs associated with exporting take the form of marketing expenses.

- While relatively low risk, exporting entails substantial costs and limited control.

- Exporters typically have little control over the marketing and distribution of their products, face high
transportation charges and possible tariffs, and must pay distributors for a variety of services.

- What is more, exporting does not give a company firsthand experience in staking out a competitive position
abroad, and it makes it difficult to customize products and services to local tastes and preferences.

- Exporting is a typically the easiest way to enter an international market, and therefore most firms begin their
international expansion using this model of entry.

- Exporting is the sale of products and services in foreign countries that are sourced from the home country. The
advantage of this mode of entry is that firms avoid the expense of establishing operations in the new country.

Why Do Companies Export?

Companies export because it’s the easiest way to participate in global trade, it’s a less costly investment than the
other entry strategies, and it’s much easier to simply stop exporting than it is to extricate oneself from the other entry
modes. An export partner in the form of either a distributor or an export management company can facilitate this process.

Benefits of Exporting:

 Market. The company has access to a new market, which has brought added revenues

 Money. It has gained access to foreign currency, which benefits companies located in certain
regions of the world, such as in Vitrac’s home country of Egypt.

 Manufacturing. The cost to manufacture a given unit decreased because Vitrac has been able to
manufacture at higher volumes and buy source materials in higher volumes, thus benefitting from
volume discounts.

Risk of Exporting:

 The distributor or buyer might switch to or at least threaten to switch to a cheaper supplier in order
to get a better price.

 Someone might start making the product locally and take the market from you.

 Local buyers sometimes believe that a company which only exports to them isn’t very committed to
providing long-term service and support once a sale is complete.

 Indirect Exporting

It means selling to an intermediary, who in turn sells your products either directly to customers or to importing
wholesalers. The easiest method of indirect exporting is to sell to an intermediary in your own country. When selling by
this method, you normally are not responsible for collecting payment from the overseas customer, nor for
coordinating the shipping logistics.

Benefits of Indirect Exporting:

 It is an almost risk-free way to begin.

 It demands minimal involvement in the export process.

 It allows business people to continue to concentrate on your domestic business.

 Business people have limited liability for product marketing problems—there's always someone else
to point the finger at!

Risk of Indirect Exporting:

 Profits are lower.

 Business people lose control over foreign sales.
 Business people very rarely know who your customers are, and thus lose the opportunity to tailor your
offerings to their evolving needs.
 The intermediary might also be offering products similar to yours, including directly competitive
products, to the same customers instead of providing exclusive representation.

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 Indirect Importing

In case of economics when demand for good is more than the supply of good than the price of good increases
but what if supply of goods of the whole country is less than the total demand of the whole country than the country
will have to buy goods from other countries so as to meet demand of the country and under this situation the country
will have to resort to imports.

Imports refer to buying of goods by the local manufacturers and companies from outside the country and the
companies or individuals who are importing goods from other countries are called importers. Imports are usually
discouraged by governments because due to import the country’s foreign exchanges reserves get depleted as
importing leads to outflow of foreign exchange of the country.

Benefits of Importing:

 Reduction in Manufacturing Cost. As far as companies are concerned importing from other nations
can result in an increase in the bottom line of the company if the company is able to find cheaper
raw materials in other parts of the world.

 Helpful during Emergency Situations. Imports in a way helps the country in averting any anarchy by
avoiding a temporary shortage of resources.

 Helpful in Strategic Relations. If country wants to have good strategic relations with other countries
of the world than it has to do both imports as well as exports.

Risks of Importing:

 Outflow of Foreign Exchange. When companies purchase goods from other parts of the world than
it has to pay them in their currency and when these importers buy foreign currency it leads to
pressure on the domestic currency due to selling of domestic currency by the importers which in turn
leads to reduction in foreign exchange of the country.

 Country and Currency Risk. When country imports raw materials and other products from other
countries than domestic industries and manufacturers are hit because if imports are cheaper than
local goods than few people will buy local goods and due to less demand ultimately industries or
companies will be closed as they cannot keep absorbing losses for long periods.

 Licensing and Franchising

- A company that wants to get into an international market quickly while taking only limited financial and
legal risks might consider licensing agreements with foreign companies.

- An international licensing agreement allows a foreign company (the licensee) to sell the products of a
producer (the licensor) or to use its intellectual property (such as patents, trademarks, copyrights) in
exchange for royalty fees.

- Licensing gives a licensee certain rights or resources to manufacture and/or market a certain product in a
host country.

- It is a business arrangement in which one company gives another company permission to manufacture its
product for a specified payment.

- Defined as the granting of permission by the licenser to the licensee to use intellectual property rights, such
as trademarks, patents, brand names, or technology, under defined conditions.

Here’s how it works:

You own a company in the United States that sells coffee-flavored popcorn. You’re sure that your product
would be a big hit in Japan, but you don’t have the resources to set up a factory or sales office in that country.
You can’t make the popcorn here and ship it to Japan because it would get stale. So you enter into a licensing
agreement with a Japanese company that allows your licensee to manufacture coffee-flavored popcorn using
your special process and to sell it in Japan under your brand name. In exchange, the Japanese licensee would
pay you a royalty fee.

- Licensing essentially permits a company in the target country to use the property of the licensor.
Such property is usually intangible, such as trademarks, patents, and production techniques.

- The licensee pays a fee in exchange for the rights to use the intangible property and possibly for
technical assistance as well.

To summarize, in this foreign market entry mode, a licensor in the home country makes limited rights or
resources available to the licensee in the host country.

