3.7: Participating in the Global Marketplace
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6. How do companies enter the global marketplace?
Companies decide to “go global” for a number of reasons. Perhaps the most urgent reason is to earn additional profits. If a firm has a unique product or technological advantage not available to other international competitors, this advantage should result in major business successes abroad. In other situations, management may have exclusive market information about foreign customers, marketplaces, or market situations. In this case, although exclusivity can provide an initial motivation for going global, managers must realize that competitors will eventually catch up. Finally, saturated domestic markets, excess capacity, and potential for cost savings can also be motivators to expand into international markets. A company can enter global trade in several ways, as this section describes.
Exporting
When a company decides to enter the global market, usually the least complicated and least risky alternative is exporting , or selling domestically produced products to buyers in another country. A company, for example, can sell directly to foreign importers or buyers. Exporting is not limited to huge corporations such as General Motors or Apple. Indeed, small companies typically enter the global marketplace by exporting. China is the world’s largest exporter, followed by the United States. 31 Many small businesses claim that they lack the money, time, or knowledge of foreign markets that exporting requires. The U.S. Small Business Administration (SBA) now offers the Export Working Capital Program, which helps small and medium-size firms obtain working capital (money) to complete export sales. The SBA also provides counseling and legal assistance for small businesses that wish to enter the global marketplace. Companies such as American Building Restoration Products of Franklin, Wisconsin, have benefited tremendously from becoming exporters. American Building is now selling its chemical products to building restoration companies in Mexico, Israel, Japan, and Korea. Exports account for more than 5 percent of the firm’s total sales.
Plenty of governmental help is available when a company decides to begin exporting. Export Assistance Centers (EAC) provide a one-stop resource for help in exporting. Over 700 EACs are placed strategically around the country. Often the SBA is located in the same building as the EAC. The SBA can guarantee loans of $50,000 to $100,000 to help an exporter grow its business. Online help is also available at http://www.ustr.gov . The site lists international trade events, offers international marketing research, and has practical tools to help with every step of the exporting process. Companies considering exporting for the first time can go to http://www.export.gov and get answers to questions such as: What’s in it for me? Am I ready for this? What do I have to do? The site also provides a huge list of resources for the first-time exporter.
Licensing and Franchising
Another effective way for a firm to move into the global arena with relatively little risk is to sell a license to manufacture its product to a firm in a foreign country. Licensing is the legal process whereby a firm (the licensor ) agrees to let another firm (the licensee ) use a manufacturing process, trademark, patent, trade secret, or other proprietary knowledge. The licensee, in turn, agrees to pay the licensor a royalty or fee agreed on by both parties.
International licensing is a multibillion-dollar-a-year industry. Entertainment and character licensing, such as DVD movies and characters such as Batman, is the largest single category. Trademarks are the second-largest source of licensing revenue. Caterpillarlicenses its brand for both shoes and clothing, which is very popular in Europe.
U.S. companies have eagerly embraced the licensing concept. For instance, Labatt Brewing Company has a license to produce Miller High Life in Canada. The Spalding Company receives more than $2 million annually from license agreements on its sporting goods. Fruit of the Loom lends its name through licensing to 45 consumer items in Japan alone, for at least 1 percent of the licensee’s gross sales.
The licensor must make sure it can exercise sufficient control over the licensee’s activities to ensure proper quality, pricing, distribution, and so on. Licensing may also create a new competitor in the long run if the licensee decides to void the license agreement. International law is often ineffective in stopping such actions. Two common ways that a licensor can maintain effective control over its licensees are by shipping one or more critical components from the United States and by locally registering patents and trademarks in its own name.
Franchising is a form of licensing that has grown rapidly in recent years. Many U.S. franchisors operate thousands of outlets in foreign countries. More than half of the international franchises are for fast-food restaurants and business services. McDonald’s, however, decided to sell its Chinese stores to a group of outside investors for $1.8 billion, but retained 20 percent of the equity. 32
Having a big-name franchise doesn’t always guarantee success or mean that the job will be easy. In China, Home Depot closed its stores after opening 12 to serve the large Chinese population. Had they done market research, they would have known that the majority of urban dwellers live in recently built apartments and that DIY (Do It Yourself) is viewed with disdain in Chinese society, where it is seen as a sign of poverty. 33 When Subway opened its first sandwich shop in China, locals stood outside and watched for a few days. Patrons were so confused that the franchisee had to print signs explaining how to order. Customers didn’t believe the tuna salad was made from a fish because they couldn’t see the head or tail. And they didn’t like the idea of touching their food, so they would hold the sandwich vertically, peel off the paper wrap, and eat it like a banana. Most of all, the Chinese customers didn’t want sandwiches.
