Strategies for Analyzing and Entering

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CHAPTER                                         12
                     Strategies for Analyzing and Entering
                                           Foreign Markets

           After studying this chapter, students should be able to:

           > Discuss how firms analyze foreign markets.
           > Outline the process by which firms choose their mode of entry into a foreign
             market.
           > Describe forms of exporting and the types of intermediaries available to assist
             firms in exporting their goods.
           > Identify the basic issues in international licensing and discuss the advantages
             and disadvantages of licensing.
           > Identify the basic issues in international franchising and discuss the advantages
             and disadvantages of franchising.
           > Analyze contract manufacturing, management contracts, and turnkey projects as
             specialized entry modes for international business.
           > Characterize the greenfield strategies and acquisition as forms of FDI.


LECTURE OUTLINE

OPENING CASE: Starbucks Brews Up a Global Strategy

      The opening case describes Starbucks’ growth since its inception in 1971. Today,
      Starbucks is not only the largest coffee importer and roaster of specialty beans, it is also
      the largest specialty coffee bean retailer in the United States. By the end of 2002,
      Starbucks had opened 900 coffeehouses in 22 markets outside North America.

      Key Points

         Starbucks, through its promotional campaigns and commitment to quality has
          elevated coffee-drinking tastes and fueled a significant increase in demand.

         Starbucks treats its employees very well, offering health insurance to part-timers and
          lucrative stock-option plans.

         Howard Schultz, the owner since 1987, refuses to franchise Starbucks stores to
          individuals, fearing a loss of control and a potential deterioration of quality.
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         Starbucks opened coffee shops in Japan and Singapore in 1996, and moved into the
          U.K. in a big way in 1997.

         Starbucks expands its operations in three ways. Depending on circumstances, the
          firm relies on licensing agreements (in Australia, for example), company-owned
          stores (in the U.K., for example), and joint ventures (in Chinea, for example).

CHAPTER SUMMARY

      Chapter Twelve examines the various entry modes available to companies as they
      expand internationally. The chapter begins with the choice of entry modes, and then
      proceeds to discuss the advantages and disadvantages of each one.

I.    FOREIGN MARKET ANALYSIS

      To successfully increase foreign market share, firms must assess alternative markets;
      evaluate the respective costs, benefits, and risks of entering each; and select those that
      hold the most potential for entry or expansion.

      Assessing Alternative Foreign Markets

         A firm must consider a variety of factors, including market potential, levels of
          competition, the legal and political environment, and sociocultural influences when
           assessing alternative foreign markets. Discuss Table 12.1 here.
         Information on some of the factors is easily obtainable from published sources in the
          firm’s home country. Other information may be subjective and difficult to obtain. In
          fact, it may be necessary to visit the foreign location in question.
         Market Potential. The first step in foreign market selection is assessing market
          potential. Variables a firm might wish to consider include population, GDP, per
          capita GDP, public infrastructure, and ownership of goods such as automobiles and
          televisions. Students should refer to Building Global Skills in Chapter 2 for a list of
          publications that provide this type of information.
          Next, a firm must collect information relating to the specific product line under
          consideration. It may be necessary for a firm to use proxy data in some cases. The
          potential for growth in a particular market can be estimated using both objective and
          subjective measures. Show map 12.1 here.


          Cracking the Beer Market
          This Bringing the World into Focus discusses the growth of the beer market in
          Brazil. Brahma, Brazil’s oldest and largest brewery acquired smaller breweries and
          merged with the second largest producer. This powerhouse has expanded into
          Argentina, Venezuela, and Central America. Anheuser-Busch now has its eye on the
          Brazilian market.

         Levels of Competition. Firms must also consider the current and future level of
          competition in foreign markets. Firms assessing their competitive environment
          should identify the number and size of firms already competing in the potential


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          market, their relative market shares, their pricing and distribution strategies, and
          their relative strengths and weaknesses. Continual monitoring can help firms
          identify new opportunities. (See Chapter 10's closing case, The New Conquistador.)
         Legal and Political Environment. It is important that a firm understand the host
          country’s policies toward trade as well as its general legal and political environment
          prior to making an investment. Trade barriers, for example, might induce a firm to
          enter a market via FDI as opposed to exporting. In some countries, legal and
          political issues will impact both entry methods and the repatriation of profits. A
          country’s tax policies and government stability may also affect a firm’s strategy. The
          text provides specific examples of how these factors affected the international
          strategies of various firms. Map 12.1 fits in well here as well   .
         Sociocultural Influences. Sociocultural influences should also be considered when
          assessing foreign market opportunities. In many cases, firms will attempt to
          minimize the potential impact of sociocultural differences by initially focusing on
          countries that are culturally similar to their home markets.
          Depending on the proposed type of internationalization effort, certain sociocultural
          variables may be more important than others. For example, if the proposed strategy
          is to export goods to a new market, the sociocultural factors of most importance are
          those that relate to consumers. In contrast, if a firm is considering establishing a
          factory or distribution center in a foreign country, the firm should evaluate
          sociocultural factors associated with its potential employees.

      Evaluating Costs, Benefits, and Risks

         Costs. There are two types of relevant costs at this point: direct and opportunity.
          Direct costs are incurred when entering the foreign market in question and include
          costs associated with setting up a business operation, transferring managers to run
          it, and shipping equipment and merchandise. A firm incurs opportunity costs when
          entering one market precludes or delays its entry into another. The profits it would
          have earned in the second market are opportunity costs.
         Benefits. Benefits from entering a foreign market include expected sales and
          profits, lower acquisition and manufacturing costs, foreclosing of markets to
          competitors, competitive advantage, access to new technology, and the opportunity
          to achieve synergy with other operations.
         Risks. A firm entering a new market incurs the risks of opportunity costs, additional
          operating complexity, and direct financial loss due to misassessment of market
          potential. In some extreme cases, a firm may also risk loss due to government
          seizure of property, war, or terrorism.
         It is important that firms carefully assess foreign markets prior to making strategic
          decisions. Poor strategic judgments may rob a firm of profitable operations, while a
          continued inability to reach the right strategic decisions may threaten the firm’s
          existence.

                         Teaching Note:
                         Instructors may want to begin their discussion of entry methods by
                         asking students how a hypothetical (or real) firm should sell its
          product in other markets. Students can usually quickly name the various choices,
          but are uncertain as to the pros and cons of each method.




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II.   CHOOSING A MODE OF ENTRY

         Dunning’s eclectic theory (see Chapter 6) can be helpful in providing insight as to
          the best means of penetrating foreign markets. The theory considers three factors:
          ownership advantages, location advantages, and internalization factors, which in
          addition to other factors such as the firm’s need for control, the availability of
          resources, and the firm’s global strategy, help a firm decide between exporting, FDI,
          joint ventures, licensing, and franchising. Show Figure 12.1 here.
         Ownership advantages are the tangible or intangible resources owned by a firm
          that grant it a competitive advantage over industry rivals. The text provides
          examples of both tangible (Inco, Ltd’s nickel-bearing ore) and intangible (the luxury
          appeal of LVMH Moet Hennessy Louis Vuitton’s products) ownership advantages.
          The nature of a firm’s ownership advantage will play a role in the firm’s selection of
          entry mode.
         Location advantages are those factors that affect the desirability of host country
          production relative to home country production. The choice of home country versus
          host country production is affected by factors such as relative wage rates, land
          acquisition costs, capacity in existing plants, access to R&D facilities, logistical
          requirements, customer needs, the administrative costs of managing a foreign
          subsidiary, political risk, and government restrictions. Present Map 12.2 here.
         Internalization advantages are factors that affect the desirability of a firm
          producing a good or service itself rather than relying on an existing local firm to
          handle production. If transaction costs are high, the firm may select FDI or a joint
          venture as an entry method. If transaction costs are low, franchising, contract
          manufacturing, or licensing may be a better choice. The text illustrates this concept
          with an example of the factors affecting choice of entry mode in the pharmaceutical
          industry.
         Other factors that affect a firm’s choice of entry method include its need for control,
          the availability of resources, and the firm’s overall global strategy. In sum, the
          choice of an entry mode will be a tradeoff between risk and reward, the level of
          resource commitment necessary, and the level of control the firm seeks.


