In the first phase firms go in for exports/imports, that is moving goods internationally; in the second phase strategic corporate offices are located in foreign countries and the goods and/or services are produced in one country and possibly transferred to another country for additional assembly, and sold to other countries; and in the final phase the companies become truly global enterprises when the firm’s corporate offices in other countries interact with each other and headquarters.
Different activities are performed in different countries depending upon specialisation – marketing in one country, production in second country and research and development in the third country.
The mode of entry refers to the level to which an international business vertically integrates into production and distribution.
The process of internationalisation involves making three strategic decisions, which are:
Where to enter (location)?
When to enter (Timing of entry)?
How to enter (entry-mode selection)?
These three strategic decisions will determine a firm’s “investment environment, operation treatment, resource commitment, and evolutionary path.”
1. Where to Enter?
This aspect of strategic decision-making is concerned with the location, i.e., selection of particular country and the particular region/city within that country. Selection of the country shall depend on nationwide factors and the site selection shall depend on region/city specific factors. For the selection of a country analysis of both micro and macro contextual factors is required, but the decision to select a site within that country shall be based upon micro context factors. Shenkar and Luo (2008) categorise the locational factors under the following groups:
i. Cost and Tax Factors
ii. Demand Factors
iii. Strategic Factors
iv. Regulatory and Economic Factors
v. Socio-political Factors
Importance of these specific factors to a particular firm shall depend on the firm’s objectives and the nature of the project to be undertaken.
Cost and Tax Factors:
Cost and tax factors shall be determining profitability of a venture. These factors include-
i. Transportation costs (logistics for plant and machinery, and raw and finished materials)
ii. Wage rates
iii. Availability of land and its price
iv. Cost of construction
v. Raw materials and resources cost
vi. Cost of capital
vii. Rate of taxation
viii. Investment incentives
ix. Repatriation of profits
Even if a company may export 100% of its production today, ultimately the local demand factors cannot be ruled out. Most of the automobiles companies have selected India, as it has huge middle class consumers. Demand factors include not only market size and growth, presence of customers in the nereby vicinity, and local competitive scenario.
Strategic factors include availability of infrastructure, manufacturing concentration, industrial linkages, workforce productivity, and nearness to suppliers and consumers.
Regulatory and Economic Factors:
Host government’s policies relating to industries, FDI and SEZ (special economic zones) help the company to decide for a particular country or a region/city within that country.
No firm would like to come to a country infested with political instability or finds itself with a culture inimical to its working practices. Socio-political factors include – political stability, cultural barriers, local business practices, Government efficiency and corruption, attitude toward foreign business, Community characters, and pollution control.
2. When to Enter?
Decision regarding the timing of entry is important because it determines the risks, environments, and opportunities that a firm going international may confront. Basically the when decision, will be determined by the time of elimination of the protection barriers by the state. However, two choices are there with regard to timing – to move early or let others go and then to follow them. Both of them have their advantages and disadvantages.
Firms moving foreign markets early on can enjoy many benefits such as, greater market power, more pre-emptive opportunities, and more strategic options over late entrants. Most of the foreign entrants into India like Hindustan Unilever, Suzuki Motors, et al do enjoy all these benefits. Early movement enables the firms “to invest strategically in facilities, distribution networks, product positioning, patentable technology, natural resources, and human and organisational expertise.”
Second, early moving firms do have the “right to pre-empt marketing, promotion, and distribution channels”. Though international business provides endless opportunities, but window of opportunity opens at one particular time and the early mover grabs the opportunity. India’s car market is still dominated by Suzuki Motors of Japan.
Third, those who move as pioneers do have more strategic options in terms of ‘selection of industry, location, and market orientation (e.g., import substitution, local-market oriented, export-market oriented, infrastructure oriented).’ State also provides easy access to natural resources. Early movers often face competition from late movers except the local firms. If the local competitors are weak and the early movers are strong in terms of technology and organisational competencies, the foreign entrant can position its competitive advantages in business.
In the initial stage of development, the environment in most of the countries remains uncertain because of ‘underdeveloped laws and regulatory mechanism, host country’s lack of experience to deal with MNCs, and industry and market being in infant stage in the host country.
‘Shortage of qualified manpower; underdeveloped support services such as local financing, foreign exchange, arbitration, marketing, consulting, etc; poor infrastructure; and unstable market structure in which market demand and supply being imbalanced and local government’s interference with foreign firms’ working, make the operations risky.
The late entrants do not suffer, or suffer less from the problems relating to uncertain environment and risks. When the late movers enter a foreign country, the law and the regulatory mechanism, and market infrastructure are already developed. Most of the Korean MNCs (Chaebols) entered China only after 1994.
