Essay on Advantages and Disadvantages Market Entry Modes

Published: 2021/11/30
Number of words: 4022

1. Abstract

Companies choose their entry mode based on host country factors. However, in other cases, they consider firm related factors such as financial performance and firm-specific aspects. In the contemporary business world, organizations are diversifying their operations across different nations, looking for a competitive advantage. This expansion allows such organizations to pursue growth opportunities which are not available in the domestic market, exploit technological advancements, and spread risks through diversification. The choices of entry mode used by the firm to enter the U.S. market determines ownership percentage and mechanisms of governance. Being the largest economy globally, the United States has significant influence in the international market. International businesses are generally tempted to enter the market due to cultural diversity, big consumption market, and developed economic system. In the U.S. sectors such as transportation, wholesale, finance, and depository organizations attract foreign investments. The study focus on analyzing the different modes international business can utilize to enter the United States market.

2. Introduction

In the modern business community, multinational organizations desire to expand their operations internationally. Various market strategies have been developed, and such corporation assess which strategy satisfies their business needs. It is imperative to analyze the host country by considering certain factors such as business risks, country risks, currency risks, and intercultural risks (Hamilton and Webster 2018, P.59). Before entering the United States market, businesses conduct market research to evaluate whether the target market has suitable consumers for their products and services. The U.S. has been in the frontline in encouraging foreign investments in its market by providing incentives and appropriate business environment (Ang, Benischke, & Doh 2015, P. 1536). Thus, most multinational corporation considers this market profitable for setting up business operations. The financial industry thrives well in the United States market, which creates a broader market to sell financial services such as insurance, mortgages and investment portfolios. Financial institutions should, consequently, determine the advantages and disadvantages of the established entry strategies to ensure they productively penetrate the market.

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2.1. Problem statement

Most businesses today aim to advance their business operations in other nations to grow their profits. There are various modes of entering the global market, such as exporting, foreign direct investment, licensing, and franchising. Business research indicates that multinational corporations focus on the most efficient mode of penetrating the international market to attain competitive advantage. However, such modes of entry have their advantages and disadvantages which may affect the corporation’s choice of entry. Corporations, therefore, need to actively evaluate such factors to make well-informed decisions regarding the mode of entry.

2.2. Objectives

To evaluate how the modes of entry influence the decisions of multinational financial institutions.

To determine the advantages and disadvantages of each entry mode and their effect on business operations.

3. Exporting

Exporting involves selling of goods and services manufactured in a given nation to other nations. Normally, there are two kinds of exporting goods and services. Direct exporting is the most common method of exporting by an organization, which has control over production in the domestic country and affords control in distribution (Ang et al. 2015 P. 1537). This type of exporting works best of volumes exported are small. In addition, it is characterized by lack of intermediaries which eliminates unnecessary costs of paying commissions to middlemen.

There are various types of direct exporting use in the international business. Sales representatives is one type in which representatives usually represent foreign manufacturers and suppliers in their domestic markets for a determined commission of the value of sales. Sales representatives provide assistance to the suppliers with regards to domestic sales demonstrations, domestic promotions, legal requisites, and duties clearance facilities. Businesses which benefit most from sales representation are the manufacturers of technical products or services (Lederman, Olarreaga, and Zavala 2016, P. 142). For instance, when offering financial services in the given country, the financial institution may hire sales representatives who would market the product in the foreign country. Examples of such products include mortgage or insurance. It, therefore, becomes more manageable for sales representatives to market such products by advertising their benefits to the local market. Another form on direct exporting is the importing distributors. This mode of direct exporting involves buying a product in your own right and reselling the products or services to the domestic market to retailers and wholesalers (Ang et al. 2015, P. 1537). This mode may not be suitable for financial services providers as the distributors may hike the prices of the services offered, thereby discouraging consumers from buying.

