Entry Strategy and Strategic Alliances

Entry Strategy and Strategic Alliances

Firms expand internationally must decide at the initial

1)      Which markets to enter

2)      When to enter them and on what scale

3)      Which entry mode to use

a)      Exporting

b)      Licensing or franchising to a company in the host nation

c)      Establishing a joint venture with a local company

d)     Establishing a new wholly owned subsidiary

e)      Acquiring an established enterprise

Factors affecting the choice of entry mode

 

1)      Transport costs

2)      Trade barriers

3)      Political risks

4)      Economic risks

5)      Costs

6)      Firm strategy

7)      Environment

8)      Core competencies

The optimal mode varies by situation and the company to decide what is the appropriate entry mode. One company’s entry mode may not be appropriate to another company. External variables play a part in the initial decision, denotes which to go, when to go and how to go.

Basic entry decisions (External variables: company need to identify)

Firms entering foreign market make three decisions which are

1)      Which markets to enter

The choice of foreign markets will depend on their long run profit potential. Favourable markets are politically stable developed and developing nations with free market systems and relatively low inflation rates and private sector debt. The less favourable markets are politically unstable developing nations with mixed or command economies, or developing nations with excessive levels of borrowing. Markets are more attractive when the product in question is not widely available and satisfies an unmet need.

It is based on the benefit, cost and risk analysis. When external factors are taken in consideration, the political economies of a country need to be identified to access the risk. The higher the benefit, the higher the risk can be taken. The culture of the country is identified to understand the impact of doing business. Trade barriers need to be taken in consideration. 

2)      When to enter those markets

Once attractive markets are identified, the firm must consider the timing of entry. Entry is early when the firm enters a foreign market before other foreign firms. Entry is late when the firm enters the market after firms have already established themselves in the market. 

This is where companies utilize and handle resources and capabilities in a competent manner.

First mover advantages are the advantages associated with entering a market early.

The first mover advantages include:

a)      The ability to pre-empt rivals and capture demand by establishing a strong brand name.

b)      The ability to build up sales volume in that country and ride down the experience curve ahead of rivals and gain a cost advantage over late entrants.

c)      The ability to create switching costs that tie customers into products or services making it difficult for later entrants to win business.

The first mover disadvantages are disadvantages associated with entering a foreign market before other international business.

The first mover disadvantages include:

a)      Pioneering costs which arise when the foreign business system is so different from that in a firm’s home market that the firm must devote considerable time, effort and expense to learning the rule of the game.

The pioneering costs include:

a)      The costs of business failure if the firm, due to its ignorance of the foreign environment, makes some major mistakes.

b)      The costs of promoting and establishing a product offering including the cost of educating customers.

          3)      On what scale to enter those markets – small scale basis is to export and large scale is to  FDI
 

Firms need to decide on the scale of the market entry after deciding which market to enter and the timing of entry.

Entering a foreign market on a significant scale is a major strategic commitment that changes the competitive playing field.

Firms that enter a market on a significant scale make a strategic commitment to the market which decision has a long term impact and is difficult to reserve.

Small-scale entry has the advantage of allowing a firm to learn about a foreign market while simultaneously limiting the firm’s exposure to that market.

Companies chooses which entry mode is eventually influenced by internal variables, because the internal variable plays a much more important roles than external variables. It would also depend on the resources and capabilities of the company. It also depends on the companies’ products. For example is Nokia which has a flexibility then Motorola in products.

Core competences and Entry mode (Internal variables: what Influence the choice of entry mode)

The optimal entry mode depends to some degree on the nature of a firm’s core competencies.

1)      Technology know-how

When competitive advantage is based on proprietary technology know-how, the firm should avoid licensing and joint venture arrangements unless it believes that its technology advantage is only transitory or that it can establish its technology as the dominant design in the industry.

When competitive advantage is critical based on proprietary technology know-how, the firm should undertake wholly owned subsidiaries as there is no risk of losing proprietary technology know-how but the cost and risks are high.

When competitive advantage is based on proprietary technology know-how which is not critical, the firm can using joint venture as the 2^nd choice as there are some forms of contractual control over technology know-how as the risk and cost is shared.  When competitive advantage is based on proprietary technology know-how which is no longer critical, licensing is available.

