By Prem Moktan, Bank of Bhutan, 2012
In
this essay we will examine various factors that determine the entry modes of
multinational companies in the foreign markets. We will explore and analyse
with various case studies as why firms choose different entry modes for
different markets at different times. In order to study the various factors that determine the entry modes of
the firms in international market, use of various journals of international
business studies, articles, websites, newspapers and books are made as work of
references, and no field research or survey is conducted in preparing the
assignment.
Firms face three interlocking questions with
regard to international expansion, what market to enter (entry location), how
to enter (mode of entry), and when to enter (timing of entry) (Vishal, Yang and
Gerardo, 2002). The multinational company’s different entry modes in the
international markets have been regarded as closely associated with varying
degrees of resources commitment, risk exposure, control, and profit return. The
primary factors that determine their entry modes depend on different types of
factors, including firm- specific factors, industry specific and country
specific factors (Erramilli and Roa, 1993, Kim and Hang, 1992, Kumar and
Subramaniam, 1997: Madhok, 1997; cited in Yang Pan and David K, 2004). As
suggested by Kumar and Subramanian (1997), a natural hierarchy exists among the
various modes of entry.
Modes of entry can be classified as equity based
and non-equity based. Equity based modes are wholly owned operations and equity
joint ventures(EJVS), while non-equity base entry modes are divided into
contractual agreement and exports (Yang Pan and David, k., 2004).
Many
researches were interested to know how multinational firms choose the entry
mode to foreign market when they have choice though firms at times have to
adopt the entry mode dictated by the host country government. According to Yang
pan and David “three main schools of thought have been put forward to explain
the choice of entry modes. The first school of thought views business operation
in an overseas market as inherently risky because of the political, culture and
market system that the firms must adapt to”. The second school of thought
explains with respect to transactional cost perspective. Yang Pan and David (2000)
stated that firms will internalize those activities that they can perform it at
a relatively lower cost but subcontract those activities externally if other
providers have a lower cost advantage. Third school of thought highlights the
importance of location-specific factors (Hill, Hwang and Kim, 1990 cited in
Yang and David, 2000). Dunning (1988) emphasis on three pillars; such as ownership-specific
factors, location specific factors and internalization factors in his eclectic
paradigm with regard to international business.
However,
Hill, C.W.L., Cronk, T.,
Wickramasekera, R. (2010) suggest that there are six different modes to enter
the foreign market. They are exporting, turnkey project, licensing,
franchising , establishing joint venture or setting up a new wholly owned
subsidiary in the host country. When setting up production abroad, they
can start up new venture or take over existing ones by way of acquisition and
merger (Caves and Mehra, 1986). There is indication that MNEs possessing strong
R&D capabilities establish wholly-owned subsidiaries to exploit proprietary
technology abroad, while those facing high technology barriers use joint
ventures to enlist advanced technology from foreign partners ( Gatigono and
Anderson, 1989;Kogut and Chang, 1991 cite in Chen, Shih-Fen, Hennart and Jean-Francois, 2002). Numerous studies indicate a firm's entry mode choice
impacts a firm's overseas business performance and survival (Anderson &
Gatignon, 1986; Kim & Hwang, 1992; Davidson, 1982 cited in Davis, 2000).
The entry modes choice is influenced by transactional –cost, resource-based
theory and eclectic theory (Anderson & Gatignon, 1986; Chang, 1995; Kim
& Hwang, 1992 cited in Davis, 2000).
Explanations based on transaction-costs stress the
preeminent role of control that each expansion type of mode affords an entrant. Resource based explanations suggest that
resource availability and utilization figure in choices among modes of entry
if there are cost distinctions. Eclectic discussions posit a wide variety of
factors, such as firm size, multinational experience and ability to
differentiate products to influence entry mode (Gaves & Mehra, 1986). The
investment behavior and entry mode of MNCs are primarily determined by
firm-specific advantages, especially proprietary technologies and also
location-specific factors (Haishun Sun, 1999).
The timing of
entry has received relatively little attention. However, earlier
economic studies on the timing entry sought to explain how the monopolistic
advantage of the firms determined the entry modes (Vibha, Yigang and Gerardo,
2002). There are supporting evidence that surviving first movers achieve higher
market shares and profitability, largely as result of economic, preemptive,
technological, and behavioral reasons (Kerin et al., 1992; Lilien and Yoon,
1990 cited in Vibha, Yigang and Gerardo, 2002).
