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The entry modes for international/foreign market operations.
Essay: Critically discuss the various modes of entry for which an organisation can internationalise their operations. Is there one mode that is preferred above others?
This essay will discuss the entry modes for international/foreign market operations. Foreign market entry mode decisions are typically influenced by company and target market factors such as: the organisation’s objectives, its international experience, internal resources and capabilities, investment risk, government requirements, environment, access to local knowledge and partners and ease of access to capital and other resources. This essay will argue that there is no one mode that is universally preferred above others; rather, appropriate entry mode decisions should be made based on careful consideration of the organisation’s objectives and circumstance.
Reasons for internationalising business operations
Organisations engage in international business operations for various reasons including globalisation, saturation of home market, lower production costs in the host country, favourable foreign market environment and attractive foreign investment policies, with the ultimate goal of increasing profit, expansion and tackling competition. A major decision for organisations engaging in international operations is that of how to enter a foreign market once it has chosen the target market it wants to operate in (Kumar & Subramaniam, 1997; Twarowska & Kakol, 2013; Wach, 2014).
How an organisation’s international operation is structured and delivered is very much determined by its entry mode/strategy. Hence, the entry mode is a key strategic decision that defines subsequent decisions and actions of the organisation and its performance in the target market (Kumar, Stam & Joachimsthaler, 1994; Kumar & Subramaniam, 1997).
Foreign Market Entry Modes
The international business and marketing literature classify entry modes for international business operations into the following categories based on the risk-return trade-off, degree of control, and resource commitment: exporting, contractual agreements, wholly owned subsidiaries and strategic alliances. These modes can be segmented into non-equity (export and contractual agreements) and equity (strategic alliances and wholly-owned subsidiaries) modes (Mpofu & Chigwende, 2013).
The decision about whether an organisation implements an equity or non-equity foreign market entry strategy is best determined by the organisation’s objectives and circumstance. Within that decision, and depending on the organisation’s capability and level of international experience, there are also choices to be made regarding specific equity or non-equity entry modes to be implemented (Hibbert, 1997; Kumar & Subramaniam, 1997).
Non-equity foreign market entry modes
Exporting is the direct or indirect sale of goods and services produced in one country to other countries. Exporting offers the lowest level of risk and the least market control. It is a non-equity method of international business operations and can be broadly classified into direct exporting, indirect exporting and cooperative exporting (Wach, 2014).
With direct exporting, the exporter makes direct contact with customers in the foreign market and has control over its product and distribution. Types of direct exporting include: own sales subsidiary/distribution network, own representative office for marketing, sales, and consultation in the foreign market, foreign agents acting on behalf of the exporter and foreign distributors (Wach, 2014).
Indirect exporting involves the use of local intermediaries in foreign markets to facilitate the supply/distribution process and the exporter has no control over its products and distribution. Forms of indirect exports include: export trading companies, export management companies, export merchants, confirming houses, and nonconforming purchasing agents (Wach, 2014).
Direct exporting and indirect exporting share similar characteristics as both offer relatively low cost and low risk entry modes (Arnold, 2003). However, direct exporting may incur additional costs, for example, in the set up and operation of representative offices. There is also the risk of low profitability and barriers to developing in-house local knowledge in indirect exports or when foreign agents are used in direct exporting (Wach, 2014).
The third form of exporting, cooperative exporting, is one in which organisations enter into an agreement with a foreign/local organisation to use its distribution network, hence bypassing barriers and risks associated with other market entry modes. Cooperative exporting is particularly favourable to small- and medium-sized firms because of the resource advantages and the accelerated access to markets it offers (Wach, 2014).
Export grouping/consortium and piggybacking are the two main forms of cooperative exporting. With an export consortium, members benefit from joint promotion of products and services and the cost of exporting is spread (Wach, 2014). Piggybacking is an arrangement between a rider (a small/micro business) and a carrier (a larger organisation) in which the carrier is an international business operator offering the rider access to its foreign distribution network for a commission/charge (Terpstra & Chwo‐Ming 1990). The carrier often benefits from the complementary product lines and reduction of the costs of its distribution network; however it runs the risk of dilution or damage to its reputation if the rider’s products are of lesser quality. The rider enjoys the benefits of access to the carrier’s foreign distribution network but loses control over the distribution of its product (Wach, 2014).
Contractual agreements are cooperative modes in which an organisation enters into a contract with foreign partners to deliver its operations abroad. Examples include international licencing, franchising, subcontracting and assembly operations.
In international licensing, the licensor enters into a contractual agreement with a foreign entity (the licensee) that gives the licensee rights to use the assets of the licensor (Wach, 2014). The licensor typically possesses intangible assets such as technology, trademark, know-how, patents or other intellectual property that it makes available to the licensee. The licensee would typically pay an initial fee and/or percentage of sales to the licensor. The effectiveness of this form of contractual agreement is affected by the host government’s commitment to intellectual property rights and the ability of the licensor to choose the right licensing partners (Wach, 2014). Licensing is attractive to companies that are new to international business because it can be easily tailored to the needs of both parties. It also provides entrance into new markets that are not accessible through exporting and it involves relatively low risk and low capital requirement (Friesner, 2014).
Disadvantages associated with international licensing as an entry mode include loss of intellectual property/dilution of firm specific advantages through transfer of know-how, risk of poor choice of licensee leading to damaged reputation or loss of brand quality, and risk of the licensee becoming a future competitor to the licensor (Brouthers, 2013; Friesner, 2014; Wach, 2014).
