Dilla University College of Business and Economics Department of logistics and supply

chain Management Global Supply Chain Management hand-out

Chapter Three
Entering Foreign Markets
Introduction
International business holds out the promise of large new market areas, yet firms cannot
simply jump into the international marketplace and expect to be successful. They must adjust
to needs and opportunities abroad, have quality products, understand their customers, and do
their homework to comprehend the vagaries of international markets. The rapid globalization
of markets, however, reduces the time available to adjust to new market realities.
This chapter is concerned with firms preparing to enter international markets and companies
expanding their current international activities. Initial emphasis is placed on export activities
with a focus on the role of management in starting up international operations and a
description of the basic stimuli for international activities.
Entry modes for the international arena are highlighted, and the problems and benefits of
each mode are discussed. The roles of facilitators and intermediaries in international business
are described. Finally, alternatives that involve a local presence
3.1. MOTIVATION TO GO ABROAD
Normally, management will consider international activities only when stimulated to do so. A
variety of motivations can push and pull individuals and firms along the international path.
An overview of the major motivations that have been found to make firms go international is
provided in Table below. Proactive motivations represent stimuli for firm-initiated strategic
change. Reactive motivations describe stimuli that result in a firm’s response and adaptation
to changes imposed by the outside environment. In other words, firms with proactive
motivations go international because they want to; those with reactive motivations go
international because they have to.
1. PROACTIVE MOTIVATIONS
I. Profitability
Profits are the major proactive motivation for international business. Management may
perceive international sales as a potential source of higher profit margins or of more added-on
profits. Of course, the profitability expected when planning to go international is often quite
different from the profitability actually obtained.
Profitability is often linked with international growth yet many corporate international entry
decisions are made based on expectations of market growth rather than on actual market
growth. Particularly in start-up operations, initial profitability may be quite low due to the
cost of getting ready for going international and the losses resulting from early mistakes. The
gap between expectation and reality may be especially large when the firm has not previously
engaged in international business.
Even with thorough planning, unexpected influences can change the profit picture
substantially. Shifts in exchange rates, for example, may drastically affect profit forecasts.
II. Unique products or a technological advantage
Unique products or a technological advantage can be another major stimulus. A firm may
produce goods or services that are not widely available from international competitors.
Again, real and perceived advantages must be differentiated. Many firms believe that they
Dilla University College of Business and Economics Department of logistics and supply
chain Management Global Supply Chain Management hand-out

offer unique products or services, even though this may not be the case internationally. If
products or technologies are unique, however, they certainly can provide a competitive edge.
What needs to be considered is how long such an advantage will last. The length of time is a
function of the product, its technology, and the creativity of competitors. In the past, a firm
with a competitive edge could often count on being the sole supplier to foreign markets for
years to come. This type of advantage has shrunk dramatically because of competing
technologies and the frequent lack of international patent protection.
III. Exclusive information
Special knowledge about foreign customers or market situations may be another `proactive
stimulus. Such knowledge may result from particular insights by a firm, special contacts an
individual may have, in-depth research, or simply from being in the right place at the right
time (e.g., recognizing a good business situation during a vacation trip). Although such
exclusivity can serve well as an initial stimulus for international business, it will rarely
provide prolonged motivation because competitors can be expected to catch up with the
information advantage. Only if firms build up international information advantage as an on-
going process through, for example, broad market scanning or special analytical capabilities,
can prolonged corporate strategy be based on this motivation.
IV. Tax benefit
Tax benefits can also play a major motivating role. Many governments use preferential tax
treatment to encourage exports. As a result of such tax benefits, firms either can offer their
product at a lower cost in foreign markets or can accumulate a higher profit. However,
international trade rules make it increasingly difficult for governments to use tax subsidies to
encourage exports.
V. Economies of scale
A final major proactive motivation involves economies of scale. International activities may
enable the firm to increase its output and therefore rise more rapidly on the learning curve.
The Boston Consulting Group has shown that the doubling of output can reduce production
costs up to 30 percent. Additionally, studies have shown that the benefits of centralized
production are substantial enough to offset any increases in transportation costs. Therefore,
increased production for international markets can help reduce the cost of production and
make the firm more competitive domestically
2. REACTIVE MOTIVATIONS
Reactive motivations influence firms to respond to environmental changes and pressures
rather than blaze new trails.
a. Competitive pressures
Competitive pressures are one example. A company may worry about losing domestic market
share to competing firms that have benefited from the economies of scale gained through
international business activities.
Further, it may fear losing foreign markets permanently to competitors that have decided to
focus on these markets. Because market share usually is most easily retained by firms that
initially obtain it, some companies may enter the international market head over heels. Quick
Dilla University College of Business and Economics Department of logistics and supply
chain Management Global Supply Chain Management hand-out

