Selecting international modes of entry and expansion

Topic: BusinessComparative Analysis
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Last updated: April 20, 2019

The rapid globalization of business in the last two decades has prompted an increasing number of firms to develop strategies to enter and expand into markets outside their home locations. Dynamic, emerging markets in Asia and Latin America, as well as large, stable markets in North America, Europe, and Japan now attract both small and large companies from around the world. But once a firm has decided to enter or expand in a foreign market, it must determine the structural nature of its operations in that nation.Recognizing the huge potential market size, a US firm in the pharmaceutical industry recently decided to make a major new thrust into China.

A manager from the company stated: We wanted to export several lines of pharmaceuticals into China. However, their government wanted us to manufacture within the country in some kind of cooperative arrangement with a local firm … Technology transfer for market share is the name of the game. So we decided to set up a joint venture with a local firm.

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Selecting an institutional arrangement – a mode for entering or expanding in a foreign market – is one of the most crucial strategic decisions that an international firm has to make (Root, 1994). A well-chosen mode can enable a firm to gain competitive advantage. However, inappropriate modal decisions are difficult to change when long-term contracts and/or large resource commitments are made. Poor modal choices can lead to “sinking the boat” or “missing the boat” (Dickson and Giglierano, 1986). For example, a firm’s core technology can be unwillingly lost to competitors in certain “cooperative” modes.At the same time, some contractual modes of entry can prevent a company from taking full advantage of large market growth. Careful assessment of these trade-offs is essential in today’s global economy. The USA and Japan are the two largest national players in international business.

In many markets, such as the European Union, companies from these two nations are primary competitors. However, firms from these two nations differ in both the patterns of institutional arrangements they prefer and the factors that affect their choice of foreign market entry mode.In the 1950s and 1960s the USA was the dominant exporter and direct investor in the world. Japan became a major international competitor in the 1970s, as its exports surged. Its large exporting firms included Sony and Matsushita in consumer electronics and Toyota in automobiles.

In the 1970s firms from both nations primarily relied on exporting to serve foreign markets; however, the USA also had extensive numbers of overseas manufacturing sites. Japan used little foreign direct investment (FDI).The 1980s was the first decade in which Japanese firms chose to enter and expand in foreign nations via FDI on a large scale, rather than just using exports from Japan (Nakamura, 1991). Dramatic surges in Japanese FDI in the latter half of the 1980s led to some resentment and fear in both the USA and Europe, particularly when well known local firms, such as CBS Records and Columbia Pictures, were acquired by Japanese companies (Business Week, 1991). New Japanese FDI slowed in the 1990s, but economic data still reveal the strong position that Japanese firms hold in both exporting and direct investment.In 1995 the USA exported $576 billion in goods (and $219 billion in services), while Japan exported $443 billion in goods (US DOC, November 1997).

In outward FDI the USA made new investments of $91 billion and Japan’s new outward FDI amounted to $51 billion in 1995 (US DOC, July 1997). Although previous studies have revealed some differences in the modes of entry that US and Japanese companies use to enter new markets (Anand and Delios, 1996; Nitsch et al. 1995; Sohn, 1994), more insight on the different factors and strategies that affect the modal choices of companies from these two leading nations is needed.As the important factors are uncovered, veteran and novice international managers may discover important conditions or issues to consider when making critical entry mode decisions. Because US and Japanese firms are often major competitors in foreign markets, gaining insights into the thought processes of national competitors may also be useful to managers and researchers in understanding and predicting their modal choices. This article identifies and compares the most influential factors that affect the international modes of entry and expansion decisions of US and Japanese firms.

Rather than just using secondary economic data, this is one of the first studies to survey executives in both Japan and the USA regarding their entry mode choices. This method enables us to uncover some of the thought processes and reasoning of global managers from the two nations. We found that there are some important differences that can help managers learn how to better determine modal choices. Target market factors are generally more important to Japanese firms than company factors; whereas, company factors seem most important to US firms, when making modal choices.In this article we first discuss the modal alternatives. Then we describe our research approach and results. We conclude with a discussion of the key findings and their implications for managers. Modes of entry and expansion Firms that are beginning to internationalize and multinational companies that are expanding in nations outside their home base are both faced with the challenge of choosing the best structural arrangement.

Four major alternatives are exporting, licensing, joint ventures, and wholly-owned subsidiaries (Root, 1994).Exporting differs from the other modes in that a company’s final or intermediate product is manufactured outside the target country and subsequently transferred to it. Indirect exporting uses intermediaries who are located in the company’s home country and who take responsibility to ship and market the products. With direct exporting the producer firm does not use home country middlemen, although it may utilize target country intermediaries. Boeing is one of the largest direct exporters in the world, manufacturing most of its aircraft within the USA, but selling the majority of its planes in other nations.Licensing is a non-equity, contractual mode with one or more local partner firms. A company transfers to a foreign organization the right to use some or all of the following property: patents, trademarks, company name, technology, and/or business methods. The licensee pays an initial fee and/or percentage of sales to the licensor.

For example, Borden set up a licensing agreement with Meiji Milk to produce and market dairy products in Japan. Joint ventures and wholly-owned subsidiaries entail direct investment in business sites in the target country.Joint ventures involve two or more organizations that share the ownership, management, risks, and rewards of the newly formed entity. Each partner contributes equity that may take the form of money, plant and equipment, and/or technology.

