Entry Strategy & Strategic Alliances

In this lesson, you’re expected to learn about:
– basic entry decisions that need to be made
– different modes of entry
– the advantages and disadvantages of strategic alliances

This lesson is concerned with three closely related topics: (1) the decision of which foreign markets to enter, when to enter them, and on what scale; (2) the choice of entry mode; and (3) the role of strategic alliances.

Any firm contemplating foreign expansion must first struggle with the issue of which foreign markets to enter and the timing and scale of entry. The choice of which markets to enter should be driven by an assessment of relative long­ run growth and profit potential.

A firm contemplating foreign expansion must make three basic decisions:

– which markets to enter,
– when to enter those markets, and
– on what scale.

1) Which Foreign Markets? 

The more than 200 nation-states in the world do not all hold the same profit potential for a firm contemplating foreign expansion. Ultimately, the choice must be based on an assessment of a nation’s long-run profit potential. This potential is a function of several factors.

The attractiveness of a country as a potential market for an international business depends on balancing the benefits, costs, and risks associated with doing business in that country.

The long-run economic benefits of doing business in a country are a function of factors such as the size of the market (in terms of demographics), the present wealth (purchasing power) of consumers in that market, and the likely future wealth of consumers, which depends upon economic growth rates.

While some markets are very large when measured by number of consumers (e.g., China, India), one must also look at living standards and economic growth. On this basis, China and India, while relatively poor, are growing so rapidly that they are attractive targets for inward investment.

Creating Value in a Foreign Market

Another important factor is the value an international business can create in a foreign market. This depends on the suitability of its product offering to that market and the nature of indigenous competition.

If the international business can offer a product that has not been widely available in that market and that satisfies an unmet need, the value of that product to consumers is likely to be much greater than if the international business simply offers the same type of product that indigenous competitors and other foreign entrants are already offering.

Greater value translates into an ability to charge higher prices and/or to build sales volume more rapidly.

2) Timing Of Entry 

Once attractive markets have been identified, it is important to consider the timing of entry. Entry is early when an international business enters a foreign market before other foreign firms and late when it enters after other international businesses have already established themselves.

The advantages frequently associated with entering a market early are commonly known as first-mover advantages.

Advantages of Being a First Mover

1) The ability to preempt rivals and capture demand by establishing a strong brand name.

2) The ability to build sales volume in that country and ride down the experience curve ahead of rivals, giving the early entrant a cost advantage over later entrants. This cost advantage may enable the early entrant to cut prices below that of later entrants, thereby driving them out of the market.

3) The ability of early entrants to create switching costs that tie customers into their products or services. Such switching costs make it difficult for later entrants to win business.

Pioneering Costs

There can also be disadvantages associated with entering a foreign market before other international businesses. These are often referred to as first-mover disadvantages.

These disadvantages may give rise to pioneering costs, costs that an early entrant has to bear that a later entrant can avoid. Pioneering costs arise when the business system in a foreign country is so different from that in a firm’s home market that the enterprise has to devote considerable effort, time, and expense to learning the rules of the game.

[Optional] First-Mover Advantage
3) Scale Of Entry and Strategic Commitments 

Another issue that an international business needs to consider when contemplating market entry is the scale of entry. Entering a market on a large scale involves the commitment of significant resources. Entering a market on a large scale implies rapid entry.

Consider the entry of the Dutch insurance company ING into the U.S. insurance market in 1999. ING had to spend several billion dollars to acquire its U.S. operations. Not all firms have the resources necessary to enter on a large scale, and even some large firms prefer to enter foreign markets on a small scale and then build slowly as they become more familiar with the market.

The consequences of entering on a significant scale – entering rapidly – are associated with the value of the resulting strategic commitments. A strategic commitment has a long-term impact and is difficult to reverse.

Deciding to enter a foreign market on a significant scale is a major strategic commitment. Strategic commitments, such as rapid large-scale market entry, can have an important influence on the nature of competition in a market.

Once a firm decides to enter a foreign market, the question arises as to the best mode of entry. Firms can use six different modes to enter foreign markets: exporting, turnkey projects, licensing, franchising, establishing joint ventures with a host-country firm, or setting up a new wholly owned subsidiary in the host country.
Each entry mode has advantages and disadvantages so managers need to consider these carefully when deciding which to use.
1) Exporting 

Many manufacturing firms begin their global expansion as exporters and only later switch to another mode for serving a foreign market.

Exporting avoids the often substantial costs of establishing manufacturing operations in the host country. It may also help a firm achieve location economies. By manufacturing the product in a centralized location and exporting it to other national markets, the firm may realize substantial scale economies from its global sales volume.

2) Turnkey Projects 

Firms that specialize in the design, construction, and start-up of turnkey plants are common in some industries. In a turnkey project, the contractor agrees to handle every detail of the project for a foreign client, including the training of operating personnel. At completion of the contract, the foreign client is handed the “key” to a plant that is ready for all operation-hence, the term turnkey. This is a means of exporting process technology to other countries.

