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Article - The Choice of Entry Mode.docx

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Pat Lemieux

Article – The Choice of Entry Mode  Five main choices for mode of entry: o Exporting, licensing, franchising, entering into a joint venture with a host country company, and setting up a wholly owned subsidiary in the host country Exporting  Most manufacturing companies begin their global expansion as exporters and only later switch to one of the other modes for serving a foreign market.  Exporting has two distinct advantages: o Avoids the costs of establishing manufacturing operations in the host country o May be consistent with realizing experience-curve cost economies and location economies  By manufacturing the product in a centralized location and then exporting it to other national markets, the company may be able to realize substantial scale economies from its global sales volume  Drawbacks to exporting: o Exporting from the company’s home base may not be appropriate if there are lower-cost location for manufacturing the product abroad o May pay to manufacture in a location where conditions are most favorable from a value-creation perspective and then export from that location to the rest of the globe o High transport costs can make exporting uneconomical, particularly in the case of bulk products  One way to get around this problem is to manufacture bulk products in a regional basis, enables the company to realize some economies of scale while limiting transport costs o Tariff barriers can make exporting uneconomical, and the treat to impose tariff barriers by the government of a country the company is exporting to can make the strategy very risky o A common practice among companies that are just beginning to export also poses risks Licensing  Arrangement whereby a foreign licensee buys the rights to manufacture a country’s product in the licensee’s country for a negotiated fee  The licensee then puts up most of the capital necessary to get the overseas operation going  The advantage of licensing is that the company does not have to bear the development costs and risks associated with opening up a foreign market  Licensing therefore can be a very attractive option for companies that lack the capital to develop operations overseas  Can also be an attractive option for companies that are unwilling to commit substantial financial resources to an unfamiliar or politically volatile foreign market where political risks are particularly high  Three serious drawbacks: o Does not give a company the tight control over manufacturing, marketing and strategic functions in foreign countries that it needs to have in order to realize experience-curve cost economies and location economies  Licensing typically involves each licensees setting up its own manufacturing operations  When cost economies are important, licensing may not be the best way of expanding overseas o Competing in a global marketplace across countries so that the profits earned in one country can be used to support competitive attacks in another  Licensing, severely limits a country’s ability to do so  Licensee is unlikely to let a multinational company take its profits (beyond those due in the form of royalty payments) and use them to support an entirely different licensee operating in another country o Risk associated with licensing technological know-how to foreign companies  Technological know-how forms the basis of their competitive advantage, and they would want to maintain control over the use to which it is put  Company could quickly lose control of its technology Franchising  Franchising is a strategy employed chiefly by service companies  The company sells to franchisees limited rights to use its brand name in return for a lump-sum payment and a share of the franchisee’s profits  Franchisees have to agree to abide by strict rules as to how they do business  Advantages of franchising are similar to those of licensing  The franchiser does not have to bear the development costs and risks of opening up a foreign market on its own, for the franchisee typically assumes those costs and risks 1  Using a franchising strategy, a service company can build up a global presence quickly and at a low cost  Disadvantages are less pronounced than in the case of licensing  Franchiser does not have to consider the need to coordinate manufacturing in order to achieve experience-curve effects and location economies  More significant disadvantage concerns quality control o Foundation of franchising arrangement is the notion that the company’s brand name conveys a message to consumers about the quality of the company’s product o To reduce this drawback, a company can set up a subsidiary in each country or region in which it is expanding o Subsidiary might be wholly owned by the company or a joint venture with a foreign company o Subsidiary then assumes the rights and obligations to establish franchisees throughout that particular country or region Joint Ventures  Establishing a joint venture with a foreign company has long been a favored mode for entering a new market  Most typical form of joint venture is a 50/50 venture, in which each party takes a 50 percent ownership stake and operating control is shared by a team of managers from both parent companies  Have a number of advantages: o Company may feel that it can benefit from a local partner’s knowledge of a host country’s competitive conditions, culture, language, political systems, and business systems o When the development costs and risks of opening up a foreign market a high, a company might gain by sharing these costs and risks with a local partner o In many countries, political considerations make joint ventures the only feasible entry mode  Joint ventures can be difficult to establish and run because of two main drawbacks o As in the case of licensing, a company that enters into a joint venture risks losing control over its technology to its venture partner  To minimize this risk, a company can seek a majority ownership stake in the joint venture o Joint venture does not give a company the tight control over its subsidiaries that it might need in order to realize experience-curve effects or location economies or to engage in coordinated global attacks against its global rivals Wholly Owned Subsidiaries  A wholly owned subsidiary is one in which the parent company owns 100 percent of the stock  A company can set up a completely new operation in that country or acquire an established host country company and use it to promote its products in the host market  Offers three advantages: o When a company’s competitive advantage is based on its control of a technol
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