Getting Custom Writing Service with any of your academic assignments is easy. Simply click here.
Please have a read through the uploaded file (Book details – Title: Global Marketing / Edition: 7th / Author(s): Hollensen, S. / Date of Publication: 2016 /Publisher: Pearson / Place of Publication: London) provided below and answer the question with references, regarding the factors affecting the decision to enter a foreign market. Given the number of decisions that need to be made, what are the most important issues a business has to consider when choosing to export a product or service?
Use an example when discussing this question.
We have seen the main groupings of entry modes available to companies that wish to
take advantage of foreign market opportunities. At this point we are concerned with the
question: what kind of strategy should be used for the entry mode selection?
An institutional arrangement for the entry of a company’s products and services into a
new foreign market. The main types are export, intermediate and hierarchical modes.
1. Naive rule. The decision-maker uses the same entry mode for all foreign markets. This
rule ignores the heterogeneity of the individual foreign markets.
2. Pragmatic rule. The decision-maker uses a workable entry mode for each foreign
market. In the early stages of exporting, the firm typically starts doing business with a
low-risk entry mode. Only if the particular initial mode is not feasible or profitable will
the firm look for another workable entry mode. In this case, not all potential alternatives
are investigated, and the workable entry may not be the ‘best’ entry mode.
3. Strategy rules. This approach requires that all alternative entry modes are systematically
compared and evaluated before any choice is made. An application of this decision rule
would be to choose the entry mode that maximizes the profit contribution over the
strategic planning period subject to (a) the availability of company resources, (b) risk and
(c) non-profit objectives.
Although many small and medium-sized enterprises (SMEs) probably use the
pragmatic or even the naive rule, this chapter is inspired mainly by an analytical
approach, which is the main principle behind the strategy rule.
9.2 The transaction cost approach
The principles of transaction cost analysis have already been presented in Section 3.3.
This chapter will go into further details about ‘friction’ and opportunism.
The unit of analysis is the transaction rather than the firm. The basic idea behind this
approach is that in the real world there is always some friction between the buyer and
seller in connection with market transactions. This friction is mainly caused by
opportunistic behaviour in the relationship between a producer and an export
intermediary.
In the case of an agent, the producer specifies sales-promoting tasks that the export
intermediary is to solve in order to receive a reward in the shape of commission.
In the case of an importer, the export intermediary has a higher degree of freedom, as
the intermediary itself, to a certain extent, can fix sales prices and thus base its
earnings on the profit between the producer’s sales price (the importer’s buying price)
and the importer’s sales price.
No matter who the export intermediary may be, there will be some recurrent elements
that may result in conflicts and opportunistic actions:
• stock size of the export intermediary;
• extent of technical and commercial service to be carried out by the export intermediary for its
customers;
• division of marketing costs (advertising, exhibition activities, etc.) between producer and
export intermediary;
• fixing of prices: from producer to export intermediary, and from the export intermediary to
its customers;
• fixing of commission to agents.
Opportunistic behaviour from the export
intermediary
In this connection the export intermediary’s opportunistic behaviour may be reflected in two
activities:
1. In most producer–export intermediary relations, a split of the sales-promoting costs has
been fixed. Thus statements by the export intermediary of too high sales promotion
activities (e.g. by manipulating invoices) may form the basis of a higher payment from
producer to export intermediary.
2. The export intermediary may manipulate information on market size and competitor
prices in order to obtain lower ex-works prices from the producer. Of course, this kind of
opportunism can be avoided if the export intermediary is paid a commission of realized
turnover (the agency case).
As a consequence, high control modes (e.g. own foreign company in form of a subsidiary) may
be preferred by companies, in order to protect their brand equity from possible damage done by
local partners’ inappropriate operations (Lu et al., 2011).
Opportunistic behaviour from the producer
In this chapter we have so far presumed that the export intermediary is the one who has behaved
opportunistically. The producer may, however, also behave in an opportunistic way, as the
export intermediary must also use resources (time and money) on building up the market for the
producer’s product programme. This is especially the case if the producer wants to sell expensive
and technically complicated products.