          Learning the Ropes about Pickups
          This section describes Toyota’s success in the American market. It discusses ways
          in which Toyota has adapted to the American environment, and ways in which it has
          not. American designers employed by Toyota were unable to persuade top Toyota
          managers that a full-sized pickup truck should be added to the company’s product
          line. That is, until the Americans took them to a Dallas Cowboys football game.
          One look at the parking lot was enough to convince the Toyota executives that a full-
          size pickup was a winning idea.




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III.   EXPORTING TO FOREIGN MARKETS

          The most common international business activity is exporting, or the process of
           sending goods or services from one country to other countries for use or sale there.
           Discuss Table 12.2 here.
          There are many advantages to exporting. It allows a firm to control its financial
           exposure in the host country; in fact, in most situations, the risk is limited to basic
           start-up costs and the value of the goods or services involved in the transaction.
           Exporting also allows a firm to enter a market on a gradual basis, gain experience in
           operating internationally, and obtain information about certain markets without any
           investment expense.
          Firms may have a proactive motivation for entering a foreign market, and in effect be
           pulled into the market as a result of the opportunities available there. The text
           provides several examples of firms that have exported as a result of a proactive
           motivation.
          Firms may also export as a result of a reactive motivation whereby they are pushed
           into exporting because domestic opportunities are shrinking, or production lines are
           running below capacity, or they are seeking higher profit margins.



           Jumping on a Japanese Jam Deal
           Chivers Hartley, a U.K. firm producing fruit preserves, after two years of negotiation
           landed a deal to export its products to Japan. The deal required changes in recipes
           and packaging, as well as the creation of a new brand name.

       Forms of Exporting

       There are three forms of exporting: indirect exporting, direct exporting, and
       intracorporate transfer. Discuss Figure 12.2 here.

          Indirect exporting occurs when a firm sells its products to a domestic customer,
           who in turn exports the product, in either its original form or a modified form.
           Because indirect exporting is usually not done on a conscious basis, the process
           does not provide the firm with experience in international business and does not
           allow the firm to capitalize on potential export profits.
          Direct exporting involves sales to customers located outside the firm’s home
           country. Although one-third of firms exporting for the first time are responding to an
           unsolicited order, subsequent efforts are usually the result of a deliberate effort,
           allowing a firm to gain valuable international business experience.
          An intracorporate transfer is the selling of goods by a firm in one country to an
           affiliated firm in another. Intracorporate transfer has become more important as the
           sizes of MNCs have increased, and today represents some 35 percent of all U.S.
           merchandise exports and imports.            The text provides several examples of
           intracorporate transfer, and the topic will also be discussed in more depth in Chapter
           17.




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      Trade in Ivory
      Overview: Since 1989, the Convention on International Trade in Endangered
      Species of Wild Fauna and Flora (CITES) has banned trade in ivory, the material
      found in elephant tusks. The CITES ban has been so effective that in many
      countries the elephant is no longer an endangered species. The question is whether
      the CITES ban should be continued or lifted.

      Point: Lift the ban. Trade in ivory promotes healthy elephant herds.
       Herds have grown significantly. Botswana's elephant population has grown from
         20,000 in 1981 to 106,000 in 1999 and Zimbabwe's has grown from 49,000 to
         70,000.
       Countries that can demonstrate that their elephants are no longer endangered
         should be allowed to sell limited amounts of elephant tusks to fund
         environmental projects.
       Allowing trade in ivory, with appropriate controls, will ensure the survival of the
         elephants and enrich the habitat for many other species of African flora and
         fauna.

      Counterpoint: Continuing the ban is the right policy.
       Though elephant herds are being restored in some countries, that is not true
        throughout Africa. Even limited legal trade in ivory will create new opportunities
        for poachers.
       Previous attempts at limited trade in ivory (such as the quota rules adopted in
        1986) did not work. They simply allowed merchants to explore loopholes in the
        quota system.
       The ban is working and achieving its objective. One shouldn't meddle with a
        policy that is working well.

      Answers to questions:

      1. Should the southern African countries like Botswana, South Africa, and
         Zimbabwe that have restored their elephant herds be allowed to sell
         surplus ivory?
         This question is at the heart of the point -counterpoint issue. Students will likely
         have different opinions based on the positions outlined above. A wide-ranging
         discussion should be encouraged. If a majority of the students seem to
         advocate continuing the ban, the instructor should explore how such a position
         relates to free trade theory and national sovereignty in order to ensure broad
         coverage of topics related to the class.

      2. Will allowing limited ivory exports encourage or discourage poachers?
         While arguments can be made for either side, students will probably feel that
         limited ivory exports will serve to encourage poaching. Limited legal exports
         would make it easier for poachers to market illegal ivory, since it would be
         possible to provide falsified documentation claiming that the ivory was obtained
         legally.




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          3. Is permitting ivory exports the best way to encourage countries to protect
             their elephant herds?
             It is unlikely that trade in ivory would lead to greater protection of elephant herds.
             Legal trade in ivory is likely to encourage additional poaching, especially in
             countries where governments have the least resources available to devote to
             elephant protection.

      Additional Considerations

      In additional to considering which form of exporting to use, a firm must also assess
      government policies, marketing considerations, logistical considerations, and distribution
      issues.

         Government policies such as export promotion policies, export financing programs,
          and other forms of home country subsidization encourage exporting. However, tariff
          and nontariff barriers may discourage firms from selecting exporting as an entry
          mode. The text illustrates this concept with the example of how voluntary export
          restraints on Japanese automobile exports encourage Japanese producers to
          manufacture in the United .States.
         Marketing concerns including image, logistics, distribution, responsiveness to the
          customer, and the need for quick feedback may also affect a firm’s choice of entry
          method. The text provides several examples of products, which are successful as
          exports because of their image.
         Logistical Considerations. A firm must consider the logistical costs of exporting
          such as the physical distribution costs of warehousing, packaging, transporting and
          distributing goods, and inventory carrying costs when selecting an entry mode.
         Distribution issues may also influence a firm’s decision to export. Many firms are
          forced to use distributors in foreign markets, and the selection of the distributor can
          be critical to the firm’s international success. In some cases, the best distributor may
          already be handling a competitor’s products and a firm will be forced to weigh the
          costs of using a less experienced distributor with the costs of using a distributor that
          will not handle its products on an exclusive basis. In addition, compensation
          decisions must be made, the firm may find that its business judgment differs from
          the distributor’s business judgment, and pricing strategies may differ.

      Export Intermediaries

      A firm may market and distribute its goods via an intermediary, a third party specializing
      in the facilitation of exports and imports.      There are several types of export
      intermediaries, including export management companies, Webb-Pomerene
      associations, and international trading companies.

