12.4: The Necessity of Global Markets
Learning Objective
- Why might it be necessary for a company to go international, and how might it accomplish this goal?
In this section, we explore some of the methods companies can use to go international and how they might implement them. As we have seen so many times before, each method for entering international markets has its advantages and disadvantages, and it is up to the international management team to figure out which is most suitable for its company and for the countries in which it operates.
Reasons for Internationalization
Before we get into how companies can go international, let’s look at why a company might want to expand internationally in the first place. Because navigating cross-cultural environments is fraught with dangers but holds the possibility of great success, we must understand the compelling reasons to go international.
Trade Facilitation
At a basic level, relying on a domestic market can be problematic. Because of the many factors enhancing globalization, companies of all sizes and types want to take advantage of global markets to expand and achieve sustainable competitive advantage. Despite some slowdown in trade, business-to-consumer ecommerce is expected to double to $2.2 trillion over the span 2018 to 2021 due to improvements in IT and the use of the web.
Growth Opportunities
Another critical factor that supports internationalization is that emerging markets such as China, India, Brazil, and Malaysia will continue to grow and present companies with tremendous opportunities. Research from the Boston Consulting Group suggests that such emerging markets experienced growth (as measured by GDP growth rate), surpassing more developed economies by 2.2%. Furthermore, this research predicted that economic growth in emerging markets accounted for 68% of worldwide growth in 2013 despite an economic slowdown. Finally, experts also predict that incomes in emerging markets will continue to rise.
How to Go International: Exporting
Given that it is critical for companies to go global, there are various means that companies can use to do so. The most basic and cost-effective approach is exporting , whereby a company sends its product to an international market and fills the order just as it fills a domestic order. Our earlier example of Dmitrii Dvornikov (who was selling jewelry and table clocks made from Russian semiprecious stones to international customers on Russia’s eBay) is a simple example of exporting. However, companies can also become more involved in the process and have dedicated offices in another country to tackle exports. In fact, some companies may find that exporting is so critical that they create a dedicated export department.
Because exporting is one of the easiest ways to go international, it can bring many benefits. Current research suggests that companies that export tend to be 17% more profitable than companies that don’t. Additionally, exporting provides the ability for companies to defend their markets by becoming more competitive in other markets. Furthermore, by exploring international markets, a company can acquire critical cross-cultural management skills, thereby increasing the value of the company. Consider the case of DeFeet International, a U.S. maker of socks for cyclists. Despite several major disasters during the company’s existence (it burned down in 2006), DeFeet has been able to survive and expand thanks to the global market. The company hired an international marketing manager to get advice on how to develop a market strategy for Europe. Because of its strong research and development, DeFeet International has been able to develop the best socks for cycling. While production still takes place in the U.S., exporting has resulted in distributors in over 35 countries.
Despite the many benefits of exporting, companies are often reluctant to do so. Much of such fear is based on some assumptions about how business is done. For instance, managers often assume that exporting can be too risky, but some argue that selling only to domestic markets is just as risky. Some companies believe that exporting is too cumbersome or that getting paid for exports is too complicated and not worth the time. However, experts believe that exporting is not as complicated and can be easily done through the right channels. Finally, some companies believe that they are too small to export. However, research shows that nearly 30% of all U.S. exporters in 2005 had 19 employees or less. This finding suggests that exporting is a viable strategy, even for small firms. To give you more insights into these assumptions, Table 12.4.1 summarizes some of these myths and counterarguments.
Table \(\PageIndex{1}\): Myths About Exporting and Counterarguments
| Myths | Reality |
| Exporting is risky. | Selling domestically is as difficult as exporting to some markets. Additionally, not all markets are necessarily risky. |
| It is difficult to get paid for exports. | Buying and selling internationally is now fairly routine. There are numerous ways to ensure reliable payment. |
| Exporting is so complicated. | Exporting requires minimal paperwork. It is now very easy to search for buyers using the internet. There are many intermediaries available to help with exports. |
| I can’t succeed because I don’t speak another language. | As mentioned in the chapter, there are many organizations offering help with translation etc. Setting up global websites can be seamless now. |
| My product won’t do well in other markets. | If you do well in the U.S., your product will probably do well in other countries. There are many services available to test the market. |
Solving a Disadvantage of Exporting through Licensing and Franchising
Although exporting is an easy way to go international, it has some disadvantages. Exporting does not give much control to the company in terms of how the product is presented in the international market. For instance, if the company decides to use an international intermediary to sell its product abroad, it is at the mercy of that intermediary. Additionally, exporting sometimes requires travelling and other tasks that may take managers away from domestic activities. In the light of such disadvantages, companies will often resort to licensing.
