14.2 Modes of Entry into a Foreign Market

The selection of the market entry mode is the final and most important step in the international business decision-making process. The selection of the entry mode depends on company readiness factors, which were discussed in Chapter 9. They are the firm’s competitive capabilities, experience and training, skills and knowledge, resources, motivation for going international, and the commitment of owners and managers.

There are many modes of entry from which to select, such as exporting, licensing, franchising, joint ventures, and wholly owned subsidiaries.

Exporting

Most firms begin their international market expansion by exporting – selling their product or services either directly or indirectly in an international market. Exporting is considered a low-risk and cost-effective entry mode.

It involves selling goods or services to customers across international borders. This can be done either by setting up the company’s own selling program or by using local distributors through contractual agreements, where the local distributors will help with the delivery process and can play a role in marketing the goods and after-sales services.

• Advantages – exporting allows companies to avoid substantial costs associated with establishing manufacturing operations in the host country. Exporting may also help a company achieve economies of scale (see Chapter 9) by increasing its sales volume in the global market.
• Disadvantages – there are a number of disadvantages to exporting. First, high supply chain costs and tariffs can make exporting expensive. Second, by delegating work to local distributors, the company has less control over product delivery and marketing of the product. Third, the firm also doesn’t have access to direct feedback from the customer, and that makes it difficult to customize their products and services to local preferences and tastes.

Licensing

An international licensing agreement is an arrangement between two parties whereby a producer company (licensor) allows a foreign company (licensee) to sell its products in exchange for royalty fees. The licensing agreement, therefore, allows the licensee to use the licensor’s property for the duration of the agreement. This property is usually intangible property such as trademarks, patents, and production techniques.

• Advantages – the licensor is not responsible for the costs and risks associated with the foreign venture.
• Disadvantages – licensing offers very moderate returns and involves the loss of control over property.

Franchising

Replicating a business model is called franchising. Like licensing, franchising requires a limited-time agreement between a franchisor and a franchisee. But unlike in a licensing agreement, the franchisee not only pays royalty fees but also agrees to abide by strict rules as to how it does business. The franchisor often helps the franchisee with business operations on an ongoing basis. Royalty fees are paid based on revenue earned by the franchisee. While licensing is pursued mainly in manufacturing firms, franchising is mainly pursued by service firms.

• Advantages – The franchisor is relieved of costs and risks associated with setting up the franchise in the foreign market. Instead, the franchisee assumes all setup and operating costs, which creates a good incentive for the franchisee to run the operations efficiently and become profitable.
• Disadvantages – The main disadvantage of franchising is quality control. The very essence of franchising is delivering the same service and experience to a consumer, no matter where and in which country it is located. This level of quality may not be easy to achieve when a company is operating in foreign countries, especially when the franchisee in another country is not committed to delivering the same level of quality service.

Joint Venture

This strategy is used to share risk and cost when expanding to an international market. A joint venture is when two companies agree to work together and create an independently managed third company in a market, either geographic or product. The agreement could be based on an equal stake, minority stake, or controlling stake. In some countries, foreign companies are required to create a joint venture with local companies.

• Advantages – there are a number of advantages to joint ventures.
  • First, the company can benefit from the local partner’s knowledge of market conditions and competition, culture and language, political system, and social environment.
  • Second, a joint venture eliminates the need to start from scratch in a new market, which can be risky, especially if the project is capital-intensive.
  • Third, having a local partner gives some protection against political unrest and government policy changes. Many policy changes may not apply to local business owners.
• Disadvantages – the major disadvantage of a joint venture is loss of control over technology. Another disadvantage of the joint venture is that it does not give the firm tight control over its operations to increase the efficiency or sales volume and realize economies of scale, which can then result in gaining a competitive advantage over rivalry.

Wholly Owned Subsidiaries

In this mode of entry, the firm owns 100 percent of the subsidiary. Wholly-owned subsidiaries can be formed in two ways: acquisition, where the firm can acquire an already established firm in the host country and integrate its product into that firm. Or greenfield venture, where the firm sets up the operation from the ground up and builds a brand-new operation system. We will look at both forms in detail separately.

• Advantages – there are several advantages associated with wholly owned subsidiaries. For firms that use technology as their main competitive advantage, the wholly owned subsidiary mode provides protection for and reduces the risk of losing control over their proprietary product. This form of entry is popular among high-tech firms. Another advantage of wholly-owned subsidiaries is keeping control over their operations, which gives firms the opportunity to achieve economies of scale, reduce costs, and increase their profit.
• Disadvantages – this mode requires heavy capital investment in the foreign market and is not the most cost-effective way of entering a market. Businesses also have to learn cultural ways of doing business in the host country and that could be challenging and costly as well (see Chapter 13).

Acquisition

Acquisition is a strategy where a firm gains control of another firm by purchasing its stock or by outright purchasing the company.  Which option they take depends on whether the firm is public or private. The acquisition strategy is appealing because it helps a firm establish its presence rapidly by integrating its operations with the firm in the target market. As much as the integration of operations provides firms with access to the already established customer base and business network, the process of cultural integration between two firms from different countries can pose a challenge. A cultural clash between the acquiring and the acquired firm may result in high management and employee turnover. This loss of expertise in an international business can be harmful to the performance of the acquired firm, as it is difficult to find replacements for those who have local knowledge.

Greenfield Venture

Greenfield venture is a strategy where a firm builds a subsidiary from the ground up and establishes a brand-new operation in the host country. This type of venture is often costly, but it gives the company maximum control and offers high returns. Greenfield venture also gives organizations the ability to build their culture and operation routines from scratch. It is easier to build from scratch in this new venture than to convert the culture and operating routine of an acquired firm. The challenge with greenfield ventures is that it takes time to establish itself and generate revenue.

Attributions

“14.2 Modes of Entry to a Foreign Market” is adapted from the following:

• “ 7.1 International Entry Modes ” from Core Principles of International Marketing by Babu John Mariadoss, licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.
• “6.1 International Entry Modes” from Global Marketing In a Digital World by Lina Manuel, licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.