entry, however, may result in equally quick withdrawal once the firm recognizes that its
preparation has been inadequate.
b. Overproduction
Similarly, overproduction may represent a reactive motivation. During downturns in the
domestic business cycle, foreign markets can provide an ideal outlet for excess inventories.
International business expansion motivated by overproduction usually does not represent full
commitment by management, but rather a temporary safety valve. As soon as domestic
demand returns to previous levels, international business activities are curtailed or even
terminated. Firms that have used such a strategy once may encounter difficulties when trying
to employ it again because many international customers are not interested in temporary or
sporadic business relationships.
c. Declining domestic sales
Declining domestic sales, whether measured in sales volume or market share, have a similar
motivating effect. Goods marketed domestically may be at the declining stage of their
product life cycle. Instead of attempting to push back the life cycle process domestically, or
in addition to such an effort, firms may opt to prolong the product life cycle by expanding the
market. Such efforts often meet with success, particularly with high– technology products
that are outmoded by the latest innovation. Such ‘‘just-dated’’ technology may enable vast
progress in manufacturing or services industries and, most importantly, may make such
progress affordable. For example, a hospital without any imaging equipment may be much
better off acquiring a ‘‘just-dated’’ MRI machine, rather than waiting for enough funding to
purchase the latest state-of-the-art equipment.
d. Excess capacity
Excess capacity can also be a powerful motivator. If equipment for production is not fully
utilized, firms may see expansion abroad as an ideal way to achieve broader distribution of
fixed costs. Alternatively, if all fixed costs are assigned to domestic production, the firm can
penetrate foreign markets with a pricing scheme that focuses mainly on variable cost. Yet
such a view is feasible only for market entry. A market penetration strategy based on variable
cost alone is unrealistic because, in the long run, fixed costs have to be recovered to replace
production equipment.
e. Saturated domestic market
The reactive motivation of a saturated domestic market has similar results to that of declining
domestic sales. Again, firms in this situation can use the international market to prolong the
life of their good and even of their organization.
f. proximity to customers
A final major reactive motivation is that of proximity to customers and ports. Physical and
psychological closeness to the international market can often play a major role in the
international business activities of the firm. For example, a firm established near a border
may not even perceive itself as going abroad if it does business in the neighboring country.
In this context, the concept of psychic or psychological distance needs to be understood.
Geographic closeness to foreign markets may not necessarily translate into real or perceived
closeness to the foreign customer. Sometimes complex cultural variables, such as language,
Dilla University College of Business and Economics Department of logistics and supply
chain Management Global Supply Chain Management hand-out

religion, legal, and political systems, make a geographically close foreign market seem
psychologically distant.
S. N Major Motivation to Firms
Proactive Motivations Reactive Motivations
1. Profit advantage Competitive pressures
2. Unique products Overproduction
3. Technological advantage Stagnant or declining domestic sales
4. Exclusive information Excess capacity
5. Tax benefit Saturated domestic markets
6. Economies of scale Proximity to customers and ports