         An export management company (EMC) is a firm that acts as its client’s export
          department. Several thousand EMCs operate in the United .States., providing
          clients with information about the legal, financial, and logistical details of exporting.
          Some EMCs act as commission agents, while others take title to the good.
         A Webb-Pomerene association is a group of U.S. firms that operate within the
          same basic industry and that are allowed by law to coordinate their export activities
          without fear of violating U.S. antitrust laws. Fewer than 25 associations exist today,



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          providing market research, overseas promotional activities, freight consolidation,
          contract negotiations, and other services for members.
         An international trading company is a firm directly engaged in trading a wide
          variety of goods for its own account. Unlike an EMC, an international trading
          company participates in both exporting and importing. Japan’s sogo sosha are the
          most important trading companies in the world. The success of the sogo soshas is a
          result of several factors. First, they are able to continuously obtain information about
          economic conditions and business opportunities anywhere in the world. Second,
          they have a ready source of financing from the keiretsu, and a built-in source of
          customers (fellow keiretsu members.) Discuss Table 12. 3 here.
         Other Intermediaries. Manufacturers’ agents solicit domestic orders for foreign
          manufacturers while manufacturers’ export agents act as an export department for
          domestic manufacturers.        Finally, export and import brokers bring together
          international buyers and sellers of standardized commodities, and freight forwarders
          specialize in the physical transportation of goods.

IV.   INTERNATIONAL LICENSING

         Licensing is an arrangement whereby a firm, the licensor, sells the rights to use its
          intellectual property to another firm, the licensee, in return for a fee. Firms
          operating in countries with weak intellectual property protection are not advised to
          use licensing. However, in cases where tariff and nontariff barriers, restrictions on
          the repatriation of profits, or restrictions on FDI discourage other alternatives,
          licensing may be the only option. Show Figure 12.3 here.
         Licensing is attractive because it requires few out-of-pocket costs, and because it
          allows a firm to capitalize on location advantages of foreign production without
          incurring any ownership, managerial, or investment obligations. The text provides
          an example of why the Kirin Brewery company chose licensing as a means of
          international expansion.

      Basic Issues in International Licensing

      The actual licensing agreement is a critical part of the licensing process, and reflects the
      bargaining power and skills of the licensor and licensee. The contract should consider
      the boundaries of the agreement; compensation, rights, privileges, and constraints;
      dispute resolution; and duration of the contract.

         Specifying the Agreement’s Boundaries. The first step in negotiating a licensing
          contract is specifying the boundaries of the agreement. The text provides an
          example of how Pepsi sets the boundaries in its licensing agreement with Heineken.
         Determining Compensation. Compensation under a licensing agreement is called
          a royalty. Both parties have an interest but opposing views in the determination of
          an agreement’s compensation.             The licensor wants to receive as much
          compensation as possible, while the licensee wants to pay as little as possible.
          Royalties of 3-5 percent are common.
         Establishing Rights, Privileges, and Constraints. A licensing contract should
          spell out the rights and privileges of the licensee and the constraints the licensor
          may impose. Typically, licensees are prohibited from divulging information learned
          from the licensor to third parties, are required to keep specific records on the sale of



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          products or services, and must follow specified standards regarding product and
          service quality.
         Specifying the Agreement’s Duration. Finally, a licensing agreement specifies the
          duration of the arrangement. Licensors who have chosen licensing as a low-cost
          means of gaining information about a foreign market may seek a short-term
          agreement. However, a licensee will seek an agreement that is long enough for it to
          recoup its investments in market research, the establishment of distribution
          networks, and/or production facilities. The text notes, for example, that the
          licensees that built Tokyo Disneyland required a 100-year agreement with Walt
          Disney Company.



      Advantages and Disadvantages of International Licensing

         A primary advantage of licensing is its relatively low financial risk. In addition,
          licensing permits a company to investigate foreign market sales potential without
          making significant investment in financial and managerial resources. Licensees
          benefit from the arrangement by being able to make and sell products with a proven
          track record, yet incur relatively little R&D cost.
         A primary disadvantage of licensing is that it limits market opportunities for both the
          licensee and the licensor. In addition, there is mutual dependence between the
          licensor and the licensee, and costly and tedious litigation to resolve disputes may
          hurt both parties. Finally, firms must carefully word their licensing agreements to
          minimize problems and misunderstandings, and also guard against creating a future
          competitor.

V.    INTERNATIONAL FRANCHISING

      A franchising agreement allows an independent entrepreneur or organization, called
      the franchisee, to operate a business under the name of another, called the
      franchisor, in return for a fee. Franchising is one of the fastest growing forms of
      international business today.

      Basic Issues in International Franchising

         International franchising is more likely to succeed when the franchisor has already
          achieved considerable success in franchising in its domestic market; the franchisor
          has been successful domestically because of unique products and advantageous
          operating systems; the factors that contributed to its domestic success are
          transferable to foreign locations; and there are foreign investors who are interested
          in entering into franchise agreements. The text illustrates this concept by examining
          the franchise agreements of McDonald’s.
         A formal contract is associated with franchise agreements. A typical contract
          specifies the fee and royalties paid by the franchisee for the rights to use the name,
          trademarks, formulas, and operating procedures of the franchisor. In addition, under
          a franchise contract, the franchisee typically agrees to adhere to the franchisor’s
          requirements for appearance, reporting, and operating procedures. Usually, the
          franchisor agrees to help the franchisee establish the new business.



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         U.S. firms are the leaders in the international franchise business, perhaps because
          franchising is more common in the U.S. than in other countries. The text provides
          examples of U.S. and non-U.S. firms that have been successful at franchising.

      Advantages and Disadvantages of International Franchising

         Primary advantages of international franchising are that it allows franchisees to enter
          a business with a proven track record, and allows franchisors to expand
          internationally at relatively low cost and risk. Franchisors also have the opportunity
          to obtain information about local markets that they might otherwise have difficulty
          acquiring.
         As with licensing, a primary disadvantage of franchising is that profits are shared
          between the franchisor and the franchisee. International franchising may also be
          more complex than domestic franchising. The text provides an example of some of
          the problems McDonald’s had with a franchisee in Moscow.


VI.   SPECIALIZED ENTRY MODES FOR INTERNATIONAL BUSINESS

      Firms may also use specialized entry modes such as contract manufacturing,
      management contracts, and turnkey projects.

         Contract Manufacturing is used by firms that outsource most or all of their
          manufacturing needs to other companies in an effort to reduce the amount of
          resources needed in the physical production of their products. The text notes that
          both Nike and Mega Toys use contract manufacturing in the production of their
          goods.
         A management contract is an agreement whereby one firm provides managerial
          assistance, technical expertise, or specialized services to a second firm for some
          agreed-upon time in return for a fee. In many cases, management contracts are
          arranged as a result of government activities. For example, the text notes that when
          Saudi Arabia nationalized Aramco, it hired the former owners to manage the firm.
          Management contracts are attractive because they allow firms to earn additional
          revenues without incurring investment risks or obligations. The text illustrates this
          concept with an example of Hilton Hotel’s management contracts.
         A turnkey project is a contract under which a firm agrees to fully design, construct,
          and equip a facility and then turn the project over to the purchaser when it is ready
          for operation. International turnkey projects typically involve large, complex,
          multiyear projects, such as the construction of a nuclear power plant or airport. In
          some cases, turnkey projects are used when firms fear difficulties in procuring
          resources locally. The text provides an example of the latter concept by exploring
          PepsiCo’s operations in the former Soviet Union.
         Some firms today are using a B-O-T project in which the firm builds a facility,
          operates it, and later transfers ownership of the project to another party. The text
          provides an example of such a project involving the country of Gabon.