Thus the export intermediary carries a great part of the economic risk, and will always have the
threat of the producer’s change of entry mode hanging over its head. If the export intermediary
does not live up to the producer’s expectations, it risks being replaced by another export
intermediary, or the producer may change to its own export organization (sales subsidiary), as
the increased transaction frequency (market size) can obviously bear the increased costs.
The last case may also be part of a deliberate strategy from the producer: namely, to tap the
export intermediary for market knowledge and customer contacts in order to establish a sales
organization itself.
What can the export intermediary do to meet this
situation?
Heide and John (1988) suggest that the agent should make a number of further ‘offsetting’
investments in order to counterbalance the relationship between the two parties. These
investments create bonds that make it costly for the producer to leave the relationship, i.e. the
agent creates ‘exit barriers’ for the producer (the principal). Examples of such investments are as
follows:
• establish personal relations with the producer’s key employees;
• create an independent identity (image) in connection with selling the producer’s products;
• add further value to the product, such as a before–during–after (BDA) service, which creates
bonds in the agent’s customer relations.
If it is impossible to make such offsetting investments, Heide and John (1988) suggest that the
agent reduces its risk by representing more producers.
These are the conditions that the producer is up against, and when several of these factors appear
at the same time, the theory recommends that the company (the producer) internalizes rather than
externalizes.
9.3 Factors influencing the choice of
entry mode
A firm’s choice of its entry mode for a given product/target country is the net result of
several, often conflicting, forces. The need to anticipate the strength and direction of
these forces makes the entry mode decision a complex process with numerous tradeoffs among alternative entry modes.
Generally speaking, the choice of entry mode should be based on the expected
contribution to profit. This may be easier said than done, particularly for those foreign
markets where relevant data are lacking. Most of the selection criteria are qualitative in
nature, and quantification is very difficult.
The choice of ‘entry mode’ in Figure 9.1 is built on a ‘matchmaking’ of internal
capabilities (internal factors) and the external environment (external factors), moderated
by the ‘desired mode characteristics’ and ‘transaction-specific factors’. One of the
other important preconditions of the model is that the ‘entry mode’ decision in a
specific country is independent of other ‘entry mode’ decisions undertaken earlier on in
the firm’s internationalization process. This is of course not a complete realistic
assumption (Shaver, 2013), and this calls for ‘entry mode’ researchers to study
longitudinal ‘entry mode’ interdependences more extensively (Hennart and Slangen,
2015).
As shown in Figure 9.1, four groups of factors are believed to influence the entry mode
decision:
1. internal factors
2. external factors
3. desired mode characteristics
4. transaction-specific behaviour.
In what follows, a proposition is formulated for each factor: how is each factor
supposed to affect the choice of foreign entry mode? The direction of influence is also
indicated both in the text and in Figure 9.1. Because of the complexity of the entry
mode decision, the propositions are made under the condition of other factors being
equal.
Internal factors
Firm size
Size is an indicator of the firm’s resource availability; increasing resource availability provides
the basis for increased international involvement over time. Although SMEs may desire a high
level of control over international operations and wish to make heavy resource commitments to
foreign markets, they are more likely to enter foreign markets using export modes because they
do not have the resources necessary to achieve a high degree of control or to make these resource
commitments. Export entry modes (market modes), with their lower resource commitment, may
therefore be more suitable for SMEs. As the firm grows, it will increasingly use the hierarchical
model.
International experience
Another firm-specific factor influencing mode choice is the international experience of managers
and thus of the firm. Experience, which refers to the extent to which a firm has been involved in
operating internationally, can be gained from operating either in a particular country or in the
general international environment. International experience reduces the cost and uncertainty of
serving a market, and in turn increases the probability of firms committing resources to foreign
markets, which favours direct investment in the form of wholly owned subsidiaries (hierarchical
modes).
A high degree of international experience reinforces the use of an already preferred entry mode
in subsequent entry decisions (Swoboda et al., 2015). Once a firm has had success with a
particular entry mode, it will to use the same entry mode in new markets, but there may also be a
tendency to be less risk-averse with greater international experience, which could result in using
higher-control modes in subsequent entry decisions.