3.2. Foreign Market Entry Modes

Here we will present the most typical international entry and expansion strategies.
These are exporting and importing, licensing, and franchising. Another key way to expand
is through a local presence, either via inter-firm cooperation or foreign direct investment.
These can take on many forms such as contractual agreements, equity participation and joint
ventures, or direct investment conducted by the firms alone.
i. EXPORTING AND IMPORTING
Firms can be involved in exporting and importing in an indirect or direct way.
Indirect involvement means that the firm participates in international business through an
intermediary and does not deal with foreign customers or firms.
Direct involvement means that the firm works with foreign customers or markets with the
opportunity to develop a relationship. Firms typically opt for direct involvement based on
cost decisions. Transaction cost theory postulates that firms will evaluate and compare the
costs of integrating an operation internally, as compared to the cost of using an external party
to act for the firm abroad. Once it becomes easier and more efficient for a firm to conduct all
the research, negotiations, shipping, and monitoring itself, rather than paying someone else to
do it, the firm is likely to become a direct exporter or importer.
The end result of exporting and importing is similar whether the activities are direct or
indirect. In both cases, goods and services either go abroad or come to the domestic market
from abroad, and goods may have to be adapted to suit the targeted market. However, the
different approaches have varying degrees of impact on the knowledge and experience levels
of firms. The less direct the involvement of the firm, the less likely is the internal
development of a storehouse of information and expertise on how to do business abroad,
information that the firm can draw on later for further international expansion. Therefore,
while indirect activities represent a form of international market entry, they may not result in
growing management commitment to international markets or increased capabilities in
serving them.
ii. LICENSING
Under a licensing agreement, one firm permits another to use its intellectual property for
compensation designated as royalty. The recipient firm is the licensee. The property licensed
might include patents, trademarks, copyrights, technology, technical know-how, or specific
Dilla University College of Business and Economics Department of logistics and supply
chain Management Global Supply Chain Management hand-out

business skills. For example, a firm that has developed a bag-in-the-box packaging process
for milk can permit other firms abroad to use the same process. Licensing therefore can also
be called the export of intangibles.
 Licensing agreement an agreement in which one firm permits another to use its
intellectual property in exchange for compensation.

Licensing has intuitive appeal to many would-be international managers. As an entry

strategy, it requires neither capital investment nor detailed involvement with foreign
customers. By generating royalty income, licensing provides an opportunity to exploit
research and development already conducted. After initial costs, the licensor can reap benefits
until the end of the license contract period. Licensing also reduces the risk of expropriation
because the licensee is a local company that can provide leverage against government action.

A special form of licensing is trademark licensing, which has become a substantial source
of worldwide revenue for companies that can trade on well-known names and characters.
Trademark licensing permits the names or logos of designers, literary characters, sports
teams, or movie stars to appear on clothing, games, foods and beverages, gifts and novelties,
toys, and home furnishings. Licensors can make millions of dollars with little effort, while
licensees can produce a brand or product that consumers will recognize immediately.
Trademark licensing is possible, however, only if the trademark name conveys instant
recognition.
 Trademark licensing providing someone the right to use an established brand
symbol in exchange for payment.

iii. FRANCHISING

Franchising A form of licensing that allows a distributor or retailer exclusive rights to sell a
product or service in a specified area.

Franchising is the granting of the right by a parent company (the franchisor) to another,
independent entity (the franchisee) to do business in a prescribed manner.
The right can take the form of selling the franchisor’s products, using its name, production,
and marketing techniques, or using its general business approach. Usually franchising
involves a combination of many of those elements. The major forms of franchising are
manufacturer-retailer systems (such as car dealerships), manufacturer- wholesaler systems
(such as soft drink companies), and service-firm retailer systems (such as lodging services
and fast-food outlets).
Typically, to be successful in international franchising, the firm must be able to offer unique
products or unique selling propositions.
A franchise must also offer a high degree of standardization, which does not require 100%
uniformity, but rather, international recognizability. Concurrent with this recognizability, the
franchisor can and should adapt to local circumstances.
Dilla University College of Business and Economics Department of logistics and supply
chain Management Global Supply Chain Management hand-out