International franchising is another form of contractual agreement similar to licensing, in which the franchisor makes its business model or trademark available to the franchisee for the sale of its products or services. In return, the franchisee pays a fee or royalty to the franchisor (Malhotra et al., 2003). The low start-up cost associated with this entry mode highly favours SMEs, and is particularly attractive to small and micro enterprises (Wach, 2014). A franchise agreement may provide the franchisee with access to the franchisor’s equipment, business model, training, trademark/brand name, operations and management. It may also impose restrictions/guidelines on how the franchisee may use the franchise (Mpofu & Chigwende, 2013). Franchising is a less risky and accelerated form of foreign market entry mode because it is based on an already successful business model, the franchisee typically has local knowledge and it allows simultaneous access to multiple foreign markets. Hence, the franchisor is protected from typical risks associated with foreign market operations (Mpofu & Chigwende, 2013). However, there are other problems that the franchisor may have to contend with, such as: legal disputes with the franchisee, monitoring and managing the performance of the franchisee, preserving the franchisor’s image/brand quality, and the risk of the franchisee becoming a future competitor (Wach, 2014). Overall, the benefits associated with franchising are seen to outweigh the associated risks and hence it is a popular foreign market entry and expansion mode (Hoy & Stanworth, 2003; Cavusgil et al., 2008; Decker, 2013). Well known examples of successful franchises include KFC, McDonalds, Subway, and Dominoes. These brands were able to rapidly expand their operations globally using the franchise platform in a way that would not have been possible through any other foreign market entry strategy.
Subcontracting − turnkey operations: turnkey operations refer to projects in which the exporter (seller) is paid by a contractor (buyer) to design and build complete, ready-to-operate facilities. Turnkey is a way by which a foreign company can export its processes and technology to other countries, especially industrial companies who need to export their entire system to a foreign country, such as those in the chemical, mining or petroleum industries (Evans, 2005; Wach, 2014). With turnkey, there is the potential risk of company secrets leaking to competitors and of the plant being taken over by the government. Large turnkey projects could also suffer costly delays due to restrictive regulations. However, this entry mode is particularly advantageous for industrial companies that specialize in complex production technologies as it offers access to establishing a plant in a foreign country where direct investment is restricted (Evans, 2005).
Equity based foreign market entry modes
Equity-based market entry modes are investment models whereby a company either establishes a wholly-owned subsidiary, with 100 per cent ownership or a joint venture subsidiary, with less than 100 per cent ownership. A subsidiary is a separate legal entity operating under the laws of its country of foreign location. However, in legal terms, subsidiaries are created in one of the legal forms of economic activities occurring in the law of the host country (Buckley & Casson, 1998; Wach, 2014).
Wholly-owned subsidiaries are established either through acquisitions, whereby the organisation acquires a foreign company to enter a foreign market or through greenfield operations, which involves building a new organisation from start. With acquisition, the organisation is able to limit its risk and maximise its access to the foreign market because of the already established brand name and customer-base of the acquired company, which provides it with accelerated access to, and a foothold in the foreign market. Hence, acquisition can potentially be the quickest route to entering and expanding in foreign markets through equity (Buckley & Casson, 1998; Wach, 2014).
Greenfield operations offer a more expensive equity mode of foreign market entry due to the costs of establishing a new business in a new country and the time consuming process it entails; however, it is gives full control to the parent company and has the potential to produce above average returns (Wach, 2014).
Both modes are based on foreign direct investment and provide relatively lower production costs and a direct presence in the foreign market. However, from a strategic perspective, acquisition strategy is likely the more effective choice in service industries where customer relationships, specialised know-how and customisation are critical. Greenfield investment, on the other hand, is likely to be more suited to projects involving capital intensive plants, where there are no suitable platforms to acquire already established competitive advantages such as skills and embedded capabilities (Buckley & Casson, 1998; Wach, 2014).
The final form of equity-based market entry mode discussed is the joint venture subsidiary. An international joint venture (JV) is a collaborative equity strategy in which the organisation has joint control, with minority shares or majority shares in a foreign company. In JVs, investors share ownership, control, risk, reward and proprietary rights (Durmaz & Tasdemir, 2014). Primary reasons for forming a JV include sharing resources and leveraging on the combined strengths of the partners to achieve common objectives such as government requirements and access to new markets that the partners cannot achieve alone (Wach, 2014). The shared risk and the combined assets and resources of the partners help to reduce investment costs, hence making JVs an attractive entry mode for risky markets (Durmaz and Tasdemir, 2014). Potential problems that could arise with JVs include: how to manage proprietary rights, disagreement over reward formula, cultural clashes and how to exit (Chang et al., 2012). Environmental factors also play a significant role in this entry mode. Studies indicate that the greater the perceived distance between the home and host country in terms of culture, economic systems, and business practices, the more likely it is that an international organisation will adopt a joint venture as an entry mode (Koch, 2001).
To summarise, it is clear from the entry modes discussed that there are a variety of reasons why organisations engage in international business and that the entry modes adopted differ for various reasons. Likewise, entry modes vary in the degree of risk, control, resource commitment and reward. When an organisation enters a foreign market, it is important to understand where they are positioned in relation to these variables in order to enable the right decisions about which markets to enter, the segments to focus on, the structural form to take, the level of investment and how to manufacture, market and sell its product/service. Hence, organisations have to determine which entry mode will give them the best chance of succeeding in their target market based on their goals and weighing their strengths and limitations.
Based on the argument presented above, the author is of the opinion that there is no one market entry mode that is to be preferred above all others. Organisations wanting to internationalize their operations must perform prior due diligence including political, economic, financial, internal, environmental and cultural analyses, in order to determine which of the foreign market entry modes would be appropriate for its objectives, risk-return profile and control requirements as well as any other vital requirements peculiar to the organisation’s circumstance.
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