Modes of entry

The firm has a number of choices when it is attempting to evaluate a mode of market entry. It should be remembered that there is no one method which is suitable for all firms under a particular set of circumstances. Instead there are a number of options which companies and the individuals within them have to weigh up under the pertaining market situation. Box 4,5 highlights those favoured by exporters in Canada and Latin America.

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The company will have a number of broad strategic choices which it will have to address including: is a domestic export-based strategy, or a production-based strategy in the host country, more appropriate? It may be that the host country will only welcome the exporter if it involves a presence in the host market. Such a presence will require a commitment, at the very least, to international marketing or a production plant, unlike a pure domestic export-based strategy. Under such a strategy the responsibility could be devolved to the intermediary being used. A number of specific factors will shape their choice. These will include the:

* Speed of entry required

■ Financial resources available

■ Flexibility required

■ Degree of risk aversion

■ Period over which the investment is expected to provide a return

■ Long-term objectives of the organization

■ Degree of marketing control.

Firms can also make use of outside advice on market entry concerns as Box 4.6 illustrates.

BOX 4,6: Mr.HKF«' KMTRV: TARGKT VVESi^M i i-ti?. - AuvlCF GlViiiV TO CANADIAN I.aP0R'Il';.:.

Try to obtain language and cultural expertise, and use this in al] aspects of negotiation, marketing and promotion. You will not only be seen as respectful, but will be able to differentiate your company from many competitors.

Clients in the European market arc well-versed in international affairs, if you wish to gain ttwir respect, be prepared to discuss these issues intelligently.

Approach distribution strategy very carefully. This area is crucial and complex. Do not hesitate to sock advice from other exporters and/or trade consultants.

Trade shows arc plentiful and utiiiI I -lis'market. Participiiiiori through federal and provincial government programs is a good first, stop.

Despite a more homogeneous Europe (since 1992) the region will not be one uniform market in the near future/Consequently, be sensitive to di .i:in.ii\v national ..mi •• -n sub-national requirements.

There are a number of ways to classify the options open to companies, and no one method is correct. The approach used in this book is to look at indirect and direct market entry together with strategies which do or do not involve foreign investment. This is outlined in Table 4.3 and discussed below.

Indirect market entry

This is often referred to as passive exporting or as being the result of an 'export pull' effect, since people outside the company stimulate the activity. The main strategies which come under this category are:

(i) Responding to unsolicited or chance orders. For some companies, this is the first introduction to international markets, which may stimulate them to explore the feasibility of exporting more seriously as the stage models would suggest. It does have that advantage of being new, unexpected business. It illustrates the fact that there are potential, as yet unreached, customers in the world, and it involves no product adaptation costs or promotion costs.

However, on the downside, the company is not geared up for exporting, and therefore there are relatively high costs involved because of the learning curve which has to be gone through. For example, a one-off distribution channel will be relatively expensive as no economies of scale are available. The potential benefits of this initial involvement depend on the company's medium-term response to the unsolicited order.

Table 4.3 Classification of modes of market entry

Indirect market entry

Strategies without foreign investment

Unsolicited orders Domestic based intermediaries Courier/express services Export management companies Export houses Trading companies Piggybacking Brokers Jobbers

Licensing Franchising

Management contracts

Direct market entry

Strategies with foreign investment

Domestic based intermediaries Freight forwarders Consortium exporting Export department Foreign based intermediaries Agents Distributors

Marketing subsidiary Manufacturing subsidiary Joint ventures Joint equity venture Contractual joint venture

(ii) Use of a range of home-based intermediaries. This can include making use of courier/express delivery services, export management companies, export houses, trading companies, piggybacking, brokers and jobbers. Effectively by using the services of these intermediaries, the experience is little different than undertaking a domestic sale, as there is no direct export marketing experience being gained.

Courier and express delivery services will be of little use for bulk items, as they will have weight restrictions, but for low-weight high-value items they are an option. It is a cost efficient way for a micro-business to reach international clients, for example, in the jewellery or hand-made ceramic businesses.

Export management companies are estimated to handle approximately 10% of all manufactured goods. They offer a personal service to clients who come to view them as an extension of their own business. It may even be that the buyer does not realize they are dealing indirectly with the exporter. For the exporter without the personnel or funds to run an export operation, this route offers market entry at low investment.

An export house will buy directly from the domestic manufacturer on behalf of an international client. This is a straightforward sale for the domestic company with the export house taking responsibility for organizing the export of the goods.

Trading companies gather together, transport and distribute goods from many companies. Names from the past include the East India Company and the Hudson Bay Company, and today the United Africa Company is a major player on that continent. They handle a huge range of items across the consumer and business to business markets. In Japan the 'sogo shosha' have a long history of trading as both importers and exporters, and offer integrated financial and insurance services as part of the package.

Piggybacking, or complementary marketing as it is sometimes known, allows one firm to use the distribution channels of another firm to reach an international customer. It .may be that the existing exporter has excess capacity in the channel, or they may be keen to expand the range of products carried by seeking out complementary, non-competing products to those already carried. The request can also come from an existing customer for another product to be sourced. The domestic firm may then seek a third party offering a complete export package, based on its existing channels, to meet this request.