It’s not unusual for Western food chains to adapt their strategies when selling in China. McDonald’s, aware that the Chinese consume more chicken than beef, offered a spicy chicken burger. KFC got rid of coleslaw in favor of seasonal dishes such as shredded carrots or bamboo shoots.
Contract Manufacturing
In contract manufacturing , a foreign firm manufactures private-label goods under a domestic firm’s brand. Marketing may be handled by either the domestic company or the foreign manufacturer. Levi Strauss, for instance, entered into an agreement with the French fashion house of Cacharel to produce a new Levi’s line, Something New, for distribution in Germany.
The advantage of contract manufacturing is that it lets a company test the water in a foreign country. By allowing the foreign firm to produce a certain volume of products to specification and put the domestic firm’s brand name on the goods, the domestic firm can broaden its global marketing base without investing in overseas plants and equipment. After establishing a solid base, the domestic firm may switch to a joint venture or direct investment, explained below.
Joint Ventures
Joint ventures are somewhat similar to licensing agreements. In a joint venture , the domestic firm buys part of a foreign company or joins with a foreign company to create a new entity. A joint venture is a quick and relatively inexpensive way to enter the global market. It can also be very risky. Many joint ventures fail. Others fall victim to a takeover, in which one partner buys out the other.
Sometimes countries have required local partners in order to establish a business in their country. China, for example, had this requirement in a number of industries until recently. Thus, a joint venture was the only way to enter the market. Joint ventures help reduce risks by sharing costs and technology. Often joint ventures will bring together different strengths from each member. In the General Motors-Suzuki joint venture in Canada, for example, both parties have contributed and gained. The alliance, CAMI Automotive, was formed to manufacture low-end cars for the U.S. market. The plant, which was run by Suzuki management, produces the Chevrolet Equinox and the Pontiac Torrent, as well as the new Suzuki SUV. Through CAMI, Suzuki has gained access to GM’s dealer network and an expanded market for parts and components. GM avoided the cost of developing low-end cars and obtained models it needed to revitalize the lower end of its product line and its average fuel economy rating. After the successful joint venture, General Motors gained full control of the operation in 2011. The CAMI factory may be one of the most productive plants in North America. There GM has learned how Japanese automakers use work teams, run flexible assembly lines, and manage quality control. 34
Direct Foreign Investment
Active ownership of a foreign company or of overseas manufacturing or marketing facilities is direct foreign investment . Direct investors have either a controlling interest or a large minority interest in the firm. Thus, they stand to receive the greatest potential reward but also face the greatest potential risk. A firm may make a direct foreign investment by acquiring an interest in an existing company or by building new facilities. It might do so because it has trouble transferring some resources to a foreign operation or obtaining that resource locally. One important resource is personnel, especially managers. If the local labor market is tight, the firm may buy an entire foreign firm and retain all its employees instead of paying higher salaries than competitors.
Sometimes firms make direct investments because they can find no suitable local partners. Also, direct investments avoid the communication problems and conflicts of interest that can arise with joint ventures. IBM, in the past, insisted on total ownership of its foreign investments because it did not want to share control with local partners.
General Motors has done very well by building a $4,400 (RMB 29,800) minivan in China that gets 43 miles per gallon in city driving. The Wuling Sunshine has a quarter the horsepower of U.S. minivans, weak acceleration, and a top speed of 81 miles per hour. The seats are only a third of the thickness of seats in Western models, but look plush compared to similar Chinese cars. The minivans have made GM the largest automotive seller in China, and have made China a large profit center for GM. 35
Walmart now has over 6,000 stores located outside the United States. In 2016, international sales were over $116 billion. About one-third of all new Walmart stores are opened in global markets. 36
Not all of Walmart’s global investments have been successful. In Germany, Walmart bought the 21-store Wertkauf hypermarket chain and then 74 unprofitable and often decrepit Interspar stores. Problems in integrating and upgrading the stores resulted in at least $200 million in losses. Like all other German stores, Walmart stores were required by law to close at 8 p.m. on weekdays and 4 p.m. on Saturdays, and they could not open at all on Sundays. Costs were astronomical. As a result, Walmart left the German retail market.