Indirect Exporting is a method of foreign entry involves exporting by means of domestically recognized export intermediaries. In the overseas marketplace, the exporter lacks control over their goods and services. There are various types of indirect exporting. Export Trading Companies (ETCs) usually offer assistance for the entire exporting process for several suppliers. ETCs are suitable for financial services providers like insurance and banks, which are not familiar with the process of exporting (Petras and Veltmeyer 2016, p.107). They perform all paperwork, present the financial service to consumers, locate foreign trading partners, and quotation on particular enquiries. Export Management Companies (EMCs) ordinarily export for producers and thus are similar to ETCs. However, they focus on one product or service, for instance, insurance. EMCs trade for their suppliers in their export units. Export Merchants entails buying unpackaged products from producers to resale in foreign countries under their own product name. Confirming houses are usually transitional sellers who work for overseas purchasers. They acquire products necessities from the manufacturer or suppliers and negotiate purchases, make deliveries, and make payments to the manufacturers (Dikova and Brouthers 2016, P. 489). Nonconforming purchasing agents is another mode of indirect exporting in which agents do not make any direct payments to suppliers as it takes place between a foreign buyer and the supplier of the financial product.

3.1. Advantages of Direct and Indirect Exporting

There is control over the choice of representative company or foreign markets: the entering company is free to select which company they see fit to run their operations in the foreign country (Ang et al. 2015, P. 1540). For instance, an organization can choose financial advisors in the country from firms chosen to run its operations. Also, the company can assess which country they see fit depending on various factors such as political stability, economic stability, and entry incentives. There is developed relationships with consumers due to excellent information feedback; the foreign operators give feedback to the organization, which is vital is establishing working relationships with their clients. Enhanced security for goodwill, copyrights, trademarks, and other intangible assets as the host company benefits from foreign investments in terms of taxes and employment to local residents; therefore, it protects the intangible properties of such organization.

Potential for improved sales due to market demands, the organization may realize improvement in their sales, which in turn leads to enhanced profitability (Dikova and Brouthers 2016, P. 490). In the financial sector, people have different needs which create more market for financial services. Fast access to market; the foreign company can easily access the market as they use experienced agents to penetrate the market. When offering financial services, the company can choose an agent who would run their operations on behalf of the company. There is low risk for organizations which perceive their local market to be more crucial and financial institutions which are in the process of developing their sales, marketing, and research and development strategies.

3.2. Disadvantages of Direct and Indirect Exporting

Increased risks and start-up costs as related to indirect exporting: establishing operations in any foreign country is usually associated with high costs of starting like registration and hiring foreign representatives and distribution. This may slow down growth and decrease profit margins (Dikova and Brouthers 2016, p.492). Besides, the organization is normally not sure if its operations would succeed in the foreign market, which is a considerable risk. This mode requires high investments with regards to personnel, resources, and time: any company desiring to export their financial services must commit resources in order to accomplish their objectives. Higher information requirement; before entering the United States market, the company needs to do prior research on the laws governing business operations in the U.S. Failure to do so may put the company at risk of breaking various laws which govern labor and taxation Crescenzi, Gagliardi, and Iammarino 2015, p.596). Conducting research may, at times, be expensive. A longer time is taken in marketing; as opposed to indirect exporting, a lot of time is consumed in marketing the financial services of the corporation to familiarize consumers which the specified products. Thus, foreign operations may take some time before yielding any returns.

The company does not have control over sales, marketing, or distribution as compared to direct marketing. This makes the company unaware of what transpires in the market which is risky. If the company choose the wrong distributors, it may lead to insufficient market feedback. This will affect the global sales of the financial institution to a significant extent. There may be a lower sales volume of the financial service, unlike direct exporting (Dikova and Brouthers 2016, p.492). If the company does not choose the right distributor, it may affect the performance of the organization.

Exporting is somehow an effective method of market entry and grants the provider of the services full control. Financial institutions. In this regard, financial institutions which see the global market as a vital part of their success, they would consider direct exporting as an appropriate entry strategy. In order to avoid financial risk, such organization can select indirect exporting to attain their set objectives. The next sub heading will discuss the influence of foreign direct investments in the United States market entry.