2)      Management know how

When competitive advantage is based on management know-how, the risk of losing control over the management skills is not high and the benefits from getting greater use of brand names is significant.

The entry mode applicable is franchising because franchising controls everything but the disadvantage is that is does not exploit the market completely as royalty are collected only. In addition, Stephen Hymer and John Dunning say that firms cannot license management skills. For example is McDonald’s. However, if competitive advantage is based on management know-how is critical and companies wants exploit the market, the wholly owned subsidiaries or joint venture will be ideal entry modes.

3)      Pressures for cost reductions and entry mode

When pressure for cost reductions is high, firms are more likely to pursue wholly owned subsidiaries to enter the market and uses exporting to serve the market. This will allow the firm to achieve location and scale economies as well as retain some degree of control over its worldwide product manufacturing and distribution.

Firms pursing global standardization or transnational strategies prefer wholly owned subsidiaries. After which, firms use exporting to serve the markets where EOS increases and costs decreases to counter high fixed cost of wholly owned subsidiaries. Thus, it is a dual entry strategy.

Entry modes

There are six different ways to enter a foreign market

1)      Exporting

Exporting is a common first step in the international expansion process for many manufacturing firms. It is popular and quickest to enter and exit.

Exporting is attractive because it avoids the costs of establishing local manufacturing operations. It helps firm to achieve experience curve and location economies.

Exporting is unattractive because there may be lower-cost manufacturing locations, high transport costs and tariffs which can make export uneconomical, agents in a foreign country may not act in exporter’s best interest.

2)      Turnkey projects

In Turnkey projects, the contractor agrees to handle every detail of the project for a foreign client, including the training of operating personnel. At the completion of a contract, the foreign client is handed the key to a plant that is ready for full operations. Turnkey projects are common in the chemical, pharmaceutical, petroleum refining and metal finishing industries.

Turnkey projects are attractive because they are the best way of earning economic returns from the know-how required to assemble and run a technologically complex process. They can be less risky than conventional FDI.

Turnkey projects are unattractive because the firm that enters into a turkey deal will have no long term interest in the foreign country or create a competitor. If the firm process technology is a source of competitive advantage, then selling this technology through a turnkey project is also selling the competitive advantage to potential and/or actual competitors.

3)      Licensing

Licensing agreement is an arrangement whereby a licensor grants the rights to intangible property to another entity (Licensee who are people who want to buy the knowledge) for a specified time period and in return the licensor receives a royalty from the licensee. For example is the brand name Davidoff.

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

Licensing is attractive because the firm does not have to bear the development costs and risks associated with the opening a foreign market, the firm also avoids barriers to investment and firms with intangible property that might have business applications can capitalize on market opportunities without developing those applications itself.

Licensing is unattractive because the firm does not have tight control over manufacturing, marketing and strategy required for realizing experience curve and location economies, and it limits the firm’s ability to co-ordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another. Importantly, proprietary information may be lost.

One way of reducing risk is to cross licensing agreements where a firm might license intangible property to a foreign partner but requests that the foreign partner license some form of its valuable know-how to be the firm in addition to a royalty payment.

4)      Franchising

Franchising is basically a specialized form of licensing in which the franchisor not only sells intangible property to franchisee but also insists that the franchisee agree to abide by strict rules as to how it does business. Franchising is primarily done by service firms.

Franchising is attractive because firm avoids many costs and risks of opening up a foreign market and quickly build a global presence

Franchising is unattractive because it may inhibit the firm’s ability to take profits out of one country to support competitive attacks in another and the geographical distance of the firm from its foreign franchisees can make poor quality difficult for the franchisor to detect.

5)      Establishing Joint ventures with host country firm

Joint venture is the establishment of a firm that is jointly owned by 2 or more otherwise independent firms

Joint venture is attractive because they allow firm to benefit from a local partner’s knowledge of the host country’s competitive conditions, culture, language, political systems and business systems. The costs and risks of opening a foreign market are shared with the partner. Lastly, political considerations make joint ventures the only feasible entry mode.

