Going Global with Your Business: Modes of Entry

Entering new markets opens the possibility of increasing revenue and/or decreasing the costs of goods sold, thereby increasing profits. Entering new markets may also allow a company to follow its existing customers abroad, attack competitors in their home markets, guarantee a continued supply of raw materials, acquire technology or ingenuity, diversify geographically or satisfy stockholders’ desire to expand.

For many companies, it may be a matter of survival. There’s simply not enough domestic demand to keep many firms in business, without going overseas.

Selecting a mode of entry into a foreign market is among the most crucial strategic decisions a company can make. Weighing all factors and choosing the proper method can result in huge competitive advantages or it can cripple the organization.

Here is an overview of possible modes of entry, each with its own pros and cons.

1. Acquisition of existing company. A merger may mean short-term cash, but not necessarily future stability. Half of merged entities never achieve their projected financial and market goals. Acquiring a company also means acquiring existing business, synergy and staff problems. And, bottom line, should the acquisition be financed by cash or stock?

Pros

Established market
Skilled workers available
Licenses are “grandfathered” in
Technology, clients and vendors instantly acquired
Negotiations usually occur at top level, target handles licensing and compliance
Instant branding
Reduction of competition
Increased knowledge base

Cons

Hidden surprises?
Which employees are politically connected, and with whom?
“Favors” and concessions are assumed
Technology often outmoded, vendors usually chosen for reasons other than merit
Branding often not part of HQ’s ideals
Acquisition often expensive and time-consuming
Blending of corporate cultures
Necessity to train local management (and HQ’s management)
Potential tax and legal problems

2. Greenfield investments. A “greenfield investment” starts with bare ground and builds up from there. Coca-Cola, McDonald’s and Starbucks are great examples of U.S. firms that have invested in greenfield projects around the world.

Pros

Economies of scale and scope in production, marketing, finance, research and development, transportation and purchasing
Greater control in all aspects
Best long-term strategy
Commitment to market
Vendor financing often available
Work with authorities from the beginning
Control over your brand
Control over staff
Press opportunities

Cons

Higher expense
Competition in these markets difficult to overcome
Entry into markets may take years to happen.
Costly barriers to entry
Governmental regulations may put multinational enterprises at a disadvantage in the short-term.

3. Licensing. Licensing is a contractual arrangement whereby a company transfers (via a license) the right to distribute or manufacture a product or service to a foreign country, or the right to use any type of expertise that may include patents, trademarks, company name, technology and technological know-how, design and/or business methods. The licensee pays a fee and/or percentage of sales in exchange for the rights.

This approach works best where there are barriers to import and investment, where legal protection is possible in the target environment, and where there is a low sales potential in the target country.

Pros

Quick, easy entry into foreign markets; allows a company to “jump” border and tariff barriers
Lower capital requirements
Potential for large ROI, returns realized fairly quickly
Low risk since you enter with established product and have fewer financial and legal risks

Cons

Control by licensee is low
Licensee may become a competitor.
Intellectual property may be lost.
License period usually limited
Poor quality management can damage brand reputation in other license territories.

3a. Technology licensing. A licensor’s patents, trademarks, service marks, copyrights, trade secrets or other intellectual property may be sold or made available to a licensee for compensation negotiated between parties in advance.

Pros

Provides “reverse flow” of technology in which original licensor shares in technical improvements developed by the licensee
Licensee uses intangible property and receives technical assistance

Cons

Can yield loss of control over technology
Loss of intellectual property
Weakened control over technology because it’s been transferred to unaffiliated firm

3b. Franchising. This type of licensing agreement offers an efficient model for distributing goods and services. The franchisee gains control over operations in exchange for some type of payment and the promise to abide by the terms of the contract.

Pros

Market entry with less financial, legal and political risk
Economies of scale by ordering with owner and other franchisees
Partners can see the business up-close, first-hand.

Cons

Licensor has little direct control.
Licensee has lower profits than if it owned business or exported its own goods.

4. Foreign direct investment. Direct ownership of facilities in the target country can be achieved through acquisition of an existing entity or establishment of a new enterprise. This approach, while requiring a high level of commitment and resources, is advantageous where import barriers exist, where assets can’t be fairly priced, and where there is high sales potential and low political risk.

Pros

High degree of control over operations
Ability to better know consumers and competitive environment
Provides jobs in target country, which means government will help you
Comparative advantage of different economies in terms of labor supply and/or raw materials
Value of technology ownership

Cons

Higher risks, due to high capital and management costs
Greater difficulty managing local resources
Wide array of uncontrollable factors (currency and exchange risks, performance requirement risks, discriminatory tax and licensing requirements)

5. Management contract. This occurs when one firm provides management in all or specific areas for another firm, in exchange for a fee. Hilton Hotels, for example, provides management services for non-owned overseas hotels that use the Hilton name. In exchange, Hilton probably earns a fee that is a percentage of sales and, more importantly, gains brand recognition.

Pros

Entry to the market is rather simple.
Use business experience to help similar companies in other countries to set up, operate and collect on.
Allows experienced company to research the market for other modes of entry

Cons

Lack of profit (a percentage of sales is not typically the largest margin possible when operating a business)
Foreign company gains insight into business procedures of the export company.
Detrimental to the export company in the long run if the foreign firm ever becomes a competitor

6.  Exporting.  One option is selling the product or service directly to a foreign firm by the home-country firm.  Costs and prices are lowest if production occurs in only a few locations around the world and efficiently produced goods are exported to most markets.  This approach works best where there is limited sales potential in the target market; little product application is required; and distribution channels are close to plants.

