CHAPTER THREE

INTERNATIONAL MARKET ENTRY

DECISIONS
 CHAPTER THREE
INTERNATIONAL MARKET ENTRY DECISIONS

There are basically eight ways to enter a foreign market:

1. Exporting,
2. turnkey projects,
3. licensing,
4. franchising,
5. management contracts,
6. joint venturing with a host-country firm, and
7. Strategic Alliance
8. setting up a wholly owned subsidiary in the
host country.
Managers need to consider these carefully when deciding which entry mode to use.
1. Exporting

• Most manufacturing firms begin their global

expansion as exporters and only later switch to
another mode for serving a foreign market.
Advantages:
 It allows a company to centrally manufacture its
products and, therefore obtain economies of scale.

 Since exports represent incremental volume of an

existing production, their marginal profitability will
be high.
 Cont…

 It avoids the costs of establishing manufacturing

operations in the host country, which are often
substantial.
 Helps the firm to realize substantial scale of
economies from its global sales volume.
Disadvantages:
 Exporting from the firm’s home base may not be
appropriate if there are lower-cost locations for
manufacturing the product abroad.
 Cont…

 High transport costs can make it

uneconomical, particularly for bulk products.
 Tariff barriers can make it uneconomical &
very risky.
 Foreign agents may not do as good a job as
the firm would if it managed its marketing
itself.
2. Turnkey projects

• When the contractor agrees to handle every detail of the

project for a foreign client including the training of
operation personnel.
• At completion of the contract, the foreign client handled
the “key” to a plant that is ready for full operation –hence
the term turnkey.
• A type of project that is constructed by a developer and
sold or turned over to a buyer in a ready-to-use condition.
• It is just a very specialized kind of exporting.
• Most common in the chemical, pharmaceutical, petroleum
refining, and metal refining industries:
 all of which use complex, expensive production-
process technologies.
 Cont…
• A turnkey project is a project where an organization or
company performs all the activities from design to
operational testing before the project is turned over to
another enterprise to operate.
• Such projects are at times referred to as BOOT (build,
own, operate, transfer).
• Examples of turnkey projects are move-in ready homes
that are already furnished.
• These homes won't need extensive renovations to be
livable, and it will be ready for occupancy as soon as
the real estate agency or firm gives you the keys.
• Turnkey projects are also used in business and
government owned housing projects
 Cont…
• An outside developer does all the work to produce the
end product including:
 purchasing the land,
 getting the necessary building permits,
 hiring the plumbers, electricians, and other skilled
trades people,
 building the housing units, and
 furnishing them with appliances.
• They then sell the project to the government entity.
• In general a turnkey project is one that is completed to
the point that it could be sold or given away to another
person.
Advantages:
 They are a way of earning great economic returns
from the asset.
 (The know-how required to assemble and run a
technologically complex process, such as refining
petroleum or steel, is a valuable asset.)
 Useful in cases where FDI is limited by host-
government regulations.
 Useful to invest in a country were the political and
economic environment is unstable
– (e.g., the risk of nationalization or of economic
collapse)
Disadvantages:

 Problem of having no long-term interest in the

foreign country.
 Risk of inadvertently creating a competitor. (the
foreign enterprise)
 If the firm’s 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 competition.
3. Licensing
• When a company assigns the right to a patent
(which protects a product, technology, or process),
or a trade mark (which protects product name) to
another company for a fee or royalty.
• A company can gain market presence without an
equity investment.
• The foreign company or licensee, gains the right to
commercially exploit the patent or trade mark either
on exclusive or unrestricted basis.
 Cont…

• A licensing agreement is an arrangement whereby a

licensor grants the rights to intangible property to
another entity (the licensee) for a specified period of
time, and in return, the licensor receives a royalty
fee from the licensee.

• Intangible property includes patents, inventions,

formulas, processes, designs, copyrights and
trademarks.
• Example: Dream Works 2oth
Century Fox
Advantages:
 No development costs and risks associated with opening
a foreign market. FAC /Zero
 Is a very attractive option for firms lacking the capital to
develop operations overseas.
 Preferable when a firm is unwilling to commit
substantial financial resources to an unfamiliar or
politically volatile foreign market.
 when a firm wishes to participate in a foreign market but
is prohibited from doing so by barriers to investment.
 a company may not have the knowledge or the time to
engage more actively in international marketing.
Disadvantages:

 limits the firm’s ability to realize experience curve

and location economies.
 A licensee is unlikely to allow a multinational firm to
use its profits to support a different licensee
operating in another country.
 A firm can quickly lose control over its technology
(technological know-how) by licensing it.
 Insuring a uniform quality requires additional
resources from the licensor that may reduce the
profitability.
4. Franchising