4. Foreign Direct Investments

The U.S. is the world’s biggest recipient of foreign domestic investments and changes in the global economy makes the country strive to retain the position and attract more investments. FDI is a form of investment which involve controlling ownership of a business located in a given country by another company located in another country. FDIs take the form of building new facilities, reinvesting revenues earned from foreign operations, mergers and acquisitions, and intra company loans (Chan 2016, p.3). The United States has low barriers and open economy for FDIs. According to statistics, foreign companies hold a large number of shares in the U.S than in their domestic markets (Chetty, Ojala, & Leppäaho 2015, p.1436). Data from the White House also indicated that more than 5 million workers were employed in foreign entities. In 2018, the Bureau of Economic Analysis reported $253.6 billion in investments by the FDI in the United States. The top industry was the chemicals which represented $109 billion in FDI.

FDIs can still be developed through the establishment of an associate company or a subsidiary in the foreign nation. In addition, financial institution intending to invest its financial services can acquire a controlling interest in a preexisting company in the overseas nation. FDIs are categorized in three forms which include vertical, horizontal or conglomerate (Erdogan and Unver 2015, p.82). Vertical FDIs entail different but linked business operations from the main business of the investor being set up or acquired in a foreign nation. Horizontal FDI involves investors setting up similar business operations in the overseas nation as it operates in the domestic country (Corcoran and Gillanders 2015, pp.103-106). For instance, a bank offering loan products based in China setting up operations in the U.S. Conglomerate FDIs is where the company sets up foreign investment in business activities unrelated to the present operation in the home country. FDIs have played a crucial role in ensuring prosperity and economic growth in the United States, spurring innovation, creating highly compensated jobs, and driving exports (Chetty et al. 2015, p.1438). Foreign-owned organizations have created over 7.4 million jobs while over $62.6 billion has been spent by FDIs in research and developments by such organizations. Moreover, a total of $4.3 trillion in stock is associated with foreign direct investment.

4.1. Advantages of FDIs

Economic development stimulation: FDIs stimulate the economy of the target country by establishing a conducive environment for investors and benefiting the local industries. Easy international trade: typically, countries have their established trade tariffs which make international trade difficult. Additionally, there are other industries which must be present in the global market to make sure their goals and sales targets are met (Chetty et al. 2015, p.1439). For instance, a financial institution would require to ensure their products reach the target customers. All this is made easier with foreign domestic investments. Employment and economic enhancement: as investors build new companies in foreign countries, they create new jobs and opportunities. This results in increased income and more purchasing power, which in turn leads to an enhanced economy. Human capital resources development: FDSs leads to human capital development. Attributes attained from sharing experience and training enhances the level of education and overall human capital for the nation.

Tax incentives: The United States offers tax incentives as a way of promoting foreign investments in selected business fields (Chetty et al. 2015, p.1440). Financial institutions can take advantage of such incentives to promote their businesses. For example, they can offer differentiated insurance packages which would target a specific market. Successful companies benefit the host company as well as the global economy. Resources transfer: FDIs allows for the transfer of resources such as technology, skills and know-how. The host company is, therefore given access to such resources. Increased income: FDIs result in increased income in the target country. This is attributed to higher wages and more jobs which increases the national income and gross domestic product. A larger financial institution offering financial services would offer higher salaries to their personnel as compared to whet the domestic financial institutions offer their personnel, and in turn, leads to increased income (Picciotto 2017, pp.177-180). Increased productivity: the equipment and facilities used by foreign investors can enhance the productivity of their workforce in the host country.

4.2. Disadvantages of FDIs

Currency risks: changes in foreign exchanges can affect FDIs. It can be an advantage for one country and a disadvantage to another. Intercultural risks: countries have different cultures which affect business operations such as consumer preferences and language. In addition, some countries believe in certain customs, values and beliefs. For instance, if a particular community does not believe in insurance products, the company may lose a potential market which may affect its profitability. Country risks: these are perils related to lending or investing in a specific nation which may come from business environment variations and in turn, affects the value of assets or working profits. These risks affect the performance of foreign domestic investments, and they may perform poorly due to such risks (Chetty et al. 2015, p.1440). Also, the political situation of the host country can change, which may put the FDIs at risk. Political instability can affect business operations and may seem risky for foreign domestic investments.