Licensing is a contractual agreement whereby, in exchange for a royalty or fee, a company gives the right to another company to use a trademark, know-how, or other proprietary technology. Similar to exporting, licensing is an easy way for a company to enter an international market quickly and without the need for laying out much capital. A licensor often has some asset that it can offer to the licensee in exchange for a fee. This asset might include a valuable patent, a trademark, technological know-how, or a company name that the licensor provides to the licensee in return for a payment.
A recent study of European firms’ entry to the Vietnamese market shows that these companies relied on licensing. For instance, consider Haymarket Media, one of the largest publishers in the United Kingdom. Haymarket enters into simple licensing agreements with the local affiliates to provide generic content to all worldwide licensees. This content is similar in all overseas editions of its magazines. However, through this licensing arrangement, the country affiliate adds local content. In this way, Haymarket has been able to increase sales of existing content by selling it in new global markets.
International franchising takes licensing up a notch. Rather than simply license some specific aspect of the value chain, a company will license the complete business model. The business model usually includes trademarks, business organization structures, technologies and know-how, and training. Similar to licensing, the franchisor owns a trademark that the franchisee pays a royalty for. Additionally, the franchisee will usually pay for the right to use the business model of the franchisor.
Many fast food companies have relied on franchising agreements to enter the Indian market. As India has experienced economic growth, more people have greater amounts of disposable income. In addition, because more couples are now busy working, they rely more on fast food as a meal option. Companies such as McDonald’s, KFC, Domino’s Pizza, and Pizza Hut have all entered franchising agreements with local companies to sell their products. This move has proven to be very successful because the franchisors have been able to expand their markets while the franchisees have seen significant profits in the local Indian markets.
Similar to other forms of entry, licensing and franchising have benefits and disadvantages. In terms of benefits, both forms of entry provide the receiving company with an established brand or some other technological know-how that has already proved itself. The recipient of the franchise agreement doesn’t need to build a new reputation but can rely on a well-known international competitor. For the franchisor, this often provides a quick way to expand revenue from an existing business model. Additionally, while licensing and franchising are cost effective ways to go international, the companies granting the license or franchise still retain control over their product. If things don’t work out as planned, the licensor can end the agreement. For the franchisee, an added benefit is that corporate support is provided to help the company succeed.
Disadvantages of Licensing and Franchising
Both licensing and franchising have disadvantages that can affect both the recipient of the agreement and the grantor of the agreement. For instance, a study of Indian entrepreneurs entering into franchise agreements with fast food companies in the United States reported that the master franchisor had too much control. Furthermore, a franchise agreement can be risky and capital intensive for the local companies. For the licensor or franchisor, the biggest disadvantage is that the company can create a new competitor. While the host country laws may dictate the terms of agreement, local enforcement of these laws may not always be strong. Thus, a local company can therefore use the business model for its own purpose. Furthermore, compared to exporting, the licensor gives up additional control. Once the agreement is signed, it is possible for the licensee to sell the product at a lower price or with lower quality. This has the potential to affect reputation of the licensor.
How to Go International: Strategic Alliances
Because of some of the dangers of licensing and franchising, companies can often get even more involved in global operations by engaging in strategic alliances. International strategic alliances occur when two or more companies from different countries enter into an agreement to conduct joint business activities. Strategic alliances are often the preferred means of entry in emerging markets because they make it easier to do business in the country. A strategic alliance is a way for a foreign company to bypass barriers imposed by local governments.
A prominent example of one of the most successful strategic alliances is the one entered into by Nissan and Renault in 1999. In this case, both companies were facing situations in which finding an international partner made sense. Nissan had historically low profitability and needed to find a partner. In contrast, Renault had just ended a failed relationship with Volvo and also needed to expand globally. Furthermore, both companies had what the other partner needed. For instance, Nissan had a strong presence in North America, providing a much-needed boost to Renault’s global ambition. Nissan also had strong engineering abilities that would benefit Renault. In contrast, Renault had ample cash and superior design capabilities, both of which Nissan needed.
The Nissan-Renault example shows some of the benefits of strategic alliances. Strategic alliances often provide both partners with sorely needed skills or capabilities. Strategic alliances also often provide access to new markets and customers. In terms of going global, a company may not always have the necessary know-how or financial assets to enter an international market. Strategic alliances therefore provide the means for a company to spring into the international domain. In that context, China remains an attractive destination for many multinationals. China’s market presents tremendous potential given the increase in disposable income. A recent study sheds some light on the many aspects of entering alliances in China. Figure 12.4.1 therefore provides you with some of the main benefits foreign companies expect to gain from strategic alliances.
Strategic alliances also enable companies to share resources to develop new technologies and make technological advances. This issue is acknowledged by the South Korean government, which encourages South Korean small and medium enterprises to enter into strategic alliances with foreign partners as a way to gain access to advanced technology as well as getting management skills to expand internationally. A recent study examined data from South Korea and found that entering strategic alliances also allowed companies to enjoy higher productivity.