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VII.   FOREIGN DIRECT INVESTMENT

          Some firms choose to establish operations in a host country at the beginning of their
           internationalization effort, while others prefer to use one of the other entry methods
           initially, and later invest in facilities in the host country.
          FDI is attractive not only for its profit potential, but also because a firm has increased
           control over its foreign operations. Control is important to firms because it allows
           firms to closely coordinate the activities of its foreign subsidiaries to achieve
           strategic synergies, and because control may be necessary to fully exploit the
           economic potential of an ownership advantage. FDI is also attractive if host country
           customers prefer to deal with local factories.
          However, FDI is riskier and more complex than other types of entry strategies. In
           some cases, government actions encourage firms to invest in local operations
           (through such policies as the availability of political risk insurance), while in other
           cases, government actions discourage FDI (through direct controls on foreign capital
           or repatriation of profits).
          The three basic methods of FDI are greenfield strategies, whereby a firm builds
           new facilities; acquisitions strategies (also known as "brownfield strategies"),
           whereby a firm buys existing assets in a foreign country; and joint ventures.
          A greenfield strategy involves starting from scratch: buying or leasing and
           constructing new facilities, hiring and/or transferring managers and employees, and
           launching the new operation. The greenfield strategy is attractive because the firm
           can select the site that meets its needs best, the firm starts with a clean slate, and
           the firm can acclimate itself to the new national business culture at its own pace. The
           main disadvantages of the greenfield strategy include the time and patience
           necessary for successful implementations; the fact that land in the desired location
           is not available, or is only available at an unreasonable price; local and national
           regulations must be complied with during the building of the new factory; the firm
           must recruit and train a local workforce; and the firm may be perceived as a foreign
           enterprise. The text provides an example of the difficulties Disney had with some of
           these issues when it opened its European operations.
          Acquisition strategies (or brownfield strategies) are popular because, unlike other
           entry methods, an acquisition quickly gives the purchaser control over the firm’s
           factories, employees, technology, brand names, and distribution networks. The text
           provides examples of several recent acquisitions made by firms including Proctoer
           and Gamble, Arabia Oil Co., and Komomklijke PTT Netherland. The main
           disadvantage of an acquisition strategy is that the purchaser assumes all liabilities of
           the acquired firm. In addition, the purchasing firm must also spend substantial sums
           up front. In contrast, a greenfield strategy allows a firm to spread its investment over
           an extended period of time.
          The joint venture involves an arrangement whereby a new enterprise is created by
           two or more firms working together for mutual benefit. Joint venture creation is on
           the rise, in part because of rapid changes in technology, telecommunications, and
           government policies. Joint ventures will be explored in more depth in Chapter 13.




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CHAPTER REVIEW

1. What are the steps in conducting a foreign market analysis?

   A market analysis usually is comprised of three steps: (1) assessing alternative markets; (2)
   evaluating respective costs, benefits, and risks of entering each; and, (3) selecting those
   that hold the most potential for entry or expansion.

2. What are some of the basic issues a firm must confront when choosing an entry mode for a
   new foreign market?

   When choosing an entry mode for a new foreign market, a firm must confront issues
   relating to ownership advantages, location advantages, internalization advantages, the need
   for control, the availability of resources, and the firm’s global strategy.

3. What is exporting? Why has it increased so dramatically in recent years?

   Exporting, the most common form of international business activity, is the process of
   sending goods or services from one country to other countries for use or sale there. There
   are three forms of exporting: indirect exporting, direct exporting, and intracorporate transfer.
   Many firms are pushed into exporting because of shrinking domestic marketplaces, but
   other firms are pulled into exporting because of foreign market opportunities.

4. What are the primary advantages and disadvantages of exporting?

   One of the primary advantages of exporting is its relatively low level of financial exposure.
   A second advantage of exporting is related to speed of entry. Exporting allows a firm to
   expand into a foreign market gradually, and therefore allows a company to assess the local
   environment and adapt its products to local consumers. The disadvantages of exporting
   include a lack of presence in the local marketplace, vulnerability to trade barriers, and
   potential problems with trade intermediaries.

5. What are the three forms of exporting?

   The three forms of exporting are indirect exporting, direct exporting, and intracorporate
   transfer. Indirect exporting involves selling a product to a domestic customer, which then
   exports the product in its original form or a modified form. Direct exporting involves selling
   directly to distributors or end-users in other markets. Intracorporate transfer occurs when a
   company sells its product to a foreign affiliate.

6. What is an export intermediary? What is its role? What are the various types of export
   intermediaries?

   An export intermediary is a third party that specializes in facilitating imports and exports.
   There are various types of export intermediaries, including export management companies,
   the Webb-Pomerene association, international trading companies, manufacturer’s agents,
   and export and import brokers. The role of an export intermediary can range from simply
   handling transportation and documentation to taking ownership of foreign-bound goods
   and/or assuming total responsibility for marketing or financing exports. Export



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   intermediaries are third parties that specialize in facilitating trade. There are several types
   of export intermediaries. An export management company is a firm that acts as the client’s
   export department, while a Webb-Pomerene association handles market research,
   overseas promotion, freight consolidation, contract negotiations, and other services for its
   members. An international trading company trades a variety of goods for its own account.
   A manufacturer’s agent, acting on a commission basis, solicits domestic orders for foreign
   manufacturers, while a manufacturer’s export agent acts as an export department for
   domestic manufacturers. Export and import brokers bring together buyers and sellers of
   standardized commodities, and freight forwarders handle the physical transportation of
   goods.

7. What is international licensing? What are its advantages and disadvantages?

   International licensing occurs when a firm, the licensor, sells the right to use its intellectual
   property to another firm, the licensee. The primary advantages of international licensing are
   its relatively low financial risk and the opportunity it provides the licensor to learn about
   sales potential in foreign markets. Licensees like the arrangements because they are able
   to make and sell products with proven success tracks, yet incur low R&D costs. However,
   the agreements limit market opportunities for both the licensor and the licensee, and there
   is mutual dependency between the two parties. Further, there is potential for problems and
   misunderstandings. Finally, licensors must be careful to avoid creating a future competitor.

8. What is international franchising? What are its advantages and disadvantages?

   International franchising involves an agreement whereby the franchisee operates a
   business under the name of the franchisor in return for a fee. International franchising
   agreements are attractive because they allow franchisees to enter a business that is
   established and has a proven track record. Franchisors benefit from the agreements
   because they can expand internationally at relatively low cost and risk. In addition, they can
   obtain critical information about the local marketplace from franchisees. However, an
   international franchising agreement requires both parties to share profits and may be more
   complicated than domestic franchisee agreements.




9. What are three specialized entry modes for international business, and how do they work?

   Three specialized entry modes for international business are management contracts,
   turnkey projects, and contract manufacturing. Under a management contract agreement,
   one firm provides managerial assistance, technical expertise, or specialized services to a
   second firm in exchange for a fee. A turnkey project is an agreement whereby a firm
   agrees to fully design, construct, and equip a facility and then turn the key over to the
   purchaser when it is ready for operation. Contract manufacturing involves outsourcing
   manufacturing needs to other companies.




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10. What is FDI? What are its three basic forms? What are the relative advantages and
    disadvantages of each?

   FDI is foreign direct investment. The three basic forms of FDI are greenfield investments,
   acquisitions, and joint ventures. Greenfield investments involve the construction of new
   facilities. It is attractive because its allows a firm to select the most suitable site for
   construction, the firm starts with a clean slate, and the firm can adapt to its new
   surroundings at its own pace. However, greenfield investments take time and patience,
   may be expensive, require the firm to comply with local regulations and recruit a workforce,
   and may result in a firm being perceived as a foreigner. Acquisitions, in contrast, allow a
   firm to generate profits even as it integrates the new company into its overall strategy.
   However, acquisition requires a firm to assume all of the acquired firm’s liabilities, and
   spend substantial money up front. Joint ventures involve the creation of a new firm by two
   or more companies working together for mutual benefit.


QUESTIONS FOR DISCUSSION

1. Do you think it is possible for someone to make a decision about entering a particular
   foreign market without having visited that market? Why or why not?

   The response to this question probably depends in part on the market in question and the
   degree of risk one is willing to assume. Typically, managers will not be able to obtain all of
   the information needed to make a decision about a foreign market from secondary sources.
   Thus, managers have two options: they can visit the market in person and obtain
   information directly from local experts, embassy staff, and chamber of commerce officials,
   or, hire consulting firms to provide the necessary information.