And they did benefit for being late as China had deepened economic reforms, law and regulatory mechanism were developed and infrastructure had been developed considerably. “Early movers also tend to pay higher costs in learning about and adapting local environments and in countervailing imitation. Late entrants do not invest money in creating market infrastructure, training local manpower.”
With respect to timing of entry, “the truth is that there really is little evidence one way or the other concerning the effect of timing of a firm’s entry into a new market on its ultimate profitability in that market or the value generated for shareholders.”
3. How to Enter?
Having decided to enter a particular country at a particular time, it is equally important to decide about which entry mode to use. Entry mode options fall under three categories: trade related, transfer related, and foreign direct investment related. The levels of resource commitment, organisational control, risks, and expected returns shall be different among these three modes.
Trade Related Entry Modes:
This mode includes exporting, turnkey and subcontracting, and counter trade.
Most of the firms while internationalizing their operations for the first time opt for this option only. It has certain merits in the sense that it requires little investment, involves less risk and provides an excellent way to have a feel for international business. Exporting can be of two types – direct and indirect.
If a firm does not export directly but uses other exporters, it is called indirect exporting. Exporters may be (;) manufacturers’ export agents (selling for the manufacturer), (ii) export commission agents (buying for their overseas customers,) (iii) export merchants (buy and sell for their own accounts), and (iv) international firms (which use the goods overseas).
Exporters that sell for the manufacturers, i.e., manufacturer’s agents as discussed above, needs special mention of the Japanese sogo shosha (general trading companies) and the Korean chaebols, which have been especially successful in promoting exports of the manufacturers located in their respective countries.
Using the services of intermediaries means paying commissions (to first three types of exporters); depending on their mercy (business is lost if intermediaries change the source of supply), and the firms hardly get any experience from such deals. It is because of these reasons that after initial indirect exporting the firms decide to go in for direct exporting.
A firm may directly export to foreign buyer, without the assistance of any intermediary. The Sales department may be asked to develop export business. If the business increases, a separate export division may be created. Increasing volume of exports may require the exporting firm to establish a sales company in the clients’ area. The company shall import in its own name and shall bill the clients in local currency. Internet has made direct exporting very easy.
Turnkey and Subcontracting:
“Turnkey project export refers to export of technology, management expertise, and in some cases capital equipment.” The exporter agrees to design and erect a plant, supply the process technology, provide necessary raw materials and other inputs including training.
Subcontracting and turnkey operations are much more complex because of specifications written into contracts. Subcontracting has been extensively used by MNCs to procure goods from those destinations which can offer cost advantage.
Under subcontracting a foreign company provides all the facilities as being done under turnkey with a difference that local manufacturer is only responsible for the manufacturing goods which will be bought back by the foreign company.
Local company gets processing fee and has no right over the goods or the parts supplied to it. Many international companies have opted for this system. Most of the auto manufacturing companies have subcontracting facility in countries like Thailand, India, and Malaysia; Sports shoe firm Nike have spread its subcontracting facility over China, Vietnam, Thailand, Indonesia, and Bangladesh.
Many of the global capital goods companies in aviation, auto, heavy machinery, etc use original equipment manufacturing (OEM) method, a specific form of subcontracting. Under OEM method, a foreign company i.e., OE manufacturer supplies a local company with the technology and sophisticated components so that the local firm can manufacture goods that the foreign company will market under its own brand in international mark.
According to an estimate, counter trade accounts for about 20% of world trade. Shenkar and Luo (2008) have divided counter trade into – barter, counter purchase, offset and buyback.
It is a transaction between two parties (individuals, firms, or governments) where goods are exchanged for goods. During the first quarter of 2001, France consigned 1.38 lakh tons of soft wheat to Cuba and for half of its payment got sugar from Cuba.
One party sells its products to another party at one time and receives the value in the form of the other’s products at some future time. This form of counter trade is more flexible than barter, because total payment need not be in kind and at one go. Balance of the transaction can be paid in cash also. Number of transactions can also be many.
“An offset is an agreement whereby one party agrees to purchase goods and services with a specified percentage of its proceeds from an original sale. Like counter purchase, offset involves three contracts, including sales, protocol, and purchase. Unlike counter purchase whereby exchanged products are normally unrelated, products taken back in an offset are often the outputs processed by this party in the original contract.”
Buyback, also known as compensation arrangement, “occurs when a firm provides a local company with inputs for manufacturing products (mostly capital equipment) to be output produced by the local firm as partial payment.”