This chapter is from the book
This chapter is from the book
This chapter is from the book
Modes of Market Entry
The central managerial trade-off between the alternative modes of market entry is that between risk and control. On the one hand, low intensity modes of entry minimize risk. Thus, contracting with a local distributor requires no investment in the country-market in the form of offices, distribution facilities, sales personnel, or marketing campaigns. Under the normal arrangement, whereby the distributor takes title to the goods (i.e., buys them) as they leave the production facility of the international company, there is not even a credit risk, assuming that the distributor has offered a letter of credit from its bank. This arrangement also minimizes control, however, since the international company will have little or no involvement in most elements of the marketing plan, including how much to spend on marketing, distribution arrangements, and service standards. In particular, it should be noted here that effective control over marketing operations is impossible without timely and accurate market information, such as customer behavior, market shares, price levels, and so on. In many cases, low-intensity modes of market participation cut off the international firm from this information, since third-party distributors or agents jealously guard the identity and buying patterns of their customers for fear of disintermediation. Such control can only be obtained via higher-intensity modes of market participation, involving investments in local executives, distribution, and marketing programs. This is truly a trade-off in that companies cannot have it all, but must find compromise solutions. The fact is that control only comes from involvement, and involvement only comes from investment.
Another vital distinction here is between financial risk and marketing risk. It is financial risk that is usually the major consideration at the point of market entry, and it is financial risk that is minimized by low-intensity modes of market participation. However, this risk comes at the price of low control over business strategy, so that in fact marketing risk is maximized, with a local partner making all the important marketing decisions. It is the desire for greater control over the business (i.e., to minimize marketing risk) that explains the usual evolutionary pattern of increasing commitment.
The alternative modes of entry can therefore be distinguished by where each falls on the risk-control trade-off (see Figure 3-1). In addition, there are a number of points that should be borne in mind about each.
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Figure 3-1. The Market Entry Mode Decision
Export/Import and Trading Companies
Serving an international market through export/import agents, or trading companies such as the Japanese trading houses or the former British hongs in Hong Kong, is attractive in that it offers both low financial risk and access to substantial local operating knowledge. It is particularly suitable for companies with little international experience since almost all international operating functions are borne by the agent, including the costly and time-consuming requirements such as bills-of-lading, customs clearance, and invoice and collection. However, in addition to the low level of control, a couple of additional drawbacks should be noted. First, agents such as these operate on the basis of economies of scope, seeking to act as intermediaries for as many vendors as possible—they are servants of many masters. In many cases, therefore, the international vendor will be only a small proportion of the agent’s business, so the vendor may end up feeling underserved by the agent, who, if acting rationally, will at any time devote the greatest attention to the vendor that offers the greatest total margin in a given period. Second, agents often operate on a commission basis, and they do not actually buy the goods from the international vendor, so there is a credit and cash flow risk that is not present in distributor arrangements.
“Piggybacking”
Although such arrangements are rarely featured in international business texts, many companies begin their internationalization opportunistically through a variety of arrangements that may be described as “piggybacking,” because they all involve taking advantage of a channel to an international market rather than selecting the country-market in a more conventional manner. For example, a firm may be offered some spare capacity on a ship or plane by a business partner, or it may find that a domestic distributor is already serving an international market and so grants a foreign distribution license that requires nothing more than an increase in domestic sales. An example of this is the Italian rice firm F&P Gruppo, owners of the leading Gallo brand, which entered Poland via their Argentinean subsidiary rather than direct from Italy, thus leading to the rather bizarre situation of packets of rice with Spanish-language packaging covered in stickers in Polish. The reason, it transpires, was that the Argentinean air force was importing freight from Poland via regular flights, but it was sending over empty aircraft on the outward leg, a source of export distribution capacity that was bought by a consortium of local food companies.5
The most common form of piggybacking is to internationalize by serving a customer who is more international than the vendor firm. Thus, a customer requests an order, delivery, or service in more than one country, and the supplier starts selling internationally in order to retain the customer and increases its penetration of the account. This is particularly common in the case of business-to-business companies and technology-oriented start-ups. Another common situation is when two companies in the same industry combine to use the same distribution channel for products that are not directly competitive, thus obviating to some extent the financial disadvantage of establishing distribution when sales volumes are still low. Thus, for example, Minolta piggybacked on IBM’s international distribution network, which helped Minolta achieve otherwise unaffordable distribution and helped IBM defray the cost of the distribution network. Similarly, competitors in some industries, such as pharmaceuticals, routinely license their sales and/or distribution to each other in markets where the competitor is better established and the products are not directly competitive.
When piggybacking via distributors or other comparable partners, the main disadvantage, in addition to the obvious lack of control, is the greater marketing risk that comes from not having studied the market potential and structure. The likely result is a short-term boost in sales, since this was the nature of the opportunity, but a medium-term problem arising from the unsuitability of the country-market, which was not analyzed before entry.
In the case of piggybacking via a major customer, the dangers are quite different. In fact, the level of control is likely to be quite high, given that internationalization has occurred in the context of a preexisting interorganizational relationship. However, in these cases, the supplier firm often underestimates the commitment required. To offer anything like the levels of service and customer relationship management to which the client is accustomed in the home market, it will almost certainly be necessary to establish an office, hire some local account managers, and establish a service operation for the customer’s local operations. In addition, further expansion beyond the entry account may prove to be hampered by the fact that the products sold to that account were customized to the client in question and therefore not immediately transferable to the wider market.