Figure 1. A hierarchical model of choice of
Entry Modes
Source
: Yigang Pan; Tse, David K.,
Journal of International Business Studies, 2000 4th Quarter, Vol. 31 Issue
4, p535-554, 20p, 2 Diagrams.
While
the performance implications of entry-mode are widely acknowledged, little is
known about the underlying institutional factors impinging on entry mode
decisions. One reason is that prior investigations focused on identifying a
comprehensive set of strategic variables and relationships that influence an
entry- mode decision at its occurrence (Davidson, 1982; Anderson &
Gatignon, 1986).
Core competencies and entry mode:
Firms
enter into foreign market to earn greater returns from their core competencies,
transfering the skills and product derived from thier core compentencies to
foreign markets where indigenous competitors lack those skills (Hill, Cronk and Wickramasekera, 2010). According to
them, it is the nature of core competencies of the firms that determines the
optimal entry mode. Core competencies can be in technology know-how and
management know-how. Where firm’s core competencies are in technology know-how,
it should if possible avoid licensing and joint venture arrangement to protect
the competencies. It is suggested that wholly owned subsidiary would be best
form of the firms. In JCB case joint venture was limiting their expansion,
because JCB was hesitant to transfer their core competency; leading technology
know-how to joint venture with Escorts. If
the core competences of the firms are in management know-how, there is less
risk of losing control over the management skill to joint venture or licensing
model.
Pressure for cost reduction and
entry mode:
Firms
will choose to combine exporting and wholly owned subsidiaries if there is
greater pressure for cost reduction. Firms may be able to realize substantial
location and experience curve economies by manufacturing in those location
where factors conditions are optimal and then exporting to rest of the world (Hill, Cronk and Wickramasekera, 2010).
Then firms may export their finished products to marketing subsidiaries located
in various countries. Setting up wholly owned marketing subsidiaries is
preferable to joint- venture to controlling and coordinating dispersed value
chain. It also gives firms the ability for cross-subsidization of weaker
markets.
Figure 2: Decision Framework of
entry modes:
Source
: Hill, C.W.L., Cronk, T., Wickramasekera, R. (2010) Global Business Today:
Asia- Pacific Edition, Ch.11 p. 449.
Figure 3: Impact of micro-level factors on choice of
entry modes
IMPACT OF MACRO-LEVEL FACTORS ON CHOICE OF ENTRY MODES
|
|||
Determinants
|
Equity Vs. Non-equity
|
Within Non-equity
|
Within Equity modes
|
Export Vs.Contrctual
|
EJV Vs.WOS
|
||
Host country factors:
|
|||
Prioritized location
|
High
|
Low
|
Low
|
Host country risk
|
High
|
Low
|
Low
|
Home country Factors
|
|||
Management orientation
|
High
|
Low
|
Low
|
Risk orientation
|
High
|
Low
|
Low
|
Host and Home country
|
|||
Trade relationship
|
High
|
Low
|
Low
|
Political relationship
|
High
|
Low
|
Low
|
Industry factors
|
|||
Marketing management
|
High
|
Low
|
Low
|
Asset management
|
High
|
Low
|
Low
|
Source
: Yigang Pan; Tse, David K., Journal
of International Business Studies, 2000 4th Quarter, Vol. 31 Issue 4,
p535-554, 20p, 2 Diagrams.
A case study of an Italian fashion
firm’s entry into the Chinese market:
A leading Italian fashion company, which has a
total of 15 brands, distributed internationally attempted two separate entry
modes into Chinese market. In 2005 company started a JV with a local firm to
distribute the company’s brand. In 2006 company started new Brand with an entry
mode of WOS for distributing the Brand in the Chinese market. The firm’s entry
modes choice and decision making processes were based on: Assets specificity
gave company advantage of unique managerial capability which distinguishes them
from local company. Brand equity was competitive advantage for entering into
Chinese market and company has financial capability to establish wholly owned
subsidiary. Company was already operating in Chinese market which gave them international
experience. Country risk, market potential, cultural distance, Government
restriction, and market competition were other important factors (Yao, Elena
& Ann, 2011). The success of Company entry mode choice has been
demonstrated by its performance in China. By now the company has opened 20
stores in several locations in China, all through WOS, and is planning more
locations in the future. The company has emphasized the importance on special
assets and brand equity to select higher control entry mode, which are
fundamental considerations in a fashion brand’s foreign expansion decision
(Moore and Burt, 2007 cited in Yao, Elena & Ann, 2011). High control over
the foreign operation was preferred by Company to protect its brand equity from
possible damage by inappropriate operations on the part of local partners. A
high control entry mode was also beneficial to the company for gaining a higher
profitability during long-term operation in the market.