• Franchising involves longer-term commitments than

licensing. (but almost similar)
• Franchising is basically a specialized form of licensing in
which the franchisor not only sells intangible property
to the franchisee (normally a trademark),
– but also insists the franchisee agree to abide by strict
rules as to how it does business.
• The franchisor will also often assist the franchisee to
run this business on an ongoing basis.
• As with licensing the franchisor typically receives a
royalty payment that amounts to some percentage of
the franchisee’s revenues.
 Cont…

• Whereas licensing is pursued primarily by

manufacturing firms, franchising is employed
primarily by service firms.
• McDonald's continues to be recognized as a premier
franchising company around the world. More than
80% of its restaurants worldwide are owned and
operated by its Franchisees.
• McDonald’s provides us with a good example of a
firm that has grown by using a franchising strategy.
 Cont…
It has set down strict rules as to how franchisees
should operate a restaurant.
These rules extended to control over the menu,
cooking methods, staffing policies, and the
design and location of a restaurant.
It also organizes the supply chain for its
franchisees and provided management training
and financial assistance for franchisees.
Other Examples
• KFC, Pizza-Hut, Starbucks, Burger king, Nandos,
Wal-Mart, Subway, and Hilton Hotels
 Cont…
• For the franchisor, the franchise is an alternative to
building 'chain stores' to distribute goods that avoids
the investments and liability of a chain.
• The franchisor's success depends on the success of
the franchisees.
• Franchising is generally an arrangement where one
party (the franchiser) grants another party (the
franchisee) the right to use its trademark or trade-
name as well as certain business systems and
processes, to produce and market a good or service
according to certain specifications.
 Cont…

• The franchisee usually pays a one-time franchise fee

plus a percentage of sales revenue as royalty, and
gains:
immediate name recognition,
tried and tested products,
standard building design and décor,
detailed techniques in running and promoting
the business,
training of employees, and
Ongoing help in promoting and upgrading of
the products.
Advantages:
 A service firm can build a global presence quickly
and at a relatively low cost and risk.
 The firm is relieved of many of the costs and risks of
operating in a foreign market by itself.
– Instead, the franchisee typically assumes those
costs and risks.
 The franchiser gains rapid expansion of business and
earnings at minimum outlay.
Disadvantages:

 Franchising inhibit the firm’s ability to take profits

out of one country to support competitive attacks in
another.
 Quality control in franchising is mandatory. But
difficulty to quality control because of;
geographical distance of the firm from its foreign
franchisees and
the sheer number of franchisees.
 It will let to a decline in the firm’s worldwide
reputation.
5. Management contracts

• An arrangement whereby a company operates a

foreign firm for a client who retains the ownership.
• There are a number of variations but a broad
distinction between foreign management and local
ownership is a characteristic feature, and the
management typically extends to all functions.
• In the management contract the principal (the
contractor) operates a complete management
system.
 Cont…
Fig 3.2 illustrates the principle of the three-concerned
relationship between contractor, client and contract venture.
 Cont…

• In a basic management contract the local (host

country) company holds all the equity,
but in practice the contractor often takes a
small amount.
• The contractor company does not provide for an
increasing royalty in the event of success as it knows
that it will share anyway.
• The holding of equity may also bias the advice the
contractor gives, especially when it’s not managing
all the functions.
 Cont…
• A management contract is generally an arrangement
under which operational control of an enterprise is
vested by contract in a separate enterprise which
performs the necessary managerial functions in
return for a fee.
• A management contract can involve a wide range of
functions, such as technical operation of a
production facility, management of personnel,
accounting, marketing services and training.
• Management contracts are often formed where
there is a lack of local skills to run a project.
 Cont…
Example:
• In Asia, many hotels operate under management
contract arrangements, as they can more easily
obtain economies of scale,
a global reservation systems, brand recognition etc.
• It is not unusual for contracts to be signed for 25
years, and having a fee as high as 3.5% of total
revenues and 6-10% of gross operating profit.
• The Marriott International Corporation operates
solely on management contracts.
Advantages:
 Substitutes the dissatisfaction with an existing licensing
agreement where the licensee or franchisor does not
need to develop the business.
 Lessons the expropriation or nationalization of a
subsidiary.
 To develop a consultancy or technical aid contract along
with it.
 When fees for management services may be easier to
transfer, and subject to less tax than royalties or
dividends.
 Cont…

 Proffered in the case of under-employed-skills

and resources
 provide a useful contribution to a global strategy.
appropriate to the more difficult markets in
the less developed countries.
 It brings the foreign expertise without the
drawbacks of foreign ownership.
Disadvantages:
 From the principal’s point of view, direct export or
investment might have been more lucrative.