Franchising
Franchising is an underexplored entry mode in international markets, but it has been widely used as a rapid method of expansion within major developed markets in North America and Western Europe, most notably by fast food chains, consumer service businesses such as hotel or car rental, and business services. At heart, franchising is suitable for replication of a business model or format, such as a fast-food retail format and menu. Since the business format and, frequently, the operating models and guidelines are fixed, franchising is limited in its ability to adapt, a key consideration in employing this entry mode when entering new country-markets. There are two arguments to counter this. First, the major franchisers are increasingly demonstrating an ability to adapt their offering to suit local tastes. McDonald’s, for example, is far from being a global seller of American-style burgers, but it offers considerably different menus in different countries and even different regions of countries.6 In such cases, the format and perhaps the brand is internationally consistent, but certain customer-facing elements such as service personnel or individual menu choices can be tailored to local tastes. Secondly, it must be recognized that there are product-markets in which customer tastes are quite similar across countries. A business installing and maintaining swimming pools, for example, is a prime candidate for franchising, as sourcing and operations remain key success factors and are more or less universal. This is an example of a business, like fast food, that is not culture bound and in which marketing knowledge (i.e., the product- or service-specific knowledge involved in marketing this particular offering) is at least as important as local market knowledge (i.e., the knowledge required to operate successfully in a particular territory). It is also important to note that in such businesses, the local service personnel are a vital differentiating factor, and these will obviously still be local in orientation even if they operate within an internationally consistent business format.
The main drawback of franchising is the difficulty of adapting the franchised asset or brand to local market tastes—even experienced corporations like McDonald’s or Marriott, which have managed to thrive on this trade-off as discussed above, have taken several decades and some false starts to get to this point of advanced practice. A key indicator that franchising carries this constraint is the fact that marketing budgets at local levels are usually restricted to short-term promotions rather than market development. This is consistent with the concept that franchising is a rapid replication strategy. For example, consider the expansion of U.S.-based Weight Watchers into Mexico. Weight Watchers is a highly successful dieting business that franchises its programs to operators of local clubs and groups of people motivated to lose weight and maintain their new lighter shape. Its expansion into Mexico, which was the result of an opportunistic network initiative by a member of the U.S. executives’ network, encountered some cultural differences compared with the United States or Canada. In some parts of the country, the attitude still prevailed that being overweight was not bad because it indicated sufficient affluence to eat well. In addition, Mexican consumers were far less nutritionally aware than their northern counterparts, who encountered extensive nutritional information on all food products by law. Clearly, market development required heavy local investment in market education to establish the dieting club concept. Because it was a franchise organization, however, the local marketing funds held by the entrepreneurial and small-scale group operators were much below what was necessary. While some franchising organizations allocate larger marketing budgets from central funds, it remains true that local marketing plays only a limited role in the replication strategy for which franchising is best suited.
Licensing
Licensing is a common method of international market entry for companies with a distinctive and legally protected asset, which is a key differentiating element in their marketing offer. This might include a brand name, a technology or product design, or a manufacturing or service operating process. Licensing is a practice not restricted to international markets. Disney, for example, will license its characters to manufacturers and marketers in categories such as toys and apparel even in its domestic market while it focuses its own efforts on its core competencies of media production and distribution. But it offers a particularly effective way of entering foreign markets because it can offer simultaneously both a low-intensity (and therefore low risk) mode of market participation and adaptation of product to local markets. Continuing with Disney as an example, its many licensing arrangements in China allow its characters to adorn apparel or toys suited to local taste in terms of color, styling, or materials.7 This is because, as is usual in licensing agreements, the local licensee has considerable autonomy in designing the products into which it incorporates the licensed characters. The other major advantage of licensing is that, despite the low level of local involvement required of the international licensor, the business is essentially local and is in the shape of the local business that holds the license. As a result, import barriers such as regulation or tariffs do not apply.
As always, there are disadvantages, and two in particular should be factored into any decision on licensing. First, although it facilitates the creation of localized product, licensing is characterized by very low levels of marketing control. The licensee usually has to obtain approval from the international vendor for product design and specification, but it usually enjoys almost total autonomy over every other aspect of the marketing program (even if the contract includes constraints such as minimum price levels or promotional budgets). This is because the licensee is not a representative of the international vendor and, compared to a distributor or franchisee, is much more of an independent business that licenses only one specific and closely defined aspect of the marketing offer rather than acting as the de facto marketing arm of the international vendor. Second, and perhaps most importantly, licensing runs the risk of creating future local competitors. This is particularly true in technology businesses, in which a design or process is licensed to a local business, thus revealing “secrets,” in the shape of intellectual property that would otherwise not be available to that local business. In the worst case scenario, the local licensee can end up breaking away from the international licensor and quite deliberately stealing or imitating the technology. This might arise from malicious intent or simply a breakdown in relations, as is not uncommon between an international company and its local partner (see Chapter 5). Even in a best case scenario, the local licensee will certainly benefit from accelerated learning related to the technology or product category—this is inevitable since the international company must by definition have a superior asset if there is a market for licensing it in the country. Over time, even absent of malicious intent, the local firm is likely to develop into a position in which it can launch its own rival business. Participation in international markets via licensing is therefore best suited to firms with a continuous stream of technological innovation because those corporations will be able to move on to new products or services that retain a competitive advantage over “imitator” ex-licensees.
These particular low-intensity modes of market participation are the most frequently adopted at the time of market entry, although franchising and licensing are less common than entry via an independent local distributor—perhaps because they involve rather more complex interorganizational contracts and managerial processes. In situations in which a replication strategy is adopted and rapid expansion of the business is a priority, they are highly suitable, and to that extent they are underutilized. In all cases, it is clear that the organizational arrangement and the marketing strategy are interrelated: the less involved the international company, the less likely it is to develop locally customized offers and the more likely it is to follow a replication strategy. In fact, a replication strategy can run counter to the overarching objectives in entering the market in the first place, as much recent experience in the large emerging markets demonstrates.