Business or commercial risks: these are risks associated with the financial institution making insufficient profits as a result of uncertainties such as increasing competition, changes in consumer preferences, strikes, changes in tastes obsolescence, and changes in government policies. A particular country may develop policies which hinder some business operations in their country, such as insurance laws, banking policies, and interest rates (Chetty et al. 2015, p.1440). Competition from domestic companies and other foreign businesses may also affect the way the foreign entity conducts business. These business risks pose a threat to the productivity and profitability of the business. In the United States, FDIs dropped in 2018 due to tax reforms introduced by the Trump administration. The United States still strive to maintain their positioning being the leading global FDI investor.

Before businesses engage in any kind of a venture, it is imperative to ascertain the benefits it will provide to society through the evaluation of its advantages and disadvantages. FDIs have been portrayed as effective market entry strategy in the United States Market. It is therefore recommended for the provision of financial services in the U.S. The following sub heading will discuss how licensing impacts market entry in the United States. Respective advantages and disadvantages will be analyzed.

5. Licensing

A global licensing agreement is intended to enable foreign organizations, either entirely or partially, to produce a certain product or offer service for a predetermined period in a particular market. The licensor is usually the home country in this entry mode, and it makes resources or rights accessible to the licensee. Such rights include managerial skills, trademarks, patents, and technology which enables the licensee to sell in the foreign nation a similar good or service to the one the licensor sales in the home country, which does not require the licensor to set up new operations overseas (Egger and Wamser, 2015, pp.77-80) The earnings of the licensor come in as royalty payments, technical dues, or one-time payment, calculated based on total revenue. Licensing can be considered to be a flexible work agreement where the licensor and licensee work together to accommodate the interest of both parties (Hollender, Zapkau, & Schwens 2017, p.250). When offering a financial service, the financial institution may draft an agreement with another company in the host nation to continue offering the same service, like mortgage selling or insurance, and pay off the other company a percentage of the profits.

5.1. Advantages of Licensing

The organization can reach markets which cannot be accessed through exporting. Such markets lead to increased revenues and productivity. The mode of entry is attractive to organizations which are new in the international business as they intend to expand their new operations to a foreign country where their products are not common. There are minimal risks as the licensee is normally 100 per cent domestically owned which eliminates instances of business and intercultural risks (Hollender et al. 2017, p.251). Also, there is more potential for expansion which is less risky and requires less capital investments, and the corporation can benefit from additional income from technical services and know-how.

5.2. Disadvantages of Licensing

There are low returns unlike other modes of entry like the foreign direct investments. An incompetent partner may pose risks of ruining reputation and trademarks for the corporation which may affect the relationship between the business and potential clients. There may be loss of governance of the licensee’s market and manufacturing practices and activities which may compromise quality. Therefore, for most financial institutions, licensing may not be an effective entry mode as the foreign partner may become a competitor through marketing their services in the host country (Hollender et al. 2017, p.253). As a result, it is essential to assess potential partners before drafting any kind of agreement.

As discussed above, licensing may not be a viable mode of entry in the United Sates market. It is an unfamiliar method for financial institutions. This may be due to low returns from the strategy as opposed to other strategies of market entry. Although it is a less risky strategy, financial institutions prefer methods with higher returns and possibility of expansion like the foreign direct investments. The following sub heading will analyze how franchising is applied as a market entry.

6. Franchising

This mode of entry works by allowing semi-independent commercial operators know as a franchisee to pay royalties or fees to a holding company known as franchiser for rights to be identified with the franchisers trademarks, and trade its goods and services, and utilize its business systems and formats (Badrinarayanan and Kim 2016, p.3943). Franchising agreements are usually longer compared to licensing and offer a comprehensive package of resources and rights which consists of an operational handbook, management structures, equipment, site authorization, preliminary training, and any additional support required to run operations as done by the franchisor effectively.