Dow and Larimo (2009) conclude from their survey that practitioners should be aware that not
all forms of experience are equal. International experience from similar countries (with low
perceived psychic distance) is positively associated with the choice of a high control entry mode
(i.e. entry by wholly owned subsidiary). This indicates that exploiting each geographic region in
succession may be advisable, instead of ‘jumping’ from region to region. This would maximize
the benefits of within-cluster experience.
In developing their theory of internationalization, Johanson and Vahlne (1977) assert that
uncertainty in international markets is reduced through actual operations in foreign markets
(experiential knowledge) rather than through the acquisition of objective knowledge. They
suggest that it is direct experience with international markets that increases the likelihood of
committing extra resources to foreign markets.
Product/service
The physical characteristics of the product or service, such as its value/weight ratio, perishability
and composition, are important in determining where production is located. Products with high
value/weight ratios, such as expensive watches, are typically used for direct exporting, especially
where there are significant production economies of scale, or if management wishes to retain
control over production. Conversely, in the soft drinks and beer industry, companies typically
establish licensing agreements, or invest in local bottling or production facilities, because
shipment costs, particularly to distant markets, are prohibitive.
The nature of the product affects entry mode selection because products vary so widely in their
characteristics and use, and because the selling job may also vary markedly. For instance, the
technical nature of a product (high complexity) may require service both before and after sale. In
many foreign market areas, marketing intermediaries may not be able to handle such work.
Instead firms will use one of the hierarchical modes.
Blomstermo et al. (2006) distinguish between hard and soft services. Hard services are those
where production and consumption can be decoupled. For example, software services can be
transferred to a CD, or some other tangible medium, which can be mass-produced, making
standardization possible. With soft services, where production and consumption occur
simultaneously, the customer acts as a co-producer and decoupling is not viable. The soft-service
provider must be present abroad from their first day of foreign operations. Blomstermo et
al. (2006) conclude that there are significant differences between hard- and soft-service suppliers
regarding choice of foreign market entry mode. Managers in soft services are much more likely
to choose a high control entry mode (hierarchical mode) than those in hard services. It is
important for soft-service suppliers to interact with their foreign customers, and thus they should
opt for a high degree of control, enabling them to monitor the co-production of the services.
Products distinguished by physical variations, brand name, advertising and after-sales service
(e.g. warranties, repair and replacement policies) that promote preference for one product over
another may allow a firm to absorb the higher costs of being in a foreign market. Product
differentiation advantages give firms a certain amount of impulse in raising prices to exceed
costs by more than normal profits (quasi-rent). They also allow firms to limit competition
through the development of entry barriers, which are fundamental in the competitive strategy of
the firm, as well as serving customer needs better and thereby strengthening the competitive
position of the firm compared to other firms. Because these product differentiation advantages
represent a ‘natural monopoly’, firms seek to protect their competitive advantages from
dissemination through the use of hierarchical modes of entry. For example, Lu et
al. (2011) emphasize the importance for a fashion retailer to select a higher control entry mode to
ensure a successful transfer of its special assets and brand equity across borders, which are
important considerations in a fashion brand’s international expansion decision.
External factors
Sociocultural distance between home country and host
country
Socioculturally similar countries are those that have similar business and industrial practices, a
common or similar language, and comparable educational levels and cultural characteristics.
Sociocultural differences between a firm’s home country and its host country can create internal
uncertainty for the firm, which influences the mode of entry desired by that firm.
The greater the perceived distance between the home and host country in terms of culture,
economic systems and business practices, the more likely it is that the firm will shy away from
direct investment in favour of joint venture agreements or even low-risk entry modes like agents
or an importer. This is because the latter institutional modes enhance firms’ flexibility to
withdraw from the host market, should they be unable to acclimatize themselves to the
unfamiliar setting. To summarize, other things being equal, when the perceived distance between
the home and host country is great, firms will favour entry modes that involve relatively low
resource commitments and high flexibility. Dow and Larimo (2009) found that the perceived
cultural distance (psychic distance) is much more than Hofstede’s cultural dimensions. Psychic
distance is relevant not only on the country but also at the managerial levels. In particular,
language difference seems to be one of the least important factors. Other issues, such as
differences in religion, degree of democracy, industrial development and so on, have a much
greater impact on the management’s entry mode choice.