Successful piggybacking can work well for both the piggybacker and the carrier. The former gains a ready market and the experience of an existing exporter, while the latter increases the product range and makes more efficient use of channels which would have been served anyway.

Brokers and jobbers tend to deal mostly in commodities. Brokers bring buyer and seller together and do not necessarily have an ongoing relationship with their clients, but maintain a network of producers and buyers throughout the world. Jobbers take title to the goods but do not take physical possession; instead they organize the transportation of the goods.

All of these indirect approaches to market entry have the common advantage of being low cost, as no international sales force is required, but they do not allow the company to develop its own skills and knowledge of the exporting process. By using the expertise of others it is likely that most deals will run smoothly for the company, but crucially direct contact with the end customer is non-existent. Under these circumstances the firm must accept that its involvement in international markets is very shallow.

Direct market entry

This is an active form of exporting and can involve the use of domestic and international based intermediaries. The commitment and investment required are greater than in indirect exporting, but the rewards can also be greater. Within the domestic market the main types are:

(i) Use of freight forwarders. These companies provide advice and guidance and offer a documentation and delivery service. They act on behalf of the producer, and are indispensable to an exporter who does not possess the skills in-house to handle the paperwork associated with exporting. A full-service freight forwarder will provide information on shipping, routing, schedules, charges, labelling, certification and consular requirements. By consolidating orders into larger shipments, the freight forwarder can offer a more cost effective service to the smaller exporter than they could obtain independently.

(ii) Consortium exporting. Under this a number of companies, normally non-competing, come together in order to combine their skills and resources, especially managerial and financial. They bid for contracts and projects as a group while remaining independent. Often these are linked to large construction projects where a consortium is formed, with one lead organization driving the group forward.

(iii) Export department. Larger companies will be able to form an in-house export department to run all exporting activities. Home-based salespeople travel abroad, perhaps in defined geographical areas, in search of orders. Those methods involving the use of international-based intermediaries include:

(i) Use of agents. Agents represent the exporter abroad and are normally paid on a commission basis. They will have territorial sales rights, but may work for more than one company and carry more than one product line. The exporter may remain responsible for the inventory. This is the most common means of market entry for exporters, and is a relatively inexpensive method. However, it is important that a 'who does what' agreement is drawn up and understood by both sides before entering into any relationship, as bad agents do exist and can be difficult to get rid off. On a positive note, they offer market knowledge and access to networks.

(ii) Use of distributors. Distributors operate in a very similar way to agents, but the distributor takes title (ownership) of the goods. This means that they purchase the goods from the exporter before going on to re-sell them. The advantage of this method to the exporter is that cash flow is more assured, but there is a loss of control over the price to the end-user, and no direct knowledge about who the end user is.

Strategies without international investment

The next group of strategies involve international production strategies without direct investment. Those without direct investment include:

(i) Licensing. This involves providing permission for another operator (the licensee) to make use of a production process, trademark or patent in return for a lump sum payment and an annual royalty. The royalty would be based on a percentage of sales or profit. It is a popular method for companies, especially SMEs, who desire market entry without a large capital outlay.

One advantage of such an arrangement is that income can be obtained for older processes which are technically obsolete in the domestic market, e.g. the UK car company Rover has licensed older models of engines to the Chinese market. The original manufacturer gains an entry to international markets with relatively low risk and low cost. It may also be the only route to market entry if import restrictions exist which deny other means.

There are some potential disadvantages which have to be considered. These include a certain loss of control of the technology, which could be developed by the new operator and inadvertently create a new competitor for the original company. There can also be problems with the payment process, and in making sure that the original deal is honoured in that the technology is not passed on to any third party. Thus the supervision costs of the agreement can escalate.

(ii) Franchising. This involves the selling of a marketing concept as part of a business package which will include such things as the corporate image, trade marks and a training program for the new franchisee. The franchisee owns and manages the operation on a day-to-day basis within the regulations laid down by the franchise owner.

Currently this is a fast growing form of market entry. The types of sectors involved include business services, food, home care services, property care, car services and retailing. Many of the initial entries into the emerging markets of Eastern Europe were franchises. Usually a master franchise for a particular territory will be agreed with one partner who will have the right to issue subfranchises.

The advantage of this system is a rapid and relatively low cost market entry, which helps to create a global image. The original business idea is maximized with the minimum of investment. There can be control problems in relation to variable quality provided by the individual franchisee, which may reflect badly on the brand as a whole, e.g. when McDonald's had to close down its Paris operation. It is also possible the concept may be closely copied and a competitor may enter the market quickly.

(iii) Management contracts. These involve putting in a management system plus the personnel to operate the venture. The international company supplies the capital. This again provides rapid entry and help to fill obvious management gaps. For example, in Eastern Europe after the fall of the Berlin Wall in 1989, a number of joint ventures were created in the hotel sector to meet the rapid increase in demand for tourist facilities, as the number of visitors grew. Management contracts are also popular in the management of private hospitals.