Disadvantages of Strategic Alliances
Despite these advantages, strategic alliances are notorious for high failure rates. A major reason is that strategic alliances are very difficult to manage. Additionally, strategic alliances often present partners with the possibility of acting opportunistically. This can occur when a partner tries to access technological know-how that they were not originally privy too. Alliance partners may also decide to refuse to agree to the original terms of the strategic alliance contracts. Finally, strategic alliances inevitably involve ambiguity and uncertainty. Properly managing such ambiguity is also necessary to avoid disadvantages associated with such alliances.
Managerial Leadership
McDonald’s in India
McDonald’s has had significant success in India. In 1996, it opened its first restaurant. Today, it has over 380 restaurants in India. McDonald’s has been successful because it adequately examined cultural differences and found ways to address cultural challenges. As mentioned earlier, the practice of Hinduism, the dominant religion in India, results in preferences for vegetarian meals. McDonald’s therefore developed many vegetarian menu items while also integrating local foods. It also recognized the very diverse nature of Indian society and offers appropriate regional and local foods in different regions.
To enter the Indian market, McDonald’s entered into strategic alliances with two companies that were responsible for different parts of India. However, despite the success, McDonald’s is currently embroiled in a business war with one of two individuals who helped McDonald’s come to India. In 1996, McDonald’s entered into a 50-50 joint venture with Vikram Bakshi of Connaught Place Restaurants Limited. Over the subsequent decades, Bakshi was able to expand McDonald’s significantly in the east and north of India. However, in 2008, McDonald’s tried to buy back Bakshi’s share for $7 million. Bakshi used evidence from an accounting firm to argue that his share was worth $331 million. In the face of this challenge, McDonald’s had Bakshi fired as an alliance partner in 2013. Baskhi has been fighting McDonald’s in Indian courts. He sued to be reinstated and to be able to run his stores without interference from McDonald’s corporate headquarters. When McDonald’s tried to take Bakshi to the London Court of International Arbitration, he was able to get a local Indian court to agree that he was being subjected to “oppression and mismanagement.” Although another court has agreed to allow McDonald’s to sue Bakshi in London, he is now appealing in another Indian court. This experience has revealed some of the worst fear of multinationals about the dangers of strategic alliances and the need to respect the local courts.
Discussion Questions
- Why did McDonald’s choose to use strategic alliances to enter India? Why not use exporting or other means?
- Why is McDonald’s facing challenges in India? What disadvantages of strategic alliances do these challenges reflect?
- What can McDonald’s do to address Bakshi’s concerns?
- What can McDonald’s do about Bakshi’s use of local Indian courts? How can multinationals adequately prepare for such situations?
How to Go International: Foreign Direct Investment
Given the difficulties associated with strategic alliances, some companies elect to be wholly vested in the host country. This final form of international entry, which we discussed at the beginning of the chapter, is foreign direct investment (FDI) , which occurs when a company invests in another country by constructing facilities and buildings in that country. FDI can also occur through mergers and acquisitions, whereby a multinational company fully acquires a company in another country. Many car companies, such as Toyota, Honda, BMW, and Nissan, have fully operational plants in the United States. For example, many of the BMW SUVs, such as the BMW X3 and X5, are fully built in the BMW plant in Spartanburg, South Carolina.
Why do some companies choose FDI as a means of international entry? For BMW, FDI allows the company to be closer to its customers and to also sell the car as an American car. Additionally, because some countries may impose tariffs on imported products or otherwise discourage imports, building a plant locally allows a company to bypass such restrictions. Furthermore, FDI can also provide access to local expertise or to cheaper costs of labor, both of which can help a company become more competitive through reduced costs.
Disadvantages of FDI
As you might expect, FDI as an entry mode is not without difficulties. While this method gives the company the most control, it is also the most capital intensive. A multinational engaged in FDI is also exposed to the political risk of a country, the degree to which political decisions can impact a business’s ability to survive in that country. For instance, throughout history, countries such as Venezuela have used governmental decrees to appropriate investment from U.S. oil companies. Finally, it is important to note that FDI also involves additional coordination risks and can drain resources from local operations. A company that engages in FDI must be able to coordinate and integrate foreign and domestic operations.