Country risk/demand uncertainty
Foreign markets are usually perceived as riskier than the domestic market. The amount of risk
the firm faces is a function not only of the market itself but also of its method of involvement
there. In addition to its investment, the firm risks inventories and receivables. When planning its
method of entry, the firm must do a risk analysis of both the market and its method of entry.
Exchange rate risk is another variable. Moreover, risks are not only economic; there are also
political risks.
When country risk is high, a firm would do well to limit its exposure to such risk by restricting
its resource commitments in that particular national domain. That is, other things being equal,
when country risk is high, firms will favour entry modes that involve relatively low resource
commitments (export modes).
Unpredictability in the political and economic environment of the host market increases the
perceived risk and demand uncertainty experienced by the firm. This, in turn, makes firms less
inclined to enter the market with entry modes requiring heavy resource commitments; on the
other hand, flexibility is highly desired (Lu et al., 2011).
Market size and growth
Country size and rate of market growth are key parameters in determining the mode of entry.
The larger the country and the size of its market, and the higher the growth rate, the more likely
management will be to commit resources to its development, and to consider establishing a
wholly owned sales subsidiary or to participate in a majority-owned joint venture. Retaining
control over operations provides management with direct contact and allows it to plan and direct
market development more effectively.
Small markets, on the other hand, especially if they are geographically isolated and cannot be
serviced efficiently from a neighbouring country, may not warrant significant attention or
resources. Consequently, they may be best supplied via exporting or a licensing agreement.
While unlikely to stimulate market development or maximize market penetration, this approach
enables the firm to enter the market with minimal resource commitment, and frees resources for
potentially more lucrative markets.
Direct and indirect trade barriers
Tariffs or quotas on the import of foreign goods and components favour the establishment of
local production or assembly operations (hierarchical modes).
Product or trade regulations and standards, as well as preferences for local suppliers, also have
an impact on mode of entry and operation decisions. Preferences for local suppliers, or
tendencies to ‘buy national’, often encourage a company to consider a joint venture or other
contractual arrangements with a local company (intermediate modes). The local partner helps in
developing local contacts, negotiating sales and establishing distribution channels, as well as in
diffusing the foreign image.
Similarly, product and trade regulations and customs formalities encourage modes involving
local companies, which can provide information about and contacts in local markets and can ease
access. In some instances, where product regulations and standards necessitate significant
adaptation and modification, the firm may establish local production, assembly or finishing
facilities (hierarchical modes).
The net impact of both direct and indirect trade barriers is thus likely to be a shift towards
performing various functions, such as sourcing, production and developing marketing tactics in
the local market.
Intensity of competition
When the intensity of competition is high in a host market, firms will do well to avoid
internalization, as such markets tend to be less profitable and therefore do not justify heavy
resource commitments. Hence, other things being equal, the greater the intensity of competition
in the host market, the more the firm will favour entry modes (export modes) that involve low
resource commitments.
Small number of relevant intermediaries available
Highly concentrated markets lead to ‘small number bargaining’, which may be executed by the
few export intermediaries if they realize that they are in a kind of ‘monopolistic situation’. In
such a case, the market field is subject to the opportunistic behaviour of the few export
intermediaries, and this will favour the use of hierarchical modes in order to reduce the scope for
opportunistic behaviour.
Desired mode characteristics
Risk-averse
If decision-makers are risk-averse they will prefer export modes (e.g. indirect and direct
exporting) or licensing (an intermediate mode), because these typically entail low levels of
financial and management resource commitment. A joint venture provides a way of sharing risk,
financial exposure and the cost of establishing local distribution networks and hiring local
personnel, although negotiating and managing joint ventures often absorbs considerable
management time and effort. However, modes of entry that entail minimal levels of resource
commitment, and hence minimal risks, are unlikely to foster the development of international
operations and may result in significant loss of opportunity.