The turnkey operation is a particular version of this method of market entry. This is often associated with large-scale construction contracts, whereby a company builds and commissions a facility, for example a power station or dam, for a government customer. Over an agreed period of time the running of the facility is passed from- the original builder to the government or its appointed body.

Strategies with international investment

(i) Establish a marketing subsidiary. This mode is favoured where the company feels that its own marketing skills are better than any agent it could engage. Having the 'local' presence is deemed to be important to the image of the company in the country. By creating this feeling of presence, the company enhances its own credibility, and perhaps acceptability, in some politically sensitive markets.

(ii) Establish a manufacturing or assembly subsidiary. Wholly owned production facilities are a popular strategy for many larger companies. The organization can be attracted to this option in order to seek new markets, obtain access to resources, or improve the efficiency of their operation, partly through increased productivity.

This option allows full control with no dilution of profits to other operators or agents, and can reduce transports costs. It also allows the company to take advantage of financial incentives from the host government, lower labour costs, access to raw materials and perhaps avoid punitive import taxes. However, the capital cost involved can be prohibitive, and in certain politically risky countries the future can be uncertain. However, as we saw earlier in Chapter 2, there are many incentives offered to footloose international investment.

A variation on this approach is to establish a local presence by acquiring or merging with a local firm. This is a faster route to entering the market than building a brand new facility. It gives immediate market intelligence, market share and established channels of distribution. There can be disadvantages in amalgamating two distinct company cultures, a product line and/or a management team that was underperforming. However, this mode, which was much in fashion in the 1960s and 1970s, seems to be making a comeback in the early years of the new century.

(iii) Joint ventures. This option provides an important local feel to the investment without carrying all the risk. The partner can also provide the all important knowledge and access to networks, as well as reducing political and cultural barriers which might have been present in acquisition or in developing a wholly owned subsidiary. Some governments specifically encourage this form of investment rather than experience too many international operators moving in. On the down side there is a certain loss of control and a risk that the partner organization may not be all that it appeared. Within the corporate structure there can also be tensions between the corporate culture and ambitions versus the local identity. There are two distinct types of joint ventures: joint equity venture and contractual, as in strategic business alliances.

A joint-equity venture consists of domestic and international companies coming together to share ownership and control in a venture. This may involve buying in to a company or forming a new local business. As the name implies, such an arrangement involves investment over a period of time, which does not have to be fixed. Often such a business set-up is required by the government as the only means of market entry allowed. Alternatively the firm's own economic reasons may force such co-operation. The astute choice of partners is essential to the venture's success, as disputes can be time consuming and expensive. It is important that the partners work to establish and develop a relationship which will evolve over time.

A contractual joint venture is of fixed duration, with the specific duties of each partner well defined. Under such a scheme, a company contracts a manufacturer abroad to produce its product and provide all supporting services in the market. There is, of course, a loss of control in this arrangement, but if it works it can lead to closer co-operation between the companies, and certainly involves less capital than direct investment in production facilities.

The relationship between internationalization theories and market entry modes

While the Johanson and Vahlne model emphasizes managerial learning, the internationalization process is also reflected in the mechanisms used for mode of entry. For example, firms improve their foreign market knowledge through initial expansion with low risk, indirect exporting approaches to similar, 'psychically close' markets. Over time and through experience, firms then increase their foreign market commitment. This in turn enhances market knowledge, leading to further commitment, including equity investment in off-shore manufacturing and sales operations. Interestingly, in the same way recent FDI literature captures the concept of organizational learning, the Johanson and Vahlne model encapsulates the essence of FDI whereby the firm is ultimately expected to internalize its activities, by moving over time from purely domestic operations to finally establishing host country production.

Interestingly, Johanson and Vahlne's more recent perspective "has evolved somewhat from their early work, and reflects their ongoing research exploring the management of foreign market entry. For example, their 1992 study of internationalization in the context of exchange networks found that although foreign market entry is a gradual process (reflecting their original stage model), it results from interaction, and the development and maintenance of relationships over time. These findings support Sharma and johanson (1987), who found that technical consultancy firms operate in networks of connected relationships between organizations, where relationships become 'bridges to foreign markets,' and provide firms with the opportunity and motivation to internationalize. This view is supported by other authors who argue that network relationships provide a firm with access to external resources (Jarillo, 1989), new market contacts, and enhanced flexibility and market reputation (Bridgewater, 1992). Related to this, Johanson and Mattsson (1988) suggest that a firm's success in entering new international markets is more dependent on its relationships within current markets than on market and cultural characteristics.

Whatever method of entry is chosen, it is important to minimize the risk of failure. Careful planning and good preparation for market entry can help to offset unforeseen setbacks in the market entry process. Success can never be taken for granted and failure can never be eliminated entirely, but the research literature does point to some key characteristics of successes and failures which will be discussed in the next section.

Continue reading here: Success and failure in the internationalization process

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