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2.
2. How difficult or easy do you think it is for managers to gauge the costs, benefits, and risks    Formatted: Bullets and Numbering
   of a particular foreign market?

   In general, it is probably easier to gauge the costs, benefits, and risks of developed country
   markets than it is to gauge the same variables in a developing economy. However, there is
   a fair amount of subjectivity involved regardless of the market in question. For example,
   managers must estimate not only the costs involved in establishing a foreign operation, but
   also opportunity costs. In addition, future benefits and risks must be estimated.

2.3.   How does each advantage in Dunning’s eclectic theory specifically affect a firm’s
    decision regarding entry mode?

   Dunning’s eclectic theory considers three factors: ownership advantages, location
   advantages, and internalization advantages. Ownership advantages affect a firm’s decision
   regarding entry mode in that certain types of advantages are more easily transferred
   through certain modes than others. For example, imbedded technologies are best
   transferred through equity modes, while simple technology is more suited to a licensing
   mode. In addition, ownership advantages will affect a firm’s bargaining power, and
   therefore the outcome of entry mode negotiations. Location advantages affect a firm’s
   decision regarding entry mode because they affect the desirability of host country
   production relative to home country production. For example, if home country production is
   more desirable, perhaps because of low wage rates, a firm will probably choose exporting
   as an entry mode. Finally, internalization advantages affect a firm’s decision regarding
   entry mode because they affect the desirability of producing a good or service in-house
   versus farming it out to another firm. For example, when transaction costs are low, and the
   firm believes that it can farm out production without jeopardizing its interests, the firm may
   use licensing as an entry mode.


3.4.   Why is exporting the most popular initial entry mode?

   Exporting is the most popular initial entry mode because of its simplicity and its low risk
   relative to other types of entry modes. Exporting typically requires little or no capital
   investment, and the dollar amount of risk is limited to the value of a particular transaction.
   Exporting also allows a firm to enter a foreign market on a gradual basis, and gain
   experience in the market.

4.5.   What specific factors could cause a firm to reject exporting as an entry mode?

   There are several factors twhichat could cause firms to reject exporting as an entry mode,
   including the presence of trade barriers, logistical issues, and distribution issues. Firms
   facing high tariff or nontariff barriers may find host country production preferable to home
   country production. Logistical considerations may also affect the desirability of exporting.
   For example, the higher transportation costs associated with exporting, and the longer
   supply channel and difficulty communicating with customers may encourage a firm to
   choose an alternative entry method. Finally, firms that face difficulty finding appropriate
   distributors may turn to one of the other entry modes.

5.6.   What conditions must exist for an intracorporate transfer to be cost-effective?



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                                        Strategies for Analyzing and Entering Foreign Markets >   243




   An intracorporate transfer occurs when one firm sells goods to an affiliate in another
   country. Firms engage in intracorporate transfers to lower their production costs and use
   their facilities more effectively. Therefore, for an intracorporate transfer to be cost-effective,
   it must be cheaper to buy the product in question from the affiliate firm than from an
   alternative source, and the affiliate firm must have the capacity necessary to produce the
   product in question, while the buying firm does not.

6.7.   Your firm is about to begin exporting.        In selecting an export intermediary, what
    characteristics would you look for?

   Export intermediaries are third parties that specialize in the facilitation of trade. Depending
   on the particular circumstances of a firm, employing certain types of intermediaries is more
   appropriate than employing others. For example, a small firm may select an export
   management company because it will essentially act as the firm’s export department.
   However, a larger firm that has an in-house export department might engage a freight
   forwarder on a product-by-product basis.

7.8.    Do you think trading companies like Japan’s sogo sosha will ever become common in
    the United States? Why or why not?

   Sogo soshas acquire goods either by importing them or having them produced, and then
   resell them in both domestic and foreign markets. Most students will probably agree that
   sogo soshas will never become common in the United States, in part because of antitrust
   laws in effect, and in part because the close relationships with other firms that the sogo
   soshas imply go against the individualistic culture of the United .States. Other students,
   however, may point to export trading companies in the United. States. that provide many of
   the same services as a sogo sosha, and suggest that a form of sogo sosha is already
   common in the United .States.


8.9.   What factors could cause you to reject an offer from a potential licensee to make and
    market your firm’s products in a foreign market?

   There are several reasons why a firm might reject the offer of a potential licensee to make
   and market the firm’s product in a foreign market. First, such an arrangement would limit
   the market opportunities for the firm, and create a situation of mutual dependency. Second,
   if the licensee violated the licensing agreement, the licensing firm could face costly and
   time-consuming litigation.      Third, the firm would face a risk of problems and
   misunderstandings related to the agreement, which could affect the speed of entry into the
   foreign market. Finally, the firm may be concerned that if it licensed its proprietary
   information, it may create a future competitor.

9.10. Under what conditions should a firm consider a greenfield strategy for FDI?                 An
   acquisition strategy?

   A greenfield strategy involves setting up an operation from scratch. It is attractive to firms
   because it allows them to select the site that is most appropriate for their needs, start with a
   clean slate, and acclimate to the local environment at a gradual pace. However, because
   successful implementation takes time and patience, firms that are facing time constraints



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   should probably select an alternative option. In addition, firms using this method of
   expansion may find that the desired location is too expensive, or even unavailable; that
   workforces must be hired and trained; and that various governmental regulations must be
   complied with. Finally, greenfield investment is probably not appropriate in cases where it is
   important for a firm to be perceived as a local firm. Under an acquisition strategy, a firm
   acquires an existing firm doing business in a foreign country. This strategy makes sense
   when the purchaser needs to generate revenues from its expansion immediately. Through
   acquisition, a purchasing firm has an immediate market presence, a distribution system in
   place, as well as trained employees, brand names, and technology. This strategy would not
   make sense for a company that is short of capital since it requires substantial sums up
   front.


BUILDING GLOBAL SKILLS

Essence of the exercise
This exercise begins with a description of Heineken’s global strategy, and then asks students to
identify other products or brands that could or could not use Heineken’s strategy for entering
markets. Students should be assigned to groups for this exercise because it requires that
groups exchange lists of companies that could or could not use the Heineken approach to
international expansion.




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                                       Strategies for Analyzing and Entering Foreign Markets >   245


Answers to the follow-up questions:

1. What are the specific factors that enable Heineken to use the approach described and
   simultaneously make it difficult for some other firms to copy it? What types of firms are
   most and least likely to be able to use this approach?

   Students will probably identify several factors that enable Heineken to use its three-step
   approach to foreign market expansion, including its international experience, its deep
   pockets, its ability to enter a market on a gradual basis, and the presence of local producers
   in most markets. In addition to certain consumer products, students will probably identify
   other beer companies that could use this approach. Firms that would find this approach
   difficult include auto producers, steel producers, and clothing producers.

2. What does this exercise teach you about international business?

   Students should recognize from this exercise that an international strategy that works well
   for some companies might not be effective for other companies. Students should also
   recognize that successful global companies such as Heineken might achieve their success
   in a very methodical manner, first by testing a market and then learning about it before
   actually investing in it. In addition, students should recognize that firms might use a variety
   of modes to enter a foreign market. Finally, through the exchange of lists (steps 3 and 4 of
   the exercise), students should recognize that not all managers think alike.


CLOSING CASE

Heineken’s Global Reach

       The closing case explores Heineken NV’s global strategy. In particular, it considers the
       strategic moves and selection of entry modes Heineken is making in the United .States.
       and Europe to increase its competitiveness.

       Key Points

          Heineken NV, the world’s third largest beer producer, earns more than 85 percent of
           its revenues outside of the Netherlands. The company is a market leader in every
           European country, and sells its beer in North and South America, Africa, and Asia
           (170 countries in all).