Food franchisors, for example, will vary the products and product lines offered, depending on
local market conditions and tastes.
iv. INTERFIRM COOPERATION
The world is too large and the competition too strong for even the largest companies to do
everything independently. Technologies are converging and markets are becoming integrated,
thus making the costs and risks of both goods and market development ever greater. Partly as
a reaction to and partly to exploit the developments, management in multinational
corporations has become more pragmatic about what it takes to be successful in global
markets. The result has been the formation of strategic alliances with suppliers, customers,
competitors, and companies in other industries to achieve multiple goals.

A strategic alliance (or partnership) is an informal or formal arrangement between two or

more companies with a common business objective. It is something more than the traditional
customer-vendor relationship but something less than an outright acquisition.
The alliances can take forms ranging from informal cooperation to joint ownership of
worldwide operations.
v. FULL OWNERSHIP / FOREIGN DIRECT INVESTMENT (FDI)
For some firms, foreign direct investment requires, initially at least, 100 percent ownership.
The reason may have an ethnocentric basis; that is, management may believe that no outside
entity should have an impact on corporate decision making. Alternatively, it may be based on
financial concerns. For example, in 2009, Starbucks Coffee Company assumed full control of
the Starbucks business in France, which was previously operated through a joint venture with
Sigla S.A. (Grupo Vips) of Spain. The ownership switch was motivated by potential increases
in profitability and operational efficiency in the growing French market. Starbucks had
opened its first location at the Paris Opera House in 2004.56 In order to make a rational
decision about the extent of ownership; management must evaluate the extent to which total
control is important to the success of its international marketing activities.
vi. Joint Venture
 It is the establishment of a firm that is jointly owned by two or more otherwise
independent firms.
 Joint venture is a contractual partnership between two or more separate business
entities to pursue a business opportunity together.
 The partners in an equity joint venture each contribute capital and resources in
exchange for an equity stake and share in any resulting profits. (In a non-equity joint
venture, there is no contribution of capital to form a new entity.)
 A joint venture may be the only way to enter certain countries where, by law,
foreigners cannot own a business.
 In other situations, joint ventures let companies pool technological knowledge share
the expense and risk of research that may not produce marketable goods.
Advantages and disadvantages of the entry modes

Entry Mode Advantages disadvantages

Exporting  Ability to realize location  High transport costs
Dilla University College of Business and Economics Department of logistics and supply
chain Management Global Supply Chain Management hand-out

and scale economies  Trade barriers

 Problems with local marketing agents
Licencing  Low development costs  Inability to realize location and scale
and risks economies
 Inability to engage in global strategic
coordination
 Lack of control over technology
Franchising  Low development costs  Inability to engage in global strategic
coordination
 Lack of control over quality

Joint venture  Access to local partner’s  Inability to engage in global strategic

knowledge coordination
 Shared development costs  Inability to realize location and scale
and risks economies
  Lack of control over technology.

Wholly Owned  Protection of technology  High costs and risks

Subsidiaries  Ability to engage in
global strategic
coordination
 Ability to realize location
and scale economies

3.3. Choice of Entry Modes

 The optimal choice of entry mode involves trade-offs. The factors firms should
consider in choosing appropriate mode include:
A. Firms core competencies/ source of competitive advantage;
• Technological know-how,
 Licensing
• Management know-how, and
 Franchise
 Joint venture
B. Pressure for cost reduction
The optimal entry mode depends to some degree on the nature of a firm’s core competencies.
A firm with a competitive advantage based on proprietary technological know-how should
avoid licensing and Joint venture arrangements in order to minimize the risk of losing control
over the technology.
If a firm believes its technological advantage is only transitory, or the firm can establish its
technology as the dominant design in the industry, then licensing may be appropriate even if
it does involve the loss of know-how.
The competitive advantage of many service firms is based upon management know-how.
The risk of losing control over the management skills to franchisees or joint venture partners
is not high, and the benefits from getting greater use of brand names are significant
Dilla University College of Business and Economics Department of logistics and supply
chain Management Global Supply Chain Management hand-out