Turnkey projects are most common in the chemical, pharmaceutical, petroleum-refining, and metal-refining industries, all of which use complex, expensive production technologies.

[Optional] Turnkey Business
3) Licensing 

A licensing agreement is an arrangement whereby a licensor grants the rights to intangible property to another entity (the licensee) for a specified period, and in return, the licensor receives a royalty fee from the licensee.

Intangible property includes patents, inventions, formulas, processes, designs, copyrights, and trademarks.

Advantages of Licensing 

In the typical international licensing deal, the licensee puts up most of the capital neces­sary to get the overseas operation going. Thus, a primary advantage of licensing is that the firm does not have to bear the development costs and risks associated with opening a foreign market.

Licensing is very attractive for firms lacking the capital to develop op­erations overseas. In addition, licensing can be attractive when a firm is unwilling to commit substantial financial resources to an unfamiliar or politically volatile foreign market. Licensing is also often used when a firm wishes to participate in a foreign market but is prohibited from doing so by barriers to investment.

4) Franchising 

Franchising is similar to licensing, although franchising tends to involve longer-term commitments than licensing. Franchising is basically a specialized form of licensing in which the franchiser not only sells intangible property (normally a trademark) to the franchisee, but also insists that the franchisee agree to abide by strict rules as to how it does business.

The franchiser will also often assist the franchisee to run the business on an ongoing basis. As with licensing, the franchiser typically receives a royalty payment, which amounts to some percentage of the franchisee’s revenues. While licensing is pursued primarily by manufacturing firms, franchising is employed primarily by service firms. McDonald’s is a good example of a firm that has grown by using a franchising strategy.

5) Joint Ventures

A joint venture entails establishing a firm that is jointly owned by two or more otherwise independent firms. Establishing a joint venture with a foreign firm has long been a popular mode for entering a new market. The most typical joint venture is a 50/50 venture, in which there are two parties, each of which holds a 50% ownership stake and contributes a team of managers to share operating control.

Advantages of Joint Ventures

Joint ventures have a number of advantages.

First, a firm benefits from a local partner’s knowledge of the host country’s competitive conditions, culture, language, political systems, and business systems.

Second, when the development costs and/or risks of opening a foreign market are high, a firm might gain by sharing these costs and/or risks with a local partner.

Third, in many countries, political considerations make joint ventures the only feasible entry mode.

6) Wholly Owned Subsidiary

In a wholly owned subsidiary, the firm owns 100% of the stock. Establishing a wholly owned subsidiary in a foreign market can be done in two ways.

The firm either can set up a new operation in that country, often referred to as a greenfield venture, or it can acquire an established firm in that host nation and use that firm to promote its products.

Selecting an Entry Mode: Advantages & Disadvantages
What is a Strategic Alliance?

Strategic alliances refer to cooperative agreements between potential or actual competitors. In this section, we are concerned specifically with strategic alliances between firms from different countries.

Strategic alliances run the range from formal joint ventures, in which two or more firms have equity stakes, to short-term contractual agreements, in which two companies agree to cooperate on a particular task (such as developing a new product).

Advantages of Strategic Alliances

Firms ally themselves with actual or potential competitors for various strategic purposes.

First, strategic alliances may facilitate entry into a foreign market. For example, many firms believe that if they are to successfully enter the Chinese market, they need a local partner who understands business conditions and who has good connections (or guanxi). Thus, in 2004 Warner Brothers entered into a joint venture with two Chinese partners to produce and distribute films in China.

Strategic alliances also allow firms to share the fixed costs (and associated risks) of developing new products or processes. An alliance between Boeing and a number of Japanese companies to build Boeing’s latest commercial jetliner, the 787, was motivated by Boeing’s desire to share the estimated $8 billion investment required to develop the aircraft.
Third, an alliance is a way to bring together complementary skills and assets that neither company could easily develop on its own.

In 2003, for example, Microsoft and Toshiba established an alliance aimed at developing embedded microprocessors that can perform a variety of entertainment functions in an automobile (e.g., run a backseat DVD player or a wireless internet connection).

Fourth, it can make sense to form an alliance that will help the firm establish technological standards for the industry that will benefit the firm.

Disadvantages of Strategic Alliances

The advantages we have discussed can be very significant. Despite this, some commenta­tors have criticized strategic alliances on the grounds that they give competitors a low­ cost route to new technology and markets.

For example, a few years ago some commentators argued that many strategic alliances between U.S. and Japanese firms were part of an implicit Japanese strategy to keep high-paying, high-value-added jobs in Japan while gaining the project engineering and production process skills that under­lie the competitive success of many U.S. companies.

Making Alliances Work

The failure rate for international strategic alliances seems to be high. One study of 49 international strategic alliances found that two-thirds run into serious managerial and financial troubles within two years of their formation, and that although many of these problems are solved, 33% are ultimately rated as failures by the parties involved.

The success of an alliance seems to be a function of three main factors: partner selection, alliance structure, and the manner in which the alliance is managed.

[Optional] Strategic Alliance
Read this article from The Economist to learn more:
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