For example, Matsushita established a joint venture with Philips in Belgium to produce batteries. Wholly-owned operations are subsidiaries in another nation in which the parent company has full ownership and sole responsibility for the management of the operation. Japanese automobile manufacturers are well known for their use of wholly-owned subsidiaries in the USA in the late 1980s and 1990s (Sohn, 1994).Toyota is establishing a site in Indiana to manufacture and market four-wheel drive vehicles in the USA. Although Toyota’s new Indiana plant is a greenfield investment, international firms may also acquire and utilize existing manufacturing sites as a mode of entry or expansion. These four entry modes may be differentiated according to three characteristics of the modes that have been identified in previous research (Maignan and Lukas, 1997; Woodcock et al. , 1994): 1 quantity of resource commitment required; 2 amount of control; 3 level of technology risk.Figure 1 illustrates the relationships between these elements and the entry modes.

Resource commitments are the dedicated assets that cannot be employed for other uses without incurring costs. Resources may be intangible, such as managerial skills, or tangible, such as machines and money. The amount of required resources varies dramatically with the entry mode, ranging from almost none with indirect exporting, to minimal training costs in licensing, to extensive investments in facilities and human resources in wholly-owned subsidiaries.Control is the ability and willingness of a firm to influence decisions, systems, and methods in foreign markets. In a franchise type of licensing agreement, control over the operations is granted to the franchisee in exchange for some type of payment and for the promise to abide by the terms of the contract. Thus, the licensor has little direct control. In a joint venture control is shared formally according to level of ownership, as when equity ownership over 50 percent gives one of the partners the largest number of directors on the board.

However, informal control mechanisms may also be exerted as when one partner possesses and uses knowledge and information that the other lacks. Wholly-owned subsidiaries are attractive to many companies because this mode enables the MNC to exert the most control in decision-making. Technology risk is a third parameter of modal forms and decision-making.This concept can be defined as the potential that a firm’s applied knowledge (tangible and/or intangible) will be unintentionally transferred to a local firm. Some managers have referred to these undesired losses of technology as “bleedthroughs. In a licensing agreement, the risk of the licensee reproducing and using the licensor’s technology in the future is fairly high. Joint venture partners may also learn and acquire unspecified elements of the other firm’s technology in the context of their partnership.

Technology risk is probably lowest in a wholly-owned subsidiary, since the operations are under the control of only one firm. Resource commitment, control, and technology risk are highly correlated (Woodcock et al. , 1994). For example, as implied above, increased control leads to lower technology risk.Yet, control also requires increased resource commitment. Some researchers have argued that the entry mode decision consists mainly of determining the levels of resource commitment, control, and technology risk that the international entrant desires or can accept (Maignan and Lukes, 1997; Woodcock et al. , 1994).

Since each mode has a certain level of each factor, the entry decision can seem clear cut. In practice, the entry mode decision is highly complex. Besides the previously discussed qualities of each mode, there are a host of target market factors and within company factors that may affect decision-making.Certain antecedent conditions affect whether to use, say, a high control mode or a method that requires few resources.

We designed a study to determine which factors are most important to managers of international firms in both the USA and Japan. Research approach To accomplish our objectives, two methods of data collection were utilized. First, we sent a mail survey to the CEO/President of 1,024 US manufacturing firms and 1,189 Japanese manufacturing companies that were doing international business. The US version of the questionnaire was printed in English and the version sent to Japan was printed in Japanese.A team of Japanese linguists translated and back-translated the survey to help ensure that the data from Japan were reliable. Eliminating undeliverable and unusable surveys, we received 165 responses from the USA and 178 from Japan for an effective response rate of 18 percent for the US sample and 17. 4 percent for the Japanese sample.

For both the US and Japanese samples, t-tests indicate that responding firms are not statistically different from nonresponding ones, based on either average annual sales or average number of employees. Thus, it can be concluded that there is no evidence of nonresponse bias.Second, we conducted personal interviews in 12 multinational companies with 21 managers who were responsible for international mode of entry decisions. These interviews were used as follow up validation and to provide specific illustrations. In the survey 63 items that measured an array of factors that may affect modal choices were included. Previous research has suggested a number of target market and company factors that may play a role in the selection of particular modes of entry (Aulakh and Kotabe, 1997; Erramilli and Rao, 1993; Kim and Hwang, 1992; Kumar and Subramaniam, 1997; Root, 1994).

The target market factors include elements related to risk, competition, host government involvement, culture, partner availability and market size. Company factors include aspects concerning the organization’s experience, resources/needs, and strategy. In the analysis of the results, the ten items with the highest means associated with each mode were identified for both the Japanese sample and the US sample. Then, any items that were listed among all of the four modes were eliminated, since the objective of the study is to uncover factors that affect the choice of one mode over another.An example of an eliminated item is “large potential market size. ” Across each of the modes, managers apparently were motivated to enter the market due to the large potential size. Thus, that factor appears to be important in the overall decision of whether to enter a foreign market, but it does not appear to have major influence on the choice of one form of entry over another. For each of the four modal alternatives – exporting, licensing, joint ventures, and wholly-owned subsidiaries, a set of important factors emerged that distinguished the use of one mode from another.

The following section discusses the major findings of our study. Differences in what is most important to US and Japanese managers will be highlighted. Important factors affecting entry mode choices Knowing the factors that were central considerations in the modal choices made by other companies can improve a firm’s strategies and decision-making. Understanding why certain factors are associated with particular entry mode choices can be useful in developing and predicting international strategies. In our sample, exporting was the most frequently used mode of entry into a foreign country.

However, when combined, the investment modes of joint ventures and wholly-owned subsidiaries were used even more than exporting. Licensing was the least frequently chosen mode. Each manager evaluated the relative importance of a large set of factors that may have affected his/her decision to use a particular mode. The following section analyzes the decisions to select exporting, licensing, joint ventures, and wholly-owned subsidiaries.

Differences between US and Japanese decision-making are highlighted in the discussion of key factors associated with the choice of each modal form.

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