Joint ventures are unattractive because the firm’s risks giving control of its technology to its partner. Secondly, the firm may not have the tight control over subsidiaries need to realize experience curve or location economies. Lastly is the shared ownership can lead to conflicts and battles for control if goals and objectives differ or change over time.

6)      Setting up a new wholly owned subsidiary in the host country

In wholly owned subsidiary, the firm owns 100% of the stock. Firms can set up wholly owned subsidiary in a foreign market by setting up a new operation or acquiring an established firm in the host country.

Wholly owned subsidiaries are attractive because they reduce risk of losing control over core competencies. Secondly, they give firms the tight control over operations in different countries that are necessary for engaging in global strategic co-ordination. Lastly, they may be required in order to realize location and experience curve economies

Wholly owned subsidiaries are attractive because the firms bear the full cost and risk of setting up overseas operations.

a)      Management contract

b)      Non equity partner and joint venture

Selecting an Entry mode

All entry modes have advantages and disadvantages. However, the optimal choice of entry mode involves tradeoffs.

 

Entry mode	Advantages	Disadvantages
Exporting	Ability to realise experience curve and location economies	High transportation cost   Trade barriers   Problems with local marketing agents
Turnkey	Ability to earn returns from process technology skills in countries where FDI is restricted	Creating efficient competitors   Lack of long term market presence
Licensing	Low development costs and risks	Lack of control over technology   Inability to realize location economies and experience curve   Inability to engage in global strategic co-ordination
Franchising	Low development costs and risks	Lack of control over technology   Inability to engage in global strategic co-ordination
Joint Venture	Access to partner knowledge   Sharing development costs and risks Politically acceptable	Lack of control over technology   Inability to realize location economies and experience curve   Inability to engage in global strategic co-ordination
Wholly owned subsidiaries	Protection of technology Ability to engage in global strategic co-ordination Ability to realize location economies and experience curve	High cost and risks

 Wholly Owned Subsidiaries (Greenfield Ventures or Acquisitions)

There are 2 forms of Wholly Owned Subsidiaries which are Greenfield Ventures or Acquisitions.

Acquisitions are attractive because

1)      They are quick to response

2)      They enable firms to preempt their competitors

3)      Acquisitions may be less risky than Greenfield ventures.

Acquisitions fail when

1)      The acquiring firm overpays for the required firm which is being overvalued.

2)      The cultures of acquiring and acquired firm clash

3)      Attempts to realize synergies run into roadblocks and take much longer than forecast

4)      There is an inadequate pre-acquisition screening

In order to avoid these problems, firms should screen carefully of the firm be acquired and move rapidly once the firm is acquired to implement an integration plan.

Greenfield Ventures are attractive because

1)      It gives firm a greater ability to build the kind of subsidiary company that it wants.

Greenfield Ventures are unattractive because

1)      Green ventures are slower to establish

2)      Green ventures are risky

 Decision on Greenfield or acquisition

It depends on the situation confronting the firm.

Acquisition may be better when the market already has well-established competitors or global competitors are interested in building market presence.

Greenfield ventures may be better when the firm needs to transfer organizationally embedded competencies, skills, routines and culture

The advantages of Strategic Alliances

1)      Facilitate entry into a foreign market

2)      Allows firms to share the fixed costs and associated risks of developing new products or processes

3)      Bring together complementary skills and assets that neither partner could easily develop on its own

4)      Can help a firm establish technological standards for the industry that will benefit the firm

The disadvantage of Strategic alliances

Strategic Alliances can give competitors low cost routes to new technology and markets, but unless a firm is careful, it can give away more than it receives.

The key problems why partnership fails

Clash of organisation culture

Clash of objectives

Clash of terms and references

Opportunism which is stealing partner knowledge and turn it against their partner

Making Alliances work

The success of an alliance is a function of Partner Selection, Alliance Structure and the manner in which the alliance is managed.

1)      Partner Selection

Partner selection can minimize problems of clash of organisation culture, clash of objectives and clash of terms and references. Firstly is look for partner with the same organisation culture to reduce any form of mismatch in organization culture. Secondly, identify partners which objectives can be met which means similar objectives are followed. Thirdly is to identify partners with common terms and references which are aligned to the resources and capabilities, back ground and competencies.

