McGraw-Hill/Irwin International Management © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. International Management Phatak, Bhagat, and Kashlak

McGraw-Hill/Irwin International Management © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 7 Modes of Entry into Foreign Markets

7-3 Learning Objectives Understand the different modes of entry into foreign markets. The advantages, disadvantages, and risks in various entry modes. Explain why controlling of foreign operations is important for an international company. Explain the equity based and non-equity based control mechanisms. Understand the non-equity entry modes such as licensing, franchising, and management service contracts, and their differences. Explain the factors that influence the choice of entry modes.

7-4 Chapter Topics Environmental Influences on the Foreign Entry Decision Mode Exporting Countertrade Contract Manufacturing Licensing Franchising Management Service Contracts Turnkey Projects Equity-Based Ventures Through Foreign Direct Investment Theory of Multinational Investment

7-5 Modes of Entry into Foreign Markets Exporting Countertrade Contract Manufacturing Licensing Franchising Management Service Contracts Turnkey Projects Non-Equity Strategic Alliances Equity-based Joint Ventures Wholly-Owned Subsidiaries

7-6 Fig 7-1: Foreign Mode of Entry Choices Decision to Internationalize Wholly-Owned International Choices Cooperative International Choices Acquisition Equity Joint Ventures Non-Equity Strategic Alliances/ Licensing Contracts Greenfield Investment

7-7 Countertrade Arrangements whereby the flow of goods or services in both directions is an integral element of the specific terms of the business transaction

7-8 Contract Manufacturing and Licensing Contract Manufacturing A contractual agreement between a company and a foreign producer under which the foreign producer manufactures the company’s product Licensing The international company, or licensor, agrees to make available to another company abroad, the licensee, use of its patents and trademarks, its manufacturing processes and know-how, its trade secrets, and its managerial and technical services. In exchange, the foreign company agrees to pay the licensor a royalty or other form of payment according to a schedule agreed upon by the two parties

7-9 Fig 7-2:Licensing as a Foreign Entry Choice Licensing In Foreign Countries Cost AdvantageRisk Deflection Revenue SourceKnowledge Source Profit- driven Rationale Strategic Rationale

7-10 What the Licensor Delivers to the Licensee in Complex Licensing Agreements A patented product or service A trademark or trade name Manufacturing techniques Proprietary rights generally referred to as company or industry know-how Supply by the licensor to the licensee of components or equipment Technical advice and services of various sorts Marketing advice and assistance of various sorts Capital and/or managerial personnel

7-11 Fig 7-3: Concerns of Foreign Licensing Control  Technology  Production  Quality Licensing In Foreign Countries Licensee- Related  Competitive Positioning  Partner Selection  Partner “Cheating” Strategic Fit  Long-Term Coordination  Long-Term Configuration

7-12 Table 7-1 Foreign Licensing: Factors for Success and Failure Factors Leading to Success 1. Choice of reliable and competent partner 2. Inherent value of patent, trademark or know-how licensed 3. Goal congruence with partner 4. Some participation in ownership 5. Close personal contact with licensee 6. Appropriate level of control by licensor 7. Reputation of licensor and licensed asset 8. Sales assistance to licensee 9. Support of licensor’s top management 10. Flexibility by both partners 11. Correct timing and pacing of activity 12. Detailed spelling out of contract obligations and responsibilities 13. Effective coordination with other parts of licensor’s overseas activities 14. Thorough research and market knowledge Factors Leading to Failure 1. Inadequate market analysis by licensor 2. Higher start-up costs than anticipated by licensee 3. Insufficient attention paid to activity by top management of licensor 4. Poor timing 5. Lack of goal congruence with partner 6. Unanticipated competition from home, host and third country competitors 7. Inadequate licensee after sales effort 8. Partner rigidity 9. Insufficient marketing effort by both licensor and licensee 10. Weak licensee market research 11. Lack of fit with other licensor activities 12. Lack of sales assistance to licensee

7-13 Questions to be Asked in a Licensing Contract How many patents, processes, or trademarks will be used? How will technical assistance be rendered? Which products are included in the agreement, and to what extent? What territory is to be covered by the license? How should the licensee be compensated? The currency in which payments will be made to the licensor What happens if compensation cannot be paid by the licensee? If sublicensing is permitted, how should it be carried out? Geographical limitations on the marketing of the licensed product or service What are the provisions as to duration of the agreement and its cancellation? What rights does the licensor have in developments by the licensee?

7-14 Questions to be Asked … (contd.) What visitation and inspection privileges are held by the licensor? Can the parent company inspect accounts? What provisions are there for satisfactory promotional/sales performance and adequate quality control? What home and host government approvals are required? What tax factors are involved? How will disputes be settled?

7-15 Areas Covered in a Franchise Agreement 1.A detailed list of issues to consider regarding the cost of the franchise 2.A detailed list of issues to consider regarding the location of the franchise 3.A detailed list of issues pertaining to the buildings, equipment and supply terms 4.A detailed list of issues pertaining to the operating practices terms

7-16 Table 7-2: Type and Degree of Parent Company Control over Foreign Operations Mode of EntryStrong ControlWeak ControlNon-Existent Control Contract Manufacturing AB,C,D Licensing DCA,B Franchising DCA,B Management Service Contract DA,CB Joint Venture DA,B,C Wholly-owned Subsidiary A,B,C,D A = Daily Management Control B = Control over Physical assets C = Control over Tacit Expertise and Knowledge D = Control over Codified assets

7-17 Table 7-3: Characteristics of Entry Modes Type of Entry Mode Degree of Control Systemic RiskDissemination Risk Resource Commitment ExportLow CountertradeLow Contract Manufacturing Medium Low to Medium Low LicensingLow HighLow FranchisingLow to Medium LowMediumLow

7-18 Table 7-3 (contd.) Type of Entry Mode Degree of Control Systemic RiskDissemination Risk Resource Commitment Management Service Contract MediumLowMediumLow TurnkeyLow Equity-based Entry: Joint Venture Medium-High Equity-based Entry: Wholly- owned Subsidiary High LowHigh

7-19 Determinants of Foreign Mode of Entry Firm Size Multinational Experience Industry Growth Global Industry Concentration Technical Intensity Advertising Intensity Country Risk Cultural Distance Market Potential

7-20 Determinants … (contd.) Market Knowledge Value of Firm Specific Assets Contractual Risk Tacit Nature of Know-How Venture Size Intent to Conduct Joint R&D Global Strategic Motivation Global Synergies

7-21 Table 7-4: A Representation of the O-L-I Theory of FDI OwnershipLocation Advantage Internalization ExportXX Contractual/Licensing, etc. XX Wholly OwnedXXX

7-22 Key Terms and Concepts Licensing Franchising Management service contracts Systemic risk Dissemination risk Ownership advantage Locational advantage Internalization