Pros

No investment required in foreign production facilities
Minimized risk and investment, as well as speedy entry
Maximum economies of scale prevent competitors from gaining “first-mover” advantage in new markets
Sell excess production capacity.
Gain information about foreign competition.
Stabilize seasonal market fluctuations.
Reduce dependence on existing markets.

Cons

More expensive due to tariffs, marketing expenses, transport costs
Difficulty coordinating cooperation of exporter, importer, transport provider and government
Limited access to local information; company viewed as “outsider”
Need to develop customer base and logistics of moving goods overseas
Difficulty overcoming trade barriers
Loss of control over pricing and marketing
Task of finding customers

5a.  Indirect exporting. Another option is indirect exporting — selling goods and services through various types of intermediaries. Foreign agents can be hired for their knowledge of business practices, language, laws and culture in overseas markets. Some points worth noting:

  • Exporters most often use commissioned agents, paid a percentage only when the sale is made.
  • Retainer agents are paid a fixed amount to do certain work for a specific period of time.
  • Retainer/commissioned agents work on a retainer, but also receive a percentage from each sale. The retainer provides them with funds to help run their business while the commission provides additional incentive to work harder on the firm’s behalf.

Pros

Agents can identify customers and markets.
Uncover new opportunities/markets for your product.
Translate and act as interpreter in business dealings.
Validate translation of your publicity materials.
Assist with local travel and/or living arrangements.
Provide guidance with local government regulations.

Cons

Agents often work for numerous businesses, and truly work for the buyer, not the seller.
Agents prioritize clients based on product, incentives and/or base pay.
No guarantee that agents will make inroads in market share.

5b.  Export Management Company. Another option is use of an export management company (EMC) as an off-site export sales department representing your product. The EMC typically conducts the following services: market research and development of marketing strategy; uses existing foreign distributors or sales representatives to put your product into the foreign market; acts as overseas distribution channel or wholesaler; takes ownership of goods and operates on a commission basis.

Pros

Faster entry into overseas market
Better focus on exporting, since most firms give priority to domestic problems
Lower out-of-pocket expenses
Opportunity to study methods and potential of exporting

Cons

No quality control of export strategies and after-sales service
Can create competition from EMC’s other products
Reluctance of some foreign buyers to deal with third-party intermediary
Added costs and higher selling prices due to EMC’s gross profit margin requirements (unless offset by economies of scale)

5c. “Piggyback” exporting. This is using a company with an established export distribution system to sell another company’s product in addition to its own. The requisite logistics associated with selling abroad are borne by the exporting company.

Pros

International experience not required
Fast entry to the international market
Little to no increased financial commitment

Cons

Low control by exporting business
Possible choice of wrong market, wrong distributor
Inadequate market feedback
Potentially lower sales
Higher risk in general
Brand erosion

6.   Wholly owned subsidiary. A wholly owned subsidiary involves a direct investment in the target country. The parent company retains full ownership and sole responsibility for management of the operation. This approach is especially advantageous when the risks of investing in a particular foreign market are low, maximum operational control is desired and host governments have open trade and investment policies.

Pros

Highest level of control
Lowest technology risk
High performance
Best long-term strategy

Cons

High investment risk
High resource commitment
Generally higher tax rates on profits
More regulated; government interference possible in daily operations
Considerable planning required
Slow entry
More difficulty accessing local government-controlled raw materials and supplies

7. Contract Manufacturing. This method involves contracting with a local manufacturer to produce products to the firm’s specifications. It works best when the risks of investing in a foreign country are high, when stringent import barriers exist or when there is a lack of raw materials at home.

Pros

Generates employment and foreign exchange for the host country
Usually easy access to entry as host country knows laws, politics, customs, etc.

Cons

Could lose control of quality; possible low quality workers
Not in control of pricing or marketing
No equity in the subcontractor
Your competition may be a customer!

8. Management contract. This occurs when one firm provides management in all or specific areas for another firm, in exchange for a fee. Hilton Hotels, for example, provides management services for non-owned overseas hotels that use the Hilton name. In exchange, Hilton probably earns a fee that is a percentage of sales and, more importantly, gains brand recognition.

Pros

Entry to the market is rather simple.
Use business experience to help similar companies in other countries to set up, operate and collect on.
Allows experienced company to research the market for other modes of entry

Cons

Lack of profit (a percentage of sales is not typically the largest margin possible when operating a business)
Foreign company gains insight into business procedures of the export company.
Detrimental to the export company in the long run if the foreign firm ever becomes a competitor

Conclusion

Entering or expanding in a foreign market can be achieved through a wide variety of options. The best mode of entry should be selected only after carefully analyzing each alternative and comparing it to the others.

In general, exporting requires the least amount of resources and allows for the lowest level of control. Wholly owned subsidiaries, on the other hand, require the most resources but allow for the most control. As for technology, exporting is the least risky while licensing is generally the most risky.

Clearly, not every mode of entry works for every situation. A company considering entry into a foreign market should look at the experiences of other companies in similar markets to gain insight into the best alternative. The company should also enlist the help of a professional, such as an international marketer, to insure the best possible strategy. The most control is usually the main objective. However, complete control can be expensive.

Vistage speaker Bill Decker heads Partners International, based in Lakewood, Colo.

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