          Heineken began exporting beer to the United .States. in 1914, temporarily halted its
           sales during Prohibition, and successfully reestablished sales after Prohibition.
           Heineken’s distributor in the United .States. was Van Munching & Company.

          Today, Heineken brews beer in more than 50 countries. The company expanded
           into the soft drink and wine businesses in the 1970s to exploit its bottling technology
           and global distribution networks.

          Heineken’s current strategy is to achieve in Europe the same sort of market
           dominance Anheuser-Busch has in the United .States. To that end, Heineken has
           bought breweries in several European countries as a way of expanding its product


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          lines and facilitating distribution throughout Europe. In addition, the company has
          closed or modernized older breweries.

         Heineken has avoided establishing a brewery in the United .States., however,
          because it wants to retain its imported image. Heineken knows that from a cost
          standpoint, local production might make sense, but notes that Lowenbrau actually
          saw a decrease in sales after establishing a U.S. operation.

         Heineken has, however, bought its U.S. distributor, Van Munching & Company, to
          cut costs and increase profits. The move also enables Heineken to coordinate its
          U.S. marketing campaigns with its global ones.

         In 2002 Heineken bought Egypt’s sole brewery – which also brews a popular line of
          nonalcoholic beer (Islam forbids the consumption of alcohol) that can be marketed
          by Heineken to the 1.3 billion Muslims around the world.

      Case Questions

      1. Describe the fundamental issues in foreign market analysis for a firm like Heineken.

          First, it must assess the potential for sales of its product in different markets. Next, it
          must assess the level of local competition. Next, it must evaluate the legal and
          political environment. Finally, it must consider sociocultural influences. For example,
          in the huge U.S. market, the level of local competition may have lead Heineken to
          use an export strategy (thereby differentiating its product from those of the
          established American breweries). Similarly in Egypt, sociocultural (as well as legal)
          issues have leaed Heineken into the nonalcoholic beer market.

      2. Discuss the advantages and disadvantages of Heineken’s exporting its beer from
         one country to another.

          One key advantage is Heineken’s ability to differentiate its product (especially in the
          United .States.) as an imported beer. This allows it to avoid head-to-head
          competition with Anheuser-Busch. This focus strategy has been key to Heineken’s
          success in the U.S. market. By restricting itself to exporting, however, Heineken
          limits its ability to be a dominant force in the U.S. market and faces all the issues
          associated with restrictions on imports.

      3. Heineken earns the majority of its revenues outside of its home country, yet both
         Anheuser-Busch and Miller sell 95 percent of their output locally. What factors could
         explain this difference?

          Naturally, the limited size of the Netherlands market plays a role. To achieve
          growth, Heineken early on needed to expand into foreign markets. Being present in
          the European Common Market also made international sales a profitable venue for
          the firm. American firms achieved profitability, growth, and economies of scale
          within their large domestic market.




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        4. Use the Internet to learn more about FDI by Heineken as compared to FDI by
           Anheuser-Busch.

           Depending which sites students visit, they may come up with a wide range of
           observations. The key on this question is to use the information gathered by
           students to emphasize the contrast between Anheuser-Busch’s approach and that
           pursued by Heineken.




            Chapter 12:
Strategies for Analyzing and Entering Foreign Markets


Suggestions on incorporating the Multimedia exploration into the lesson plan

The key objectives of Chapter 12 are:

       Learning about how firms analyze foreign markets and select the best mode of entry
       Understanding exporting, licensing, and franchising
       Analyzing other specialized entry modes for international business
       Reviewing foreign direct investment


The following are some suggestions on how best to utilize the CultureQuest materials to
achieve these objectives.

   1.               Global Business Video: Understanding Entry Modes into the Chinese
        Market explores the different ways that companies enter the Chinese market.

        Show the Video as you review the section entitled, Choosing a Mode of Entry.

   2.                 Review the questions in class and use the following suggested responses to
        initiate class discussion.



Responses to end of the chapter CultureQuest questions (for video related sections
only)




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The complete video narration for the video titled, CultureQuest: Global Business Video, is noted
at the end of this chapter guide. Please reference it for a full review of the responses to the
following questions from the textbook. Below, we’ve noted suggested answers for your quick
reference

Textbook Question: This chapter has profiled the different types of arrangements that
companies consider when setting up global operations. Answer the following questions based
on the materials in the chapter and the accompanying video your instructor may choose to
show you.

(Please refer to narration below and Chapter 12 in text)


1. What factors do companies consider when determining the best form of
   operation to use when entering a new market?

There are four key ways to enter the Chinese market:

      exporting to China
      licensing, including franchising
      Equity joint ventures
      Wholly owned foreign enterprises (WOFEs or Woofies)

These are not mutually exclusive ways to enter.                                                    Comment [A1]:


   Companies have to consider a number of financial, operational and resource factors. Some
   of the key factors that companies consider when determining the best way to enter a market
   include:

   1. How much control they wish to retain while for others
   2. The extent of resources, financial and other, that they are willing to commit to the new
      market.
   3. Physical and social factors
   4. Market nuances
   5. Prior experience in foreign collaborations


2. What have been the challenges and opportunities for foreign companies in establishing
   collaborative arrangements in China?

   Opportunities
   1. Large domestic market of consumers for products and services
   2. Cheap labor pool for manufacturing collaborations


   Challenges
   1. Language and culture
   2. Need for guanxi (connections)
   3. Previous government restrictions on ownership and repatriation of gains
   4. Previous lack of convertibility of currency



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                                        Strategies for Analyzing and Entering Foreign Markets >   249


   5. Unwieldy bureaucracy
   6. Lack of disclosure of corporate accounting practices and governance
   7. Protection of intellectual property


3. How have Chinese government policies and attitudes towards foreign businesses evolved?
   How have these changes affected foreign companies' forms of operations in China?

The Chinese government has become more open to foreign companies over the past two
decades. However, foreign companies are sometimes concerned about the protecting their
intellectual property. In fact, until 1992, any technology that was part of a joint venture could be
accessed by a local Chinese company through a government agency. Though today there’s still
concern over the protection of intellectual property, China’s inclusion in the World Trade
Organization has encouraged the government to focus attention on how best to protect property
rights for everything from software, videos and DVDs to brand names for consumer products.

Prior to 1986, foreign companies could not wholly own a local subsidiary. The Chinese
government began to allow equity joint ventures only since 1979, which marked the beginning
of the Open Door Policy, an economic liberalization initiative. The Chinese government strongly
encouraged equity joint ventures as a great way to gain access to the technology, capital,
equipment and know-how of foreign companies. The risk to the foreign company was that if the
venture soured, the Chinese company could end up keeping all of these assets. Often Chinese
companies only contributed things like land or tax concessions that foreign companies couldn’t
keep if the venture ended.

In 1986, the government began to permit wholly-owned foreign enterprises -- WOFEs –
sometimes called woofies – as an alternative to joint ventures. Even then, the government
banned wholly owned enterprises that were either strategic, like utilities or transportation, or
were in industries where Chinese companies already had sufficient capabilities, like production
of blue porcelain. The government also traditionally required woofies to be high tech companies
that export at least 50% of their production. In reality, this rule has not always been uniformly
enforced.

Additional Exercises for Exploring Ethics in Global Business

1. Student Activity and Discussion:
Have the students pick a global company, American or other, and one country in which it
operates. Ask them to research how the company is currently performing in that market and
what factors the company most likely considered when first entering that market.

Operating conditions change over time. Would the students evaluate the market differently if
they were to enter it now versus when the company originally entered that market? Has the
company’s strategy in that market changed over time?