The advantages are good partners help firms to achieve strategic goals and has the capabilities the firm lacks and that it values, shares the firm’s vision for the purpose of the alliance and unlikely to try to opportunistically exploit the alliance for its own ends, that it expropriate the firms technological knowhow while giving away little in return.

2)      Alliance Structure

Once the partner is selected, the alliance should be structured to minimize the risk of opportunism by an alliance partner. Firstly is to make it difficult to transfer technology not meant to be transferred. Secondly is to contractual safeguards written into the alliance agreement to guard against the risk of opportunism by a partner. Thirdly is to allow for skills and technology swaps with equitable gains. Both partners are interdependent

3)      Alliance must be managed

Successfully managing an alliance requires managers from both companies to build interpersonal relationship. The ability to learn from its alliance partners is a major determinant of how much a company gains from an alliance. Lastly, research has shown that trust has played a primarily important role in successful partnership.

Location Economies - Location decision for Manufacturing – Concentrate or Decentralise

Location Economies

Location decision for Manufacturing – Concentrate or Decentralise

Whether the manufacturing company wants to concentrate or decentralize depends on 3 factors which are country factors, technology factors and product factors.

Country factors

Firms locate manufacturing activities in those locations where the political, economic, legal, cultural environment and relative factors costs are most conducive to performances of that activity and impact on business.

Labour skills and supporting industries are referred as externalities.

Decentralise. If the impact is high which required customisation

Concentrate. If the impact is low which does not required to customisation

 

Concentrate. If it is rare, unique or found a few places in the world

Decentralise. If it is common

 

Decentralise. Volatility Foreign exchange

Concentrate. Stability Foreign exchange

 

Decentralise. Formal and informal trade barriers high

Concentrate. Formal and informal trade barriers low

 

Technology factors

The 3 characteristics of manufacturing technology are fixed cost, minimum efficient scale and flexibility of technology

 Fixed costs

The level of fixed cost of setting up a manufacturing plant is high, it is appropriate to serve the world market from a single location or from a few location. When fixed caost are low, multiple production plants may be possible, multiple location production allows firms to responds to local markets and reduces dependency on a single location. The type of technology used can affect the location decisions.

Concentrate. Operating on high fixed cost

Decentralise. Operating on low fixed cost

 

Minimum Efficient scale

The larger the MES of a plant, the more concentrate production in a single location

The low MES allows the firm to respond to local market demands and hedge against currency risk by operating in multiple locations.

 

Concentrate. Minimum efficient scale high which requires less location to produce

Decentralise. Minimum efficient scale low which requires more location to produce

 

The flexibility of technology

It is referred to reduce set up times for complex equipment, increase the utilisation of individual machines through better scheduling and improving quality control at all stages of the manufacturing process.

 

Concentrate. High Flexible technology which could mass customise more

Decentralise. Low Flexible technology which could mass customise less

 

Flexible manufacturing technologies can produce a wide variety of end products at a unit cost that at one time could be achieved through the mass production of a standardised output.

 

Mass customisation implies that a firm may be able to customise its product range to meet the demands of local markets yet still control costs

 

Flexible machine cells allow firms to increase efficiency by improving capacity utilisation and reducing work in progress.

 

Concentration production at few choices locations makes sense when fixed costs are substantial, MES is high and Flexibility technologies are available

 

Product factors

The 2 product factors that impact location decision

 

The product’s value to weight ratio

Concentrate. Product’s value to weight ratio is high – export – (Electronics goods)

Decentralise. Product’s value to weight ratio is low – manufacture – (FMCG)

 

Products serve universal need

Concentrate. Products can serve universal needs, local responsiveness falls

Decentralise. Products cannot serve universal needs, Local responsiveness increase

 

In Academic Argument

CONCENTRATE location decision is preferred when:

 

Political stability exists

Economic environment does not play a big role

Cultural environment does not impact

Foreign exchange is stable

Skills and labour is rare

Related supporting industries is unique

Formal and informal trade barriers are low

Fixed cost is high

Minimum efficiency scale is high

High flexible technology

High value to weigh ratio

Serve universal needs

In reality, companies faced environment and market imperfection. (OLI and Market imperfection) This means that for example, if the technology and product factors direct them to concentrate but the environment factors direct them to decentralise. Companies must decentralise as environment factors are uncontrollable. For example is when the value to weight ratio is high or serve universal needs or high fixed cost, companies cannot export if the informal and formal trade barriers are distorted Thus, concentration becomes a difficulty.