The greater the pressures for cost reductions, the more likely a firm will want to pursue some
combination of exporting and wholly owned subsidiaries.
This will allow it to achieve location and scale economies as well as retain some degree of
control over its worldwide product manufacturing and distribution.
Which Markets to Enter?
Favorable markets

 Politically stable nations (both developed and developing)

 Have free market systems
 There is no dramatic increase in either inflation rates, or private sector debt.

Less desirable Markets

 Politically unstable
 a mixed or command economy,
 Nations where speculative financial bubbles have led to excess borrowing.

3.4. The Global Business Strategies

A firm’s strategy can be defined as the actions that managers take to attain the goals of the firm.
Firms that compete in the global marketplace typically face two types of competitive pressures:

 pressures for cost reductions

 pressures to be locally responsive

Pressures for cost reductions

Pressure for cost reduction is greatest in industries producing commodity type products that fill
universal needs (needs that exist when the tastes and preferences of consumers in different nations
are similar if not identical)

 where price is the main competitive weapon

 when major competitors are based in low cost locations

 where there is persistent excess capacity

 where consumers are powerful and face low switching costs

Pressure for local responsiveness

Pressures for local responsiveness arise from:

 differences in consumer tastes and preferences

 differences in traditional practices and infrastructure

 differences in distribution channels

 host government demands

 Dilla University College of Business and Economics Department of logistics and supply
chain Management Global Supply Chain Management hand-out

Depending on the strength of pressures for cost reductions and for local responsiveness, companies
typical make a choice among four main strategic postures when competing internationally:

 a global standardization strategy,

 a localization strategy,

 a transnational strategy, and

 An international strategy.

Pressures for local responsiveness

Low High
Pressures for cost reductions

Global
High

Transnational
standardization
strategy
strategy

Localization/
Low

International
Multi domestic
strategy
strategy

a. Global Standardization Strategy

In this strategy, a firm takes its existing products and sells them in other countries without making
changes to the product. A global standardization strategy focuses on increasing profitability and profit
growth by reaping the cost reductions that come from economies of scale, learning effects, and
location economies. The strategic goal is to pursue a low-cost strategy on a global scale. This strategy
makes sense when there are strong pressures for cost reductions and demands for local responsiveness
are minimal. Under this strategy, products are much more likely to be standardized rather than
Dilla University College of Business and Economics Department of logistics and supply
chain Management Global Supply Chain Management hand-out

tailored to local markets. One way to think about global strategies is that if the world is flat, you can
sell the same products and services in the same way in every country on the planet. The strategic
business units operating in each country are assumed to be interdependent, and the home office
attempts to achieve integration across these businesses. Therefore, a global strategy emphasizes
economies of scale and offers greater opportunities to utilize innovations developed at the corporate
level or in one country in other markets.

The advantages of this strategy are that the company doesn’t need to invest in new research,
development, or manufacturing. Changes may be made in packaging and labeling, but these are driven
by local regulatory requirements.

The disadvantages, however, are that its products may not be well suited to local needs.

b. Localization (Multi-domestic) Strategy

This strategy is about product adaptation that means modifying the company’s existing product in a
way that makes it fit better with local needs. It focuses on increasing profitability by customizing the
firm’s goods or services so that they provide a good match to tastes and preferences in different
national markets. For example, mobile-phone maker Nokia uses local designers to create mobile-
phone handset models that are specifically appropriate for each country. Consequently, the handsets
designed in India are dust resistant and have a built-in flashlight. The models designed in China have
a touch-screen, stylish and Chinese character recognition. Localization is most appropriate when there
are substantial differences across nations with regard to consumer tastes and preferences, and where
cost pressures are not too intense. The disadvantage of a multi-domestic strategy is that the firm faces
more uncertainty because of the tailored strategies in different countries. In addition, because the firm
is pursuing different strategies in different locations, it cannot take advantage of economies of scale
that could help decrease costs for the firm overall.

c. Transnational Strategy

A transnational strategy tries to simultaneously:

 Achieve low costs through location economies, economies of scale, and learning effects.

