McGraw-Hill/Irwin International Management © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. International Management Phatak, Bhagat, and Kashlak.

McGraw-Hill/IrwinInternational Management

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

International ManagementPhatak, Bhagat, and Kashlak

McGraw-Hill/IrwinInternational Management

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

Chapter 7

Modes of Entry into Foreign Markets

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Learning Objectives

Understand the different modes of entry into foreign markets.

The advantages, disadvantages, and risks in various entry modes.

Explain why controlling of foreign operations is important for an international company.

Explain the equity based and non-equity based control mechanisms.

Understand the non-equity entry modes such as licensing, franchising, and management service contracts, and their differences.

Explain the factors that influence the choice of entry modes.

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Chapter Topics

Environmental Influences on the Foreign Entry Decision ModeExportingCountertradeContract ManufacturingLicensingFranchisingManagement Service ContractsTurnkey ProjectsEquity-Based Ventures Through Foreign Direct InvestmentTheory of Multinational Investment

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Modes of Entry into Foreign Markets

Exporting

Countertrade

Contract Manufacturing

Licensing

Franchising

Management Service Contracts

Turnkey Projects

Non-Equity Strategic Alliances

Equity-based Joint Ventures

Wholly-Owned Subsidiaries

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Fig 7-1: Foreign Mode of Entry Choices

Decision to Internationalize

Wholly-OwnedInternational Choices

CooperativeInternational Choices

AcquisitionEquity Joint

Ventures

Non-Equity Strategic Alliances/Licensing Contracts

Greenfield Investment

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Countertrade

Arrangements whereby the flow of goods or services in both directions is an integral element of the specific terms of the business transaction

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Contract Manufacturing and Licensing

Contract ManufacturingA contractual agreement between a company and a foreign producer under which the foreign producer manufactures the company’s product

LicensingThe international company, or licensor, agrees to make available to another company abroad, the licensee, use of its patents and trademarks, its manufacturing processes and know-how, its trade secrets, and its managerial and technical services. In exchange, the foreign company agrees to pay the licensor a royalty or other form of payment according to a schedule agreed upon by the two parties

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Fig 7-2:Licensing as a Foreign Entry Choice

LicensingIn

ForeignCountries

Cost Advantage Risk Deflection

Revenue Source Knowledge Source

Profit-driven

Rationale

Strategic Rationale

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What the Licensor Delivers to the Licensee in Complex Licensing Agreements

A patented product or service

A trademark or trade name

Manufacturing techniques

Proprietary rights generally referred to as company or industry know-how

Supply by the licensor to the licensee of components or equipment

Technical advice and services of various sorts

Marketing advice and assistance of various sorts

Capital and/or managerial personnel

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Fig 7-3: Concerns of Foreign Licensing

Control

TechnologyProductionQuality

LicensingIn

ForeignCountries

Licensee-Related

Competitive PositioningPartner

SelectionPartner “Cheating”

Strategic FitLong-Term

CoordinationLong-Term Configuration

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Table 7-1 Foreign Licensing: Factors for Success and Failure

Factors Leading to Success

1. Choice of reliable and competent partner 2. Inherent value of patent, trademark or know-how licensed 3. Goal congruence with partner 4. Some participation in ownership 5. Close personal contact with licensee 6. Appropriate level of control by licensor 7. Reputation of licensor and licensed asset 8. Sales assistance to licensee 9. Support of licensor’s top management10. Flexibility by both partners11. Correct timing and pacing of activity12. Detailed spelling out of contract obligations and responsibilities13. Effective coordination with other parts of licensor’s overseas activities14. Thorough research and market knowledge

Factors Leading to Failure

1. Inadequate market analysis by licensor 2. Higher start-up costs than anticipated by licensee 3. Insufficient attention paid to activity by top management of licensor 4. Poor timing 5. Lack of goal congruence with partner 6. Unanticipated competition from home, host and third country competitors 7. Inadequate licensee after sales effort 8. Partner rigidity 9. Insufficient marketing effort by both licensor and licensee10. Weak licensee market research11. Lack of fit with other licensor activities12. Lack of sales assistance to licensee

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Questions to be Asked in a Licensing Contract

How many patents, processes, or trademarks will be used?How will technical assistance be rendered?Which products are included in the agreement, and to what extent?What territory is to be covered by the license?How should the licensee be compensated?The currency in which payments will be made to the licensorWhat happens if compensation cannot be paid by the licensee?If sublicensing is permitted, how should it be carried out?Geographical limitations on the marketing of the licensed product or serviceWhat are the provisions as to duration of the agreement and its cancellation?What rights does the licensor have in developments by the licensee?

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Questions to be Asked … (contd.)

What visitation and inspection privileges are held by the licensor?

Can the parent company inspect accounts?

What provisions are there for satisfactory promotional/sales performance and adequate quality control?

What home and host government approvals are required?

What tax factors are involved?

How will disputes be settled?

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Areas Covered in a Franchise Agreement

1. A detailed list of issues to consider regarding the cost of the franchise

2. A detailed list of issues to consider regarding the location of the franchise

3. A detailed list of issues pertaining to the buildings, equipment and supply terms

4. A detailed list of issues pertaining to the operating practices terms

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Table 7-2: Type and Degree of Parent Company Control over Foreign Operations

Mode of Entry Strong Control Weak Control Non-Existent Control

Contract Manufacturing

A B,C,D

Licensing D C A,B

Franchising D C A,B

Management Service Contract

D A,C B

Joint Venture D A,B,C

Wholly-owned Subsidiary

A,B,C,D

A = Daily Management ControlB = Control over Physical assets

C = Control over Tacit Expertise and KnowledgeD = Control over Codified assets

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Table 7-3: Characteristics of Entry Modes

Type of Entry Mode

Degree of Control

Systemic Risk Dissemination Risk

Resource Commitment

Export Low Low Low Low

Countertrade Low Low Low Low

Contract Manufacturing

Medium Medium Low to Medium

Low

Licensing Low Low High Low

Franchising Low to Medium

Low Medium Low

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Table 7-3 (contd.)

Type of Entry Mode

Degree of Control

Systemic Risk Dissemination Risk

Resource Commitment

Management Service Contract

Medium Low Medium Low

Turnkey Low Low Low Low

Equity-based Entry: Joint Venture

Medium-High Medium-High Medium-High Medium-High

Equity-based Entry: Wholly-owned Subsidiary

High High Low High

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Determinants of Foreign Mode of Entry

Firm Size

Multinational Experience

Industry Growth

Global Industry Concentration

Technical Intensity

Advertising Intensity

Country Risk

Cultural Distance

Market Potential

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Determinants … (contd.)

Market Knowledge

Value of Firm Specific Assets

Contractual Risk

Tacit Nature of Know-How

Venture Size

Intent to Conduct Joint R&D

Global Strategic Motivation

Global Synergies

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Table 7-4: A Representation of the O-L-I Theory of FDI

Ownership Location Advantage

Internalization

Export X X

Contractual/Licensing, etc.

X X

Wholly Owned X X X

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Key Terms and Concepts

Licensing

Franchising

Management service contracts

Systemic risk

Dissemination risk

Ownership advantage

Locational advantage

Internalization