Walmart has turned the corner on its international operations. It is pushing operational authority down to country managers in order to respond better to local cultures. Walmart enforces certain core principles such as everyday low prices, but country managers handle their own buying, logistics, building design, and other operational decisions.
Global firms change their strategies as local market conditions evolve. For example, major oil companies like Shell Oil and ExxonMobilhad to react to dramatic changes in the price of oil due to technological advances such as more efficient automobiles, fracking, and horizontal drilling.
MANAGING CHANGE
Managing the Drop in Oil Prices
In 2014, crude oil was $90 a barrel, but increased production due to the shale oil boom and the reluctance of OPEC countries to reduce output led to a price drop to $45–$60 throughout the first quarter of 2015. While this is terrific news for consumers, it does provide challenges to managers at both large and small companies connected to the oil industry. Companies such as Chevron, Royal Dutch Shell, and ExxonMobil saw dramatic reductions in their earnings, which were also reflected in lower stock prices.
The action taken by senior executives at Chevron was to trim their planned capital expenditures by $5 billion in 2016, resulting in the elimination of 1,500 jobs, while ExxonMobil executives Jeff Woodbury and CEO Rex Tillerson (now the former U.S. Secretary of State) were less specific; they planned several belt-tightening strategies and forecast several years of low oil prices. Likewise, Ben van Beurden, the CEO of Royal Dutch Shell, announced plans to eliminate 6,500 jobs and also predicted long-range low prices for oil.
In addition to layoffs, actions that oil company managers can employ include mergers for companies that don’t have the ability to become fully efficient themselves. They can merge with other companies that can improve overall efficiencies and operations. Contrary to the cost-cutting plans mentioned earlier, some companies might consider increasing their spending plans. Going against the reduced expenditures trend is Encana, a North American oil producer, which plans to increase its overall spending. Some of the factors that allowed Encana to increase spending was its low debt-to-equity ratio and its growth, which exceeded the industry average.
Growth is an important component of a company’s strategy, and reactive short-term strategies can often hurt long-term growth. By implementing performance-improvement programs, companies can address problems and inefficiencies within the company and allow them to focus on innovation. Another strategy that companies can use is to review and alter their supply chain by focusing on costs and efficiency. Companies can expand their supplier base, thus increasing competition and reducing costs. This also requires companies to embrace a lean manufacturing mindset.
New technology can also be used as a cost driver. New technologies such as microseismic sensors used to monitor fracking operations in drilling operations miles under the earth can boost production. Adopting new technology can also lead to changes in the workers that companies employ. New technology usually requires higher-skilled workers, while reducing the number of lower-skilled workers.
The drop in oil prices has produced a survival-of-the-fittest competition among energy companies. The companies that employ multiple strategies to improve efficiency are the ones that will survive and prosper.
Critical Thinking Questions
- Do you think that Royal Dutch Shell and ExxonMobil would have been more successful if they had considered strategies other than cutting spending and eliminating jobs? Why or why not?
- How should oil companies react if oil prices rise to the $90 to $100 per barrel level? Explain your reasoning.
Sources: Stanley Reed and Clifford Krauss, “Royal Dutch Shell Profits Continue to Fall, Prompting Layoffs,” The New York Times , http://www.nytimes.com , July 30, 2015; John Biers, “More Belt-tightening Ahead as Exxon, Chevron Profits Dive,” Yahoo! News , https://www.yahoo.com , July 31, 2015; Aisha Tejani, “How Oil Companies Are Responding to the Oil Price Drop,” http://www.castagra.com , accessed June 30, 2017.
Countertrade
International trade does not always involve cash. Today, countertrade is a fast-growing way to conduct international business. In countertrade , part or all of the payment for goods or services is in the form of other goods or services. Countertrade is a form of barter (swapping goods for goods), an age-old practice whose origins have been traced back to cave dwellers. The U.S. Commerce Department says that roughly 30 percent of all international trade involves countertrade. Each year, about 300,000 U.S. firms engage in some form of countertrade. U.S. companies, including General Electric, Pepsi, General Motors, and Boeing, barter billions of goods and services every year. Recently, the Malaysian government bought 20 diesel-powered locomotives from China and paid for them with palm oil.
CONCEPT CHECK
- Discuss several ways that a company can enter international trade.
- Explain the concept of countertrade.