2. Team Activity and Discussion:
Group the students into teams of two or three people. Have each team select one market and
determine what factors are important in reviewing market entry strategies




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      Market entry strategies
      Export/import
      Management contracts
      Licensing
      Franchising
      Joint ventures/strategic alliances
      Turnkey operations
      wholly owned subsidiaries (DFI = direct foreign investment)

Discussion Questions
1. Why would a company choose a particular market strategy over another? Can a company
have more than one strategy? Why or why not?

2. In the country and market selected above, what are the local cultural nuances to doing
business?

Additional test questions on this information can be found in the Test Item File.



Video Narration:               Global Business Video
Guanxi and Woofies: Understanding Entry Modes into the Chinese Market
With a population exceeding 1.3 billion, continued economic growth, and a large supply of
inexpensive and productive labor, China lures businesses from around the world. Despite
criticisms of its unwieldy bureaucracy or lack of disclosure of corporate accounting practices
and governance, most global companies agree that you can’t be globally successful if you
ignore this emerging market.

It’s clear that the Chinese business landscape is changing. As economic and political reforms
continue, China is charging ahead in its efforts to become one of the key global economies. At
the same time, companies looking to do business in China need to keep in mind the impact of
its long and complex history as well as its rich cultural traditions, all of which continue to exert a
strong influence on virtually every aspect of Chinese life, including how business is conducted.
The key to doing business in China is flexibility, patience and persistence, much as you’d need          Comment [A2]:
in most emerging markets, but with a few unique twists.

Companies considering doing business with China have to first determine the best way to enter
the market. Most foreign firms utilize some form of collaborative arrangement with local firms
when entering China.

In this segment, we’ll talk about how companies can enter the Chinese market; the various
factors they need to consider if they enter into a collaborative arrangement, and some of the
tactical steps they need to take in the early stages of their Chinese operations.

There are four key ways to enter the Chinese market:

      exporting to China
      licensing, including franchising
      Equity joint ventures


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                                        Strategies for Analyzing and Entering Foreign Markets >   251


      Wholly owned foreign enterprises (WOFEs or Woofies)

These are not mutually exclusive ways to enter.                                                         Comment [A3]:


It’s clear for those experienced in dealing with China that there isn’t one best way to enter
China. Companies have to consider a number of financial, operational and resource factors. For
example, some companies start by considering how much control they wish to retain while for
others, the primary concern is how much of their own resources they're willing to commit. As
companies develop more experience doing business with China, they’re likely to reassess the
way they do business in the country, particularly in terms of collaborative arrangements.
Companies that aim to have a stronger and more profitable presence in the Chinese market
need to increase their commitment of resources.

Exporting to China

Exporting may be effective, especially for smaller and mid-size companies that can’t or won’t
make any significant financial investment in the Chinese market. Companies can sell into China
either through a local distributor or through their own salespeople. Many government export
trade offices can help a company find a local Chinese distributor or producer. Increasingly, the
internet has provided a more efficient way for foreign and Chinese companies to find one
another and enter into commercial transactions.

Using distributors can have its own challenges. For example, some companies find that if they
have a dedicated salesperson who travels frequently to China, they’re likely to get more sales
than by relying on a China-based distributor. Often, Chinese distributors sell multiple products
and sometimes even competing ones. Making sure that the Chinese distributor favors your
product over another can be hard to monitor. Further, some companies often find that culturally,
Chinese consumers may be more likely buy a product from a foreign company than from a local
distributor, particularly in the case of a complicated, high-tech product. Simply, the Chinese are
more likely to trust that the overseas salesperson knows their product better.

There are risks with relying on the export option. If you merely export to China, the Chinese
distributor or buyer might switch purchases to a cheaper supplier or even just threaten to in
order to get a better price from you. Or, someone might start making the product within China
and take the market from you. Also, local Chinese buyers sometimes believe that a company
which only exports to them is not very committed to provide long-term service and support once
a sale is complete. Thus they may prefer to buy from someone who is producing within China.
At this point, many companies begin to consider having a local presence, which moves them
towards one of the other three entry options.


Licensing and Franchising

Under a licensing or franchising agreement, a foreign company grants rights on its intangible
property, like technology or a brand name, to a Chinese company for a specified period of time.
In return, it receives a royalty. The Chinese sometimes call this a contractual joint venture.
While the foreign company usually has no ownership interests, they often provide ongoing
support and advice.




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Most companies still consider this market entry option of licensing and franchising -- a low risk
option because there’s typically no upfront investment. However, foreign companies are
sometimes concerned about the protecting their intellectual property. In fact, until 1992, any
technology that was part of a joint venture could be accessed by a local Chinese company
through a government agency. Though today there’s still concern over the protection of
intellectual property, China’s inclusion in the World Trade Organization has encouraged the
government to focus attention on how best to protect property rights for everything from
software, videos and DVDs to brand names for consumer products.


Equity Joint Ventures

The next option for companies entering China is some form of equity joint ventures. In the past,
joint ventures were the only relationship foreign companies could form with Chinese companies.
In fact prior to 1986, foreign companies could not wholly own a local subsidiary.

The Chinese government began to allow equity joint ventures only since 1979, which marked
the beginning of the Open Door Policy, an economic liberalization initiative. The Chinese
government strongly encouraged equity joint ventures as a great way to gain access to the
technology, capital, equipment and know-how of foreign companies. The risk to the foreign
company was that if the venture soured, the Chinese company could end up keeping all of
these assets. Often Chinese companies only contributed things like land or tax concessions
that foreign companies couldn’t keep if the venture ended.

Equity joint ventures pose both opportunities and challenges for the companies that choose this
option. First and foremost is the challenge of finding the right Chinese partner – not just in
terms of business focus, but also in terms of compatible cultural perspectives and management
practices. We’ll talk more about these kinds of factors companies need to consider later.

Wholly Owned Foreign Enterprises

The last entry option requires the highest commitment by the foreign company, which also must
assume all of the risk, financial and otherwise. In 1986, the government began to permit wholly-
owned foreign enterprises -- WOFEs – sometimes called woofies – as an alternative to joint
ventures. Even then, the government banned wholly owned enterprises that were either
strategic, like utilities or transportation, or were in industries where Chinese companies already
had sufficient capabilities, like production of blue porcelain. The government also traditionally
required woofies to be high tech companies that export at least 50% of their production. In
reality, this rule has not always been uniformly enforced.

Some foreign companies believe that owning their own operations in China is an easier option
than having to deal with a Chinese partner. For example, many foreign companies still fear that
their Chinese partners will learn too much from them and become competitors. However, in
most cases the Chinese partner knows the local culture – both that of the customers and
workers -- and is better equipped to deal with Chinese bureaucracy and regulations.
Additionally, even woofies cannot be totally independent of Chinese firms, who they might have
to rely on for raw materials and shipping as well as maintenance of government contracts and
distribution channels.




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                                       Strategies for Analyzing and Entering Foreign Markets >   253


Collaborations offer different kinds of opportunities and challenges than self-handling Chinese
operations. For most companies, the local nuances of the Chinese market make some form of
collaboration desirable. The companies that opt to self-handle their Chinese operations tend to
be very large and / or have a proprietary technology base such as companies in high-tech or
aerospace – for example Boeing or Microsoft. Even then, these companies tend to hire senior
Chinese managers and consultants to facilitate their market entry and then help manage their
expansion. Nevertheless, navigating the local Chinese bureaucracy is tough, even for the most
experienced companies.

Just about any large venture in China will at some point comes into contact with the Ministry of
Foreign Trade and Economic Development. China has a vast bureaucracy, although it’s being
revamped, and a maze of government agencies and regulations.