Automotive and electronic industries are faced these problems. Pharmaceutical industries are supposedly to concentrate, but because of high trade barriers which makes it impossible concentrate. Trade offs are present when deciding to concentrate or decentralise.

 

The final decision when benefits outweigh cost

Manufacturing has 4 objectives

1)      Low cost

Firms disperse production to those locations where activities can be performed most efficiently and managed global supply chain efficiently to better match supply and demand

 

2)      High quality

Firms eliminate defective products from the supply chain and the manufacturing process and improved quality reduced costs.

3)      Able to response to local differences

      4)      Flexible to shift when global demand shifts

 All four objectives must be met.

Horizontal Boundaries of a Firm

Horizontal Boundaries of a Firm

 Some important questions that any manager/firm operator must ask are:

1)    How do we define our firm? 

2)    What activities do we do?

3)    What are our firm’s boundaries?

The horizontal boundaries of the firm refer to the size (how much of the total product market will the firm serve) and scope (what variety of products and services does the firm produce).  The horizontal boundaries of a firm depend critically on economies of scale and scope.

 

Economies of scale and scope are present whenever large-scale production, distribution, or retail processes provide a cost advantage over small processes. 

 

Economies of scale exist whenever the average cost per unit of output falls as the volume of output increases. 

 

Economies of scope exist whenever the total cost of producing two different products or services is lower when a single firm instead of two separate firms produces them.  In essences, cost savings associated with increasing the variety of activities in goods produced.

 

In general, capital intensive production processes are more likely to display economies of scale and scope than are labor or materials intensive processes.  By offering cost advantages, economies of scale and scope not only affect the sizes of firms and the structure of markets, they also shape critical business strategy decisions, such as whether independent firms should merge and whether a firm can achieve long-term cost advantages in the market through expansion.

 

Economies of SCALE & SCOPE come from 4 major sources

 

1) Indivisibility & Spreading of fixed costs

Input cannot be scaled down below a certain size.

Shipping 100 or 1000 lbs by rail requires some inputs.

 

2) Productivity of variable inputs (specialization). 

Specialisation in a task.

3) Inventories

     

Stock out costs vs. costs of carrying inventory.

 

4) Cube square rule

  

Production capacity is proportional to the volume of production vessel, whereas  TC is proportional to surface area. Thus, As capacity rises, AC of production capacity goes down because the ratio of Surface area to volume decreases.

 Advantages of Economies of Scale & Scope

It gives large firms the advantage.

 

Firms can expand in a number of ways.

 

Internal Expansion strategies depend upon: retained earnings, equity and debt.

External Strategies depend upon: formalizing relationships with other firms     MERGERS

Market structure refers to: the number and size distribution of firms.

 

Some Definitions:

Product-Level Economies of Scale: reductions in unit cost attributable to producing more of a given product in a given plant.

Short-run Economies of Scale: reductions in unit cost attributable to spreading fixed costs for a plant of a given size.  These arise because of increased utilization of a plant of a given capacity.

Long-run Economies of Scale: reductions in unit costs attributable to a firm switching from a low fixed/high variable cost plant to a high fixed/low variable cost plant.  These arise due to adoption of technologies or larger plants that have higher fixed costs but lower variable costs.  The distinction between long and short-run scale is very important---mistaking short-run economies of scale for long-run economies could lead a firm to the false conclusion that its unit costs will continue to fall if it expands capacity once its existing capacity is full.   

Product-Level Economies of Scope: reductions in unit cost attributable to a firm’s diversification into several products produced in the same plant.  Examples include any process in which there are chemical by-products from the same reaction such as crop rotation and oil refining.  Another example is a product that shares a key component or set of components whose production is characterized by economies of scale, such as digital watches and electronic calculators.  A final example is a firm that utilizes off peak capacity such as ski resorts, garden stores, and sporting goods stores.