Figure
4: Entry mode characteristic of fashion retailers.
As
illustrated by the continuum in Figure 4, high control entry modes demand greater
resource commitments in international market, and the foreign operation is
exposed to a higher degree of uncertainties. However, low control modes require
a more limited resource commitment, thus reducing investment risk, but the
fashion retail firm has little power over foreign operations, which could
result in reduced financial returns (Hill et al., 1990 cited in Yao, Elena
& Ann, 2011).
Case
study of JCB in India.
In
case of JCB India, it was equity based joint-venture entry mode due to country
specific factor (government regulations) with 40 per cent stake. Direct export
to India was difficult due to high tariff and Indian government regulation
required foreign investor to create joint venture with local companies. Indian
construction market was ripe for growth and opportunity for expansion.
Therefore, company decided to get a foothold in the nation on time to get
advantage of time entry (Kerin et al., 1992; Lilien and Yoon, 1990 cited in
Vibha, Yigang and Gerardo, 2002).
Since
JCB core competency was in
technology know-how, it should if possible avoid licensing and joint venture
arrangement to protect the competencies (Hill, Cronk and Wickramasekera, 2010).
So JCB decided to go
for FDI by purchasing all of Escort’s equity, transforming the joint venture
into wholly-owned subsidiary as shown in decision framework figure 2. Therefore,
it very clear from JCB’s strategy to adopt different entry mode from joint-venture
to wholly owned subsidiary was due to various factors, such as core
competencies(technology and management know-how) and host country’s regulation
(country specific factors).
Source : Hill, C.W.L., Cronk, T., Wickramasekera, R.
(2010) Global Business Today: Asia- Pacific Edition, Ch.11 p. 436. Cited
from P. Marsh, partnership feels the Indian heat, Financial Times, 22 June 2006,
JCB targets Asia to spread production, Financial
Times, 16 March, 2005. www.jcb.com/aboutjcb/jcbindia.aspx.
Conclusion:
The
multinational companies’ entry modes in the international markets are
determined by various factors such as varying degrees of resources commitment,
risk exposure, control, and profit return. The primary factors that determine
their entry modes include firm- specific factors, industry specific and country
specific factors (Erramilli and Roa, 1993, Kim and Hang, 1992, Kumar and
Subramaniam, 1997: Madhok, 1997; cited in Yang Pan and David K, 2004). Modes of
entry can be classified as equity based and non-equity based. Equity based
modes are wholly owned operations and equity joint ventures(EJVS), while
non-equity base entry modes are divided into contractual agreement and exports
(Yang Pan and David, k., 2004).
Multinational
companies core competecies can be technology know –how and management know –how
(Hill, Crank and
Wickramasekera, 2010). It is the nature of core competencies of the firms,
political risk, economic risk, transport cost, trade barriers and firms strtegy
that determines the optimal entry mode. Where firm’s core competencies are in
technology know-how, they avoid licensing and joint venture arrangement to
protect the competencies as seen in JCB joint-venture case with Escorts in India.
Wholly owned subsidiaries are preferred, since they best control technology
know-how. If the core competences of the firms are in management know-how,
there is less risk of losing control over the management skill to joint venture
or licensing model. Acquisitions are easy modes of entry and
may enable firms to preempt their global competitors with less time taken and
involve buying known revenue and profit stream. However, acquisition may fail
due to over paying for the target; culture clashes and failure integrate
operations. In
recent years, models of entry strategies have focused on structural and
transactional disequilibrium between markets and suggested that the
sustainability of entry depends on factors such as national characteristics,
competitive rivalry, and demand conditions in host markets (Porter, 1990 cited
in Davis, Desai and Francis, 2000 ). However, companies not sharing resources
and competencies may lack essential economies to effect successful direct entry
(Brown, Dev, CS & Zhou, 2003). The firms may gain efficiencies in acquiring
and implementing market specific knowledge if they access local provider’s
knowledge and technology base. In effect, such firms gain access to
complementary resources and skills, such as reputation, distribution and access
to customers that help eliminate or reduce cultural, technical and economic barriers.
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