The Incremental Path to Internationalization: The Uppsala Model
The above sections also provided some insights into how some companies can start small (say, with exporting) and eventually have FDI activities in some countries. One of the most popular ways to understand this development path of internationalization is the Uppsala model , which argues that “as firms learn more about a specific market, they become more committed by investing more resources into that market.” In this model, companies adopt an incremental approach to internationalizing. First, they develop a solid domestic market base. After they have a strong domestic foundation, they start exploring international markets and eventually export products to markets that they feel have close psychic distance. Psychic distance refers to the many differences that exist between countries because of language, cultural characteristics, social institutions, and business practices. Countries with close psychic distance are similar to each other in all these variables; those with greater psychic distance are less similar. As a firm continues to gain international experience, it will start exporting to countries with greater psychic distance. As the firm gains even more international experience and knowledge of international markets, it will eventually want to have production facilities in the overseas market.
The Uppsala model has been criticized on many fronts. Experts argue that this approach may oversimplify a very complex process. It is also criticized as being too deterministic because some companies may skip stages. The latter criticism is valid when we consider the case of born globals , companies that operate internationally from the day they are created.
The All-In Approach to Internalization: Born Globals
Born globals are considered key to most countries’ economic development. A recent report suggests that born globals were significant contributors to exports in countries such as Poland and Australia. Additionally, the Organisation for Economic Co-operation and Development (OECD), a leading international organization comprising many of the world’s leading economies, has argued that born globals were key engines that tackled the economic downturn that occurred after the financial crisis of 2007. It is therefore critical for the international management student to understand born globals.
Born globals have been made possible because of the many factors we discussed earlier that are making the world more global: the rapid development and decreasing costs of many types of information technologies have allowed companies to go international from the day they are created. Consider the case of M-PESA, the world’s leading mobile-money company, created in 2007 in Kenya. Because of M-PESA, it is now easier to pay for a taxi ride using your mobile phone in Nairobi, Kenya, than in New York. M-PESA was created by Safaricom, Kenya’s largest mobile-network operator. A customer can sign up for the service at one of the 40,000 agents throughout Kenya and place money in the account. Money can then be transferred to others by using a mobile phone. This has proved to be very useful because so many people work in Kenya’s major cities and need to transfer money to their family, who often life far away in rural areas. The mobile-money service provides a safe and convenient way to move money around in unsafe environments. The development in IT has also allowed M-PESA to quickly expand globally. Today it has 30 million users in 10 countries.
Current research suggests that born globals are unique in many ways. When compared to other start-ups, born globals tend to have higher employment and job growth rates. Born globals also serve a wider global market than domestic start-ups. Additionally, while born globals tend to experience similar internationalization patterns of smaller entrepreneurial firms, they have much more aggressive learning strategies as a result of becoming global much faster than others.
Given the critical importance of born globals, what are the factors that contribute to their success? Current research suggests that a number of factors, such as marketing competence, effective pricing, advertising and distribution capabilities, product quality, and so on, all contribute to the success of such companies. Studies also show that prior experience of managers in combining resources from different countries and having a global vision are also important. To give you more insights, Table 12.4.2 discusses the success factors for born globals based on several studies.
Table \(\PageIndex{2}\): Success Factors of Born Globals
| Study Sample | Key Success Factors |
| 21 British firms |
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Companies based in U.S. and Denmark |
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New ventures in Irish shellfish sector |
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| Irish low-technology International New Ventures |
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| Polish born globals |
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Summary
In the above sections, you have learned about the different ways in which a company can go international. Some companies have minimal engagement and only export. Others are fully vested and build production plants overseas. Yet others choose to go global from inception. Each entry mode has its benefits and costs, advantages and disadvantages. How do companies choose among these entry types?
The primary factors in the internalization decision are how much control the company wants to have over operations and how much of the company’s resources (physical, financial, natural, human) it wants to expend to go international. For example, if a company doesn’t want to invest or spend too much to access global markets but still wants to explore them, it can simply export. But with this method, the company has less control over operations, such as how the product is marketed and sold. However, if companies want to control all activities and if they have the resources, they can get involved in FDI. In such cases, the companies have significant control but at much higher costs.
A recent study of banks provides further insight into this issue. For instance, the more a bank required local resources in the form of local reputation or the availability of a local branch network to offer services, the more likely the company was to use joint ventures or acquisitions as forms of international entry. If a bank wanted to have greater control in terms of being able to manage its activities to achieve its goals, it would be more likely to acquire local firms. In some cases, banks needed this degree of control so that they could coordinate the activities to achieve economies of scale.
To become born globals, companies need to understand whether they have many of the success factors discussed in Table 12.4.2. Furthermore, all companies going international face risks, such as the barriers to export initiation (such as insufficient finances and knowledge of international market) and other complexities associated with transferring money across borders (fluctuation in exchange rates, payment delays, etc.). Companies also face political risk in terms of foreign government intervention in the form of tariffs or foreign exchange controls. Companies need to determine whether they can work around these barriers.
CONCEPT CHECK
- What are the factors and approaches that organizations can take when deciding to go global?
- Explain the term "born global" and why it is important for companies to take this approach.