 Differentiate the product offering across geographic markets to account for local differences.

 Foster a multidirectional flow of skills between different subsidiaries in the firm’s global
network of operations.

 Transnational strategy seeks to combine the best of multi-domestic strategy and a global
strategy to get both global efficiency and local responsiveness.

 For many industries, given the differences across markets and the similarities being fostered
by the flatteners, this form of strategy is highly desirable and appropriate.

The difficulty is that combining the multi-domestic and global strategies is hard to do because it
requires fulfilling the dual goals of flexibility and coordination. Firms must balance opposing
local and global goals.
Dilla University College of Business and Economics Department of logistics and supply
chain Management Global Supply Chain Management hand-out

On the positive side, firms that effectively implement a transnational strategy often outperform
competitors who use either the multi-domestic or global corporate-level strategies. A transnational
strategy makes sense when cost pressures are intense, and simultaneously, so are pressures for
local responsiveness.

d. International Strategy

An international strategy involves taking products first produced for the domestic market and then
selling them internationally with no or only minimal local customization. When there are low cost
pressures and low pressures for local responsiveness, an international strategy is appropriate.

In a nutshell

An international strategy may not be viable in the long term. To survive, firms may need to shift to a
global standardization strategy or a transnational strategy in advance of competitors.

Similarly, localization may give a firm a competitive edge, but if the firm is simultaneously facing
aggressive competitors, the company will also have to reduce its cost structures, and the only way to
do that may be to shift toward a transnational strategy.

In summary, the four basic global operations strategies are:

 The multi-domestic strategy decentralizes operating decisions to each country to enhance

local responsiveness. The primary example is McDonald's.

 The global strategy centralizes operating decisions, with the headquarters coordinating the
standardization and learning between facilities. Example is Caterpillar.

 The international strategy uses exports and licenses to penetrate the global markets. Example
may include any liquor store such as Whisky, Vodka...

 The transnational strategy exploits the economies of scale and learning, as well as pressure for
responsiveness, by recognizing that core competence does not reside in just the "home"
country, but can exist anywhere in the organization. Examples include Reuters and Nestlé.

Chapter Summary

 A firm expanding internationally must decide which markets to enter, when to enter them and
on what scale, and how to enter them (the choice of entry mode)

 Before entering to new foreign markets, a company needs to understand the needs of the new
international market through due diligence process, recognize regional differences within a
country of the new international market, and understand industry dynamics.

 The choice between different foreign markets is based on an assessment of their long run
profit potential affected by several factors.

 Firms need to weigh the first mover advantages and disadvantages in determining the timing
of entering into a foreign market.

 Exporting is one of the methods that organizations can use to enter foreign markets.
Dilla University College of Business and Economics Department of logistics and supply
chain Management Global Supply Chain Management hand-out

 In this entry method, products produced in one country are marketed in another country
through marketing and distribution channels.

 In a wholly owned subsidiary, the firm owns 100 percent of the stock.

 Another name of wholly owned subsidiary is Foreign Direct Investment (FDI).

 Foreign direct investment (FDI) refers to an investment in or the acquisition of foreign assets
with the intent to control and manage them.

 FDI is primarily a long-term strategy.

 The optimal choice of entry mode involves trade-offs.

 Core competencies, technological know-how, management know-how, and pressure for cost
reduction are some of the factors we should consider in choosing appropriate mode.