 In some countries, contracts are still regarded as the

intervention of a foreign authority-
and the issue of foreign management remains
delicate, however badly it may be needed.
6. Joint Ventures

• A joint venture entails establishing a firm that is

jointly owned by two or more otherwise
independent firms.
• The most typical joint venture is a 50/50 arrangement
in which there are two parties, each of which holds a
50 percent ownership stake and contributes a team
of managers to share operating control.
• Some firms however, have sought joint ventures in
which they have a majority share and thus tighter
control.
Advantages:
 Firms benefit from local partners’ knowledge of the host
countries’
competitive conditions,
culture,
language,
political systems, and
business systems.
 Helps to share opening costs and/or risks with a local partner.

 Local partners’ minimize the influence of political/legal

factors of the host country.
 Necessary to enter countries where the economy is largely
under state control. (when foreign investors are only allowed
to take minority positions)
Disadvantages:
• It risks giving control of a technology to a partner.
• It does not give a firm the tight control over subsidiaries
that:
• it might need to realize experience curve or location
economies.
• it might need for engaging coordinated global
attacks against its rivals.
• Shared ownership arrangement can lead to, conflicts and
battles for control:
• if their goals and objectives change over time, or
• if they take different views as to what the strategy
of the venture should be.
7. Strategic Alliances

• It is a business relationship established by two or

more companies to cooperate out of mutual need
and to share risk in achieving a common objective.
• It is a situation when each partner brings a particular
skill or resource (usually they are complementary)
• and by joining forces, each expects to profit
from the other’s experience.
• In alliance, two firms pool their resources directly in
a collaboration.
 Cont…
• Unlike in a joint venture, firms in a strategic alliance do
not form a new entity to further their aims but
collaborate while remaining apart and distinct.
• Strategic alliance agreements are common in the
biotechnology sector, where large pharmaceutical
organizations sponsor research activities at small
research companies.
• These small organizations often excel in a particular
research discipline, but lack the sales, marketing and
distribution resources to bring their innovations to
market.
• Likewise, the large organizations may lack specialized
research knowledge in a specific research discipline.
 Cont…

Alliances involve:
distribution access,
technology transfers, or
production technology, with each other.
The alliance can be:
technology-based alliance
product-based alliance
Distribution-based alliance.
 Cont…

Strategic alliance implies that:

there is a common objective
alone partner’s weakness is offset by the other’s
strength;
reaching the objective alone would be too costly,
take too much time, or be too risky; and
together their respective strength make possible
what otherwise would be unattainable.
Reasons for going into strategic alliances include:

To gain access to new technologies and acquire

the skills necessary to achieve their objectives
more efficiently, at a lower cost, or with less risk
than if they acted along.
To enter ”blocked” markets
To reduce required investment
To gain access to a brand name or customer
group
To achieve more global coverage, etc.
Problems/ Disadvantage

Partners may disagree on further investment

Different expectations of return
Inability to change with changing market
conditions
Cultural communications barriers
Difficulties in integrating the two companies’
accounting and information systems
8. Wholly Owned Subsidiaries

• In a wholly owned subsidiary, the firm owns 100

percent of the subsidiary.
• Establishing a wholly owned subsidiary in a foreign
market can be done in two ways.
The firm can:
– setup a new operation in that country, or
– acquire an established firm (acquisition)
Advantages:

• When a firm’s competitive advantage is based on

technological competence,
since it reduces the risk of losing control over
that competence.
• It gives a firm tight control over operations in
different countries
using profits from one country to support
competitive attacks in another.
• Required if a firm is trying to realize location and
experience curve economies.
Disadvantages:

• most costly method of serving a foreign

market.
• Firms doing this must bear the full costs and
risks of setting up overseas operations.
 3.2. Selecting an Entry Mode
 Trade-offs must be made considering the advantages
and disadvantages when selecting an entry mode.
 For example, when considering entry into an
unfamiliar country with a track record for
nationalizing foreign enterprises, a firm might favor
a joint venture with a local enterprise.
 Its rationale might be that the local partner:
will help it establish operations in an unfamiliar
environment , and
will speak out against nationalization
 3.3 Criteria for selecting a market entry mode

1. Speed of market entry desired:

 acquisition and licensing or exporting will be the likely
ways to ensure quick effective distribution in the foreign
market.
2. Costs to include direct and indirect costs:
 Possible savings may be outweighed by indirect costs such
as freight, strikes, or disruptions to output, lack of
continuity with the power supply, or irregularity in the
supply of raw materials.
3. Flexibility required:
 Domestic law of a third country will be used for a purpose
for which it was never designed; international disputes.
 Cont…
4. Risk factors:
including political risk and economic as well as
competitive risk.
5. Investment payback period:
Sorter-term payback may be realized from
licensing and franchising deals, whereas joint
ventures or wholly owned subsidiaries will tie up
capital for a number of years.
6. Long-term profit objectives:
the growth expected in that market for the years
ahead.
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