Exhibit 9.1 Zara is modifying its preferred choice of entry
mode, depending on the psychic distance to new markets
Zara (www.inditex.com) is a fashion retail chain that is part of the Inditex Group owned by
Spanish tycoon Amancio Ortega. Zara’s preferred entry mode is the hierarchical mode (direct
investment), which is used in most European countries, resulting in full ownership of the stores.
In 2014, 85 per cent of the Zara stores were own managed. Those markets where the hierarchical
model is used are characterized by high growth potential and relatively low sociocultural
distance (low country risk) between Spain and target market.
The intermediate modes (usually joint venture and franchising) are mainly used in countries
where the sociocultural distance is relatively high.
A Zara shop in Shanghai, China
Source: Bloomberg/Getty Images.
Joint ventures
This is a cooperative strategy in which facilities and know-how of the local company are
combined with the international fashion expertise of Zara. This particular mode is used in large,
competitive markets where it is difficult to acquire property to set up retail outlets or where there
are other kinds of obstacles that require cooperation with a local company. For example, in 1999
Zara entered into a 50–50 joint venture with the German firm Otto Versand, which had
experience in the distribution sector and market knowledge in one of Europe’s largest markets,
Germany.
Franchising
Zara employs this mode for high-risk countries that are socioculturally distant or have small
markets with a low sales forecast, such as Kuwait, Andorra, Puerto Rico, Panama and the
Philippines.
Whatever entry mode Zara uses, the main characteristic of their franchise model is the total
integration of franchised stores with own-managed stores in terms of product, human resources,
training, window-dressing, interior design, logistical optimization and so on. This ensures
uniformity in store management criteria and a global image in the eyes of customers around the
world.
Source: adapted from the Zara case study and different public media.
Control
Mode of entry decisions also need to consider the degree of control that management requires
over operations in international markets. Control is often closely linked to the level of resource
commitment. Modes of entry with minimal resource commitment, such as indirect exporting,
provide little or no control over the conditions under which the product or service is marketed
abroad. In the case of licensing and contract manufacturing, management needs to ensure that
production meets its quality standards. Joint ventures also limit the degree of management
control over international operations and can be a source of considerable conflict where the goals
and objectives of partners diverge. Wholly owned subsidiaries (hierarchical mode) provide the
most control, but also require a substantial commitment of resources.
Flexibility
Management must also weigh up the flexibility associated with a given mode of entry. The
hierarchical modes (involving substantial equity investment) are typically the most costly, but
they are the least flexible and most difficult to change in the short run. On the other hand, export
modes provide the company with higher flexibility, because the company can terminate an agent
contract on a relatively short time horizon, though the company may have to compensate the
foreign agent for the lost commission for 1-2 years (depending on the agent contract).
Equity
Some investment of a defined financial value.
Transaction-specific factors
The transaction cost analysis approach was discussed in Section 3.3 and earlier in this chapter.
We will therefore refer to only one of the factors here.
Tacit nature of know-how
When the nature of the firm-specific know-how transferred is tacit, it is by definition difficult to
articulate. This makes the drafting of a contract (to transfer such complex know-how) very
problematic. The difficulties and costs involved in transferring tacit know-how
9.4 Summary
Seen from the perspective of the manufacturer (international marketer), market entry
modes can be classified into three groups:
1. export modes: low control, low risk, high flexibility;
2. intermediate modes (contractual modes): shared control and risk, split ownership;
Intermediate modes
Somewhere between using export modes (external partners) and hierarchical modes
(internal modes).
3. hierarchical modes (investment modes): high control, high risk, low flexibility.
It cannot be stated categorically which alternative is the best. There are many internal
and external conditions that affect this choice and it should be emphasized that a
manufacturer wanting to engage in global marketing may use more than one of these
methods at the same time. There may be different product lines, each requiring a
different entry mode.
Getting Custom Writing Service with any of your academic assignments is easy. Simply click here.