Many foreign companies choose to enter China via Hong Kong. They may set up a Hong Kong
company or use a Hong Kong based Chinese company as a partner. For decades, this was the
only legally permitted option as the Chinese government strictly controlled access to its local
markets. Even with China’s liberalization, many companies continue to enter via Hong Kong
because Hong Kong places very few restrictions and red tape on foreign investment, is well-
regulated, offers operating efficiencies, and has transparent operating rules and regulations.
                                                          st
However, the handover of Hong Kong to China on July 1 , 1997 has weakened some of these
attributes.

Entering through Hong Kong does have its problems. These days, some mainland Chinese,
especially those from Beijing, complain that Hong Kong Chinese have taken advantage of
them, and thus are reluctant to deal with them. In such cases, foreign companies are better off
choosing a different way to enter the Chinese market. Further, most people in China speak
Mandarin, which is not the primary language in Hong Kong. But over 400 million speak one of
the other seven dialects such as Cantonese, which is the main language in Hong Kong and is
commonly spoken throughout the southern part of China.


Regardless of which entry strategy a company chooses, several factors are always important.

          Cultural and linguistic differences (pause) – these affect all relationships and
           interactions inside the company, with customers and with the government.
           Understanding the local business culture is critical to success
          Quality and training of local contacts and / or employees (pause) – evaluating the
           skill sets and determining if the local staff is qualified is a key factor for success
          Political and economic issues (pause) – policy can change frequently and
           companies need to determine what level of investment they are willing to make, what
           is required to make this investment and how much of earnings they can repatriate
          Experience of the partner company (pause) – assessing the experience of the
           Chinese company in the market, with the product and in dealing with foreign
           companies is essential in selecting the right local partner

One of the most important cultural factors in China is guanxi , which is loosely defined as a
connection based on reciprocity. Even when just meeting a new company or partner, it’s best to
have an introduction from a common business partner, vendor or supplier – someone the
Chinese will respect. China is a relationship-based society. Relationships extend well beyond
the personal side and can drive business as well. This stands in sharp contrast to the West



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254 > Chapter 12


where relationships have less importance. With guanxi, a person invests with relationships
much like one would invest with capital. In a sense, it's akin to the Western phrase, "You owe
me one."

Guanxi can potentially be beneficial or harmful. At its best, it can help foster strong, harmonious
relationships with corporate and government contacts. In its worst, it can encourage bribery and
corruption. Whatever the case, companies without guanxi won’t accomplish much in the
Chinese market. Many companies address this need for guanxi by entering into the Chinese
market in a collaborative arrangement with a local Chinese company. This entry option has also
been a useful way to circumvent regulations governing bribery and corruption, but it can raise
ethical questions, particularly for American and Western companies that have a different
cultural perspective of gift-giving and bribery

Once a meeting has been set up, foreign companies need to understand the local cultural
nuances that govern first meetings, from physical and verbal gestures to seating order.

Selecting an entry strategy for China is easier said than done. We’ve covered the structural
options as well as some of the issues that foreign companies need to consider when they
decide to enter the Chinese market.



Overall, foreign companies need to:

      Research the Chinese market thoroughly and learn about the country and its culture
       (pause)

      Understand the unique business and regulatory relationships that impact their industry,
       whether its consumer products or mining and forestry (pause)

      Use the Internet to identify and communicate with appropriate foreign trade corporations
       in China or their own government’s embassy in China. Each embassy has its own trade
       and commercial desk. For example, the U.S. embassy has a foreign commercial service
       desk and officer who assists American companies on how best to enter the local market.
       These resources are best for smaller companies. Larger companies who have more
       money and resources usually hire top consultants to do this for them. They’re also able
       to have a dedicated team assigned to China who can travel there frequently in the
       beginning of the relationship to meet with government representatives. (pause)

      Once a company has decided to enter the Chinese market, it needs to spend some time
       to understand the local business culture and how to operate within it. (pause)


China joined the World Trade Organization in December 2001 and it’s clear that it will be drawn
even more into the global economy as companies continue to vie for access to its 1.3 billion
consumers and cheap and productive labor pool. Most companies expect that dealing with
China will now become more straightforward if not easier. Whatever the future brings, the
Chinese economy continues to be a powerhouse of growth and opportunity.




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                                         Strategies for Analyzing and Entering Foreign Markets >   255




           Chapter 12:
Test Questions


1. List four ways to enter the Chinese market.

There are four key ways to enter the Chinese market:

       exporting to China
       licensing, including franchising
       Equity joint ventures
       Wholly owned foreign enterprises (WOFEs or Woofies)


2. True or False.

Most global companies entering China will deal with the Ministry of Foreign Trade and
Economic Development.

True. Just about any large venture in China will at some point comes into contact with the
Ministry of Foreign Trade and Economic Development. China has a vast bureaucracy, although
it’s being revamped, and a maze of government agencies and regulations.


3. List two factors that are important to consider when entering a new market.

Regardless of which entry strategy a company chooses, several factors are always important.

       Cultural and linguistic differences – these affect all relationships and interactions inside
        the company, with customers and with the government. Understanding the local
        business culture is critical to success
       Quality and training of local contacts and / or employees – evaluating the skill sets and
        determining if the local staff is qualified is a key factor for success
       Political and economic issues – policy can change frequently and companies need to
        determine what level of investment they are willing to make, what is required to make
        this investment and how much of earnings they can repatriate
       Experience of the partner company – assessing the experience of the Chinese
        company in the market, with the product and in dealing with foreign companies is
        essential in selecting the right local partner


4. Which statement best describes the concept of guanxi in Chinese business culture?

   a.   Guanxi are connections based on reciprocity.
   b.   Guanxi is like giving or receiving an “I owe you”.
   c.   Guanxi can be harmful and beneficial.
   d.   All of the above.




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256 > Chapter 12


D. All of the above. One of the most important cultural factors in China is guanxi, which is
loosely defined as a connection based on reciprocity. Even when just meeting a new company
or partner, it’s best to have an introduction from a common business partner, vendor or supplier
– someone the Chinese will respect. China is a relationship-based society. Relationships
extend well beyond the personal side and can drive business as well. This stands in sharp
contrast to the West where relationships have less importance. With guanxi, a person invests
with relationships much like one would invest with capital. In a sense, it's akin to the Western
phrase, "You owe me one."

Guanxi can potentially be beneficial or harmful. At its best, it can help foster strong, harmonious
relationships with corporate and government contacts. In its worst, it can encourage bribery and
corruption. Whatever the case, companies without guanxi won’t accomplish much in the
Chinese market. Many companies address this need for guanxi by entering into the Chinese
market in a collaborative arrangement with a local Chinese company. This entry option has also
been a useful way to circumvent regulations governing bribery and corruption, but it can raise
ethical questions, particularly for American and Western companies that have a different
cultural perspective of gift-giving and bribery


Resources for additional information


http://www.tdctrade.com/chinaguide/index_e.htm – Hong Kong TDC is the global marketing arm
and service hub for Hong Kong-based manufacturers, traders and service exporters.

http://www.usatrade.gov/website/ForOffices.nsf/(CountryList)/China?OpenDocument – U.S.
government information on doing business with China.

www.worldinformation.com – overview per continent/region; current events; trade, etc.

www.nationsonline.org – general information on countries/regions/continents; history, business
and finance information

www.executiveplanet.com – information on business etiquettes/protocols per country

www.nationbynation.com – information on geography, history and people of each country

www.culture-quest.com – business and cultural information on countries and regions around
the world

www.businesstravelogue.com – information on business etiquettes for each country
www.economist.com – search for global ethics to see most recent articles

http://www.countrybriefings.com/?showPage&PAGE=atmaGlobal.tml&RID=4196 – current
economic information on major economies around the world

www.culture-quest.com – business and cultural information on countries and regions around
the world




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      Strategies for Analyzing and Entering Foreign Markets >   257




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