 Plant-Level Economies of Scope: reductions in unit cost attributable to a firm’s diversification into several products produced in different plants.  Examples include airline hub-and-spoke systems.

Purchasing Economies: reductions in unit cost attributable to volume discounts.  Large volume buyers may be able to achieve quantity discounts that are not available to smaller-volume buyers.  Examples include hospital and hardware store purchasing groups. E.G Buying in bulk.

R&D Economies: reductions in unit cost due to spreading R&D expenses.  For example, R&D labs require a minimum number of scientists and researchers whose labor is indivisible.   As the output of the lab expands, R&D costs per unit may fall. In essences, the use nature of R&D suggests a minimum feasible size for an R&D Dept. E.G - spill overs: R& D in one area leads to a new product in a different area.

 

Marketing Economies:

 

1)    Economies of scale due to spreading advertising expenditures over larger markets

2)    Economies of scope due to building a reputation of one product in the product line benefiting other products as well.  For example, Budweiser’s cost per effective message is lower than Anchor Steam’s since Bud is widely available and its ads would thus have a higher impact.

 

3)     Reputation effects what you have in one product is implied for other. 

4)    Spreading Advertising Costs over larger markets.

Horizontal Boundaries: related to the variety of related products or services the firm sells.

Fixed Costs: costs that do not vary with output.

Indivisibility: some inputs cannot be scaled down below a certain minimum size, even as output shrinks to zero.  Examples include railroad and airline service.

Learning Curve: reductions in unit costs that result from the accumulation of know-how and experience. 

Core Competency: the collective know-how within an organization about how to work with particular technologies or particular types of product functionality (e.g. 3M in coatings and adhesives and Canon in precision mechanics, fine optics, and microelectronics).

Horizontal Boundaries 

Horizontal boundaries are those that define how much of the total product market the firm serves (size) and what variety of related products the firm offers (scope).  The basic question is: “What strategic advantages are conferred on a firm by being large or by having a broad scope of products?”  Size/scope can represent an advantage for three reasons.

·         Size = Market Power.  Larger/diversified firms may be able to exercise monopoly power or set the terms of competition for other firms in the industry.

·         Size = Entry Barriers.  Once a firm owns a large position in the market, it may be very difficult to dislodge it.  That is, potential entrants and existing firms may be deterred from attacking this firm’s core business.  A good example of this is brand proliferation in breakfast cereals.     

·         Size = Lower Unit Costs.  A large firm may be able to produce at a lower cost per unit than a small firm may.

Learning Curve

The difference between economies of scale and the learning curve relates to cumulative output, not levels of output.  For example, Lockheed pursued a learning curve strategy in building its L10-11 class of aircraft.  The firm anticipated that it would lose money by producing a lot of aircraft, gain experience, and finally achieve cost competitiveness in the industry.  The firm initially priced below its average cost and eventually cost fell to below price.  Lockheed was hard hit then with a “cheap to produce” aircraft when oil prices rose dramatically.  This particular firm lost this gamble because it banked on demand remaining high; the OPEC oil embargo changed the environment significantly enough so that they couldn’t benefit from their cost advantage.

 

Diseconomies

There are certainly limits to how big a firm can be and still produce efficiently.  For example, labour costs increase as firms get bigger (unionization, employees are less satisfied with their jobs, commuting time increases as the firm gets bigger because it draws from further away).  Smaller firms sometimes have an easier time motivating employees; moreover, rewards are much more closely linked to profits.  The trick is for the big firm to create the right motivations for workers.  Finally the source of your advantage may not be “spreadable.”  That is, a patent is not spreadable nor personal services such as in restaurants.

 

Sources of Diseconomies of Scale

Rising Labor Costs: - Larger firms, usually pay higher wages

Incentive & Bureaucracy Effects: - It is difficult for large firms to motivate workers.

Spreading Specialized Resources: - Too thin, Of a specialized input is the source of the firm's advantage, if the firm tries to expand without duplicating that resource, that resource becomes overburden.

Example:  Chief is big success in first restaurant, but fails as he tries to open others.  It was his cooking ability that was the key.