6.1. Advantages of Franchising

Low costs of starting up operations such a business registration which are normally made by the franchisor. Minimal political, business, cultural, and financial risks which lead to business efficiency and productivity. Franchising allows for simultaneous expansion into other regions across the globe and the financial institution can make additional income (Badrinarayanan and Kim 2016, p.3943). If an appropriate partner is selected, they can bring in management competences and financial investments to the operation.

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6.2. Disadvantages of Franchising

The initial costs of acquiring a franchise may be higher, which include management fees, and the franchisee has to agree to purchase the services of the franchisor. It may be challenging to sell the franchise as the franchisor has to approve the other party (Wu 2015, p.1581). Franchises are not flexible and may hinder both parties from introducing changes in the business to respond to the market requirements or business expansion

7. Conclusion

For multinational companies to successfully penetrate the United States market, it is vital to access all entry modes and evaluate which is effective in achieving their entry goals. The U.S. market is the biggest globally, and it offers a competitive market and large customer base, where financial institutions can sell their products. As seen in this paper, other forms of entry may not be the most viable strategy as compared to foreign direct investments. In order to successfully launch their products, setting up joint ventures or mergers and acquisitions would be the most feasible strategy. The U.S. is a large consumer of financial services which makes the financial business thrive well in the market. Besides, the market has political and economic stability which is essential for business success. Some risks such as intercultural risks, business risks, and currency risks are not prevalent in the U.S. market, considering English is the most common language and the United States dollar in the most common currency internationally. In this regard, financial institutions would find it easier to enter the market through foreign direct investments.

8. References

Ang, S.H., Benischke, M.H. and Doh, J.P., 2015. The interactions of institutions on foreign market entry mode. Strategic Management Journal36(10), pp.1536-1540.

Badrinarayanan, V., Suh, T. and Kim, K.M., 2016. Brand resonance in franchising relationships: A franchisee-based perspective. Journal of business research69(10), p.3943.

Chan, S. ed., 2016. Foreign direct investment in a changing global political economy. Springer. p. 3.

Chetty, S., Ojala, A. and Leppäaho, T., 2015. Effectuation and foreign market entry of entrepreneurial firms. European Journal of Marketing49(9/10), pp.1436-1440.

Corcoran, A. and Gillanders, R., 2015. Foreign direct investment and the ease of doing business. Review of World Economics151(1), pp.103-106.

Crescenzi, R., Gagliardi, L. and Iammarino, S., 2015. Foreign multinationals and domestic innovation: Intra-industry effects and firm heterogeneity. Research Policy44(3), p.596

Dikova, D. and Brouthers, K., 2016. International establishment mode choice: Past, present and future. Management International Review56(4), pp.489-492

Egger, P.H. and Wamser, G., 2015. The impact of controlled foreign company legislation on real investments abroad. A multi-dimensional regression discontinuity design. Journal of Public Economics129, pp.77-80.

Erdogan, M. and Unver, M., 2015. Determinants of foreign direct investments: Dynamic panel data evidence. International Journal of Economics and Finance7(5), p.82.

Hamilton, L. and Webster, P., 2018. The international business environment. Oxford University Press. P. 59

Hollender, L., Zapkau, F.B. and Schwens, C., 2017. SME foreign market entry mode choice and foreign venture performance: The moderating effect of international experience and product adaptation. International Business Review26(2), pp.250-253.

Lederman, D., Olarreaga, M. and Zavala, L., 2016. Export promotion and firm entry into and survival in export markets. Canadian Journal of Development Studies/Revue canadienne d’études du développement37(2), p.142

Petras, J. and Veltmeyer, H., 2016. Multinationals on Trial: Foreign Investment Matters. P. 107

Picciotto, S., 2017. Rights, responsibilities and regulation of international business. In Globalization and International Investment pp. 177-180.

Wu, C.W., 2015. Antecedents of franchise strategy and performance. Journal of Business Research68(7), p.1581

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