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The rights or resources may include patents, trademarks, managerial skills, technology, and others that can
make it possible for the licensee to manufacture and sell in the host country a similar product to the one the licensor
has already been producing and selling in the home country without requiring the licensor to open a
new operation overseas. The licensor’s earnings usually take the form of one-time payments, technical fees,
and royalty payments, usually calculated as a percentage of sales.

Reasons to use international licensing for expanding internationally:

 Obtain extra income for technical know-how and services.

 Reach new markets not accessible by export from existing facilities.
 Quickly expand without much risk and large capital investment.
 Pave the way for future investments in the market.
 Retain established markets closed by trade restrictions.
 Political risk is minimized as the licensee is usually 100% locally owned

Reasons NOT to use international licensing for expanding internationally:

 Lower income than in other entry modes.

 Loss of control of the licensee manufacture and marketing operations and practices leading to loss
of quality.
 Risk of having the trademark and reputation ruined by an incompetent partner.
 The foreign partner also can become a competitor by selling its products in places where the
parental company has a presence.

 Contract Manufacturing and Franchising

- It happens when companies manufacture their products in countries where labor costs are lower because
of high domestic labor costs

- Franchising is the practice of licensing another firm’s business model as an operator.

- It is the practice of using another firm’s successful business model. For the franchiser, the franchise is an
alternative to building “chain stores” to distribute goods that avoids the investments and liability of a chain.

- The franchiser’s success depends on the success of the franchisees. The franchisee is said to have a
greater incentive than a direct employee because he or she has a direct stake in the business.

- Similar to a licensing agreement, under a franchising agreement, the multinational firm grants rights on its
intangible property, like technology or a brand name, to a foreign company for a specified period of time
and receives a royalty in return.

Terms

Franchisee: A holder of a franchise; a person who is granted a franchise.

Franchising: The establishment, granting, or use of a franchise.
Franchise: The authorization granted by a company to sell or distribute its goods or services in a certain area.
Franchiser: A franchisor, a company which or person who grants franchises.

- Contract Manufacturing is a manufacturer that enters into a contract with a firm to produce components
or products for that firm. It is a form of outsourcing

- In contract manufacturing, a hiring firm makes an agreement with the contract manufacturer to produce
and ship the hiring firm’s goods.

- In a contract manufacturing business model, the hiring firm approaches the contract manufacturer with a
design or formula.

Reasons to use contract manufacturing:

 Cost Savings. Companies save on their capital costs because they do not have to pay for
a facility and the equipment needed for production. They can also save on labor costs such
as wages, training, and benefits. Some companies may look to contract manufacture in low-cost
countries, such as China, to benefit from the low cost of labor.

 Mutual Benefit to Contract Site. A contract between the manufacturer and the company it is
producing for may last several years. The manufacturer will know that it will have a steady flow of
business at least until that contract expires.

 Advanced Skills. Companies can take advantage of skills that they may not possess, but the
contract manufacturer does. The contract manufacturer is likely to have relationships formed with
raw material suppliers or methods of efficiency within their production.

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 Quality. Contract Manufacturers are likely to have their own methods of quality control in place that
help them to detect counterfeit or damaged materials early.

 Focus. Companies can focus on their core competencies better if they can hand off base
production to an outside company.

 Economies of Scale. Contract Manufacturers have multiple customers that they produce for.
Because they are servicing multiple customers, they can offer reduced costs in acquiring raw
materials by benefiting from economies of scale. The more units there are in one shipment, the less
expensive the price per unit will be.

Reasons to use contract manufacturing:

 Lack of Control. When a company signs the contract allowing another company to produce their
product, they lose a significant amount of control over that product.

 Relationships. It is imperative that the company forms a good relationship with its contract
manufacturer. The company must keep in mind that the manufacturer has other customers. They
cannot force them to produce their product before a competitor’s.

 Quality. When entering into a contract, companies must make sure that the
manufacturer’s standards are congruent with their own. They should evaluate the methods in which
they test products to make sure they are of good quality.

 Intellectual Property Loss. When entering into a contract, a company is divulging their formulas or
technologies. This is why it is important that a company not give out any of its core competencies to
contract manufacturers.

 Outsourcing Risks. Although outsourcing to low-cost countries has become very popular, it does
bring along risks such as language barriers, cultural differences, and long lead times. This could make
the management of contract manufacturers more difficult, expensive, and time-consuming.

 Capacity Constraints. If a company does not make up a large portion of the contract
manufacturer’s business, they may find that they are de-prioritized over other companies during high
production periods.
 Loss of Flexibility and Responsiveness. Without direct control over the manufacturing facility, the
company will lose some of its ability to respond to disruptions in the supply chain.

 Acquisitions

- It is a transaction in which a firm gains control of another firm by purchasing its stock, exchanging the stock
for its own, or, in the case of a private firm, paying the owners a purchase price. In our increasingly flat
world, cross-border acquisitions have risen dramatically.

- These are appealing because they give the company quick, established access to a new market.
However, they are expensive, which in the past had put them out of reach as a strategy for companies in
the undeveloped world to pursue.

- When deciding whether to pursue an acquisition strategy, firms examine the laws in the target country.

- Acquisition is a good entry strategy to choose when scale is needed, which is particularly the case in
certain industries (e.g., wireless telecommunications). Acquisition is also a good strategy when an industry
is consolidating.

CLASS DELIGHT

Discussion Question

Why do managers and business people need to consider the different entry modes, such as exporting, licensing,
franchising, establishing joint ventures with a host-country firm, or setting up a new wholly-owned subsidiary in the host
county, when deciding which to use?

SOURCES

 Hill, C. International Business: Competing in the Global Marketplace 9E. University of Washington
 The World Wide Web

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