Decision Determinants of an International Market Entry

1. Entry Rapidity and Proximity to the Market

The strategic concept of international market entry requires a clear formulation of the firm’s objectives in the target foreign market. Objectives are a statement as to what the company will achieve within a certain period of time in terms of market position, return on investment, and the development of key business sectors in the target countries (Hibbert 1997).

An innovator’s (technologically leading) strategy linked with skim pricing offers the opportunity to sell the products at a relatively high price level to the innovation-seeking customers in the target foreign market. Because of the product and/or service novelty, competitors are rather few (first-mover advantages of the in­novator). Disadvantages derive from delayed market penetration and the risk that competitors appear in the course of time and take advantage of higher sales volumes. If fast market penetration is desired, the firm decides on a pricing strategy that attempts to accelerate market penetration and offers the foreign firm the opportunity to expand the target market share and make use of experience curve effects in order to further lower the price and finally dominate the industry (Wheelen & Hunger 2010). Potential risks arise from the defensive strategies of local firms, which may range from severe price competition to lobbying their local governments for support.

Market entry timing targets significantly influence the selection of the firm’s entry strategies. Consequently, the length of time it takes to implement an international market activity represents an important decision­making criterion. On the one hand, a firm may be trying to achieve foreign market entry as rapidly as possi­ble. For example, a firm might have developed a new product in a market where the technology is changing rapidly, such as in high-technology industries or where the product development can readily be copied by competitors, so as rapid an exploitation as possible is required. In such cases, export or licensing activities are more desirable than, for example, greenfield manufacturing investments, which are likely to be inap­propriate because of the complexity of the project abroad and the corresponding time delay. On the other hand, if exporting is impeded through non-tariff barriers by the foreign government, contract manufacturing or licensing arrangements may be the fastest means of market entry. In operations through which the manu­facturing function is internationalized and relocated to the foreign market, such as contract manufacturing and wholly owned foreign production, the international business in the foreign target market is not affected negatively because the operations take place inside those barriers. The firm secures a closer proximity to the target market abroad, which provides first-hand information to the firm (Luostarinen & Welch 1997). The less standardized the product and service and the more different the customer expectations in terms of quality, design, and purchasing attitudes, the more desirable it is for the firm to be as close as possible to the market.

2. Degree of Hierarchical Control and Financial Risk

The choice of entry modes comprises the essential decision of locating the firm’s value-added activities and the level of operational control. Manufacturing resources might be either located domestically, and com­pletely controlled by the firm, or shifted partially or completely abroad (Hollensen et al. 2011). The degree of hierarchical control of operations and the associated financial risk differ depending on the selected entry mode (Zhao, Luo, & Suh 2004). The degree of control and financial risk can be divided into four categories.

• First, indirect and direct exports are market entry modes providing very low control mechanisms. Exports allow the producer to control its value-added functions at home and the product flow from the firm’s warehouse facilities to the carrier, who delivers the cargo to the importer. Consequently, the exporter has no control over the conditions under which the product or service is marketed abroad (Hollensen et al. 2011). The management involvement is concentrated in the exporter’s home country (Meissner 1995). As a result, export implies a minimal resource commitment abroad, which comes along with low financial risks. A letter of credit (LC) serves as a common instrument for securing the importer’s payment. Credit
  insurance protects the exporter from payment defaults by the importer in the context of an open account payment term. The premium paid by the exporter to the insurer depends on the importing firm’s credit worthiness and the economic conditions of the importer’s country of residence.
• Second, contractual agreements, such as OEM, licensing, and franchising, are market entry modes indi­cating rather low control mechanisms. The major reason is that the contract partner in the target foreign country takes over the major part of the value-added activities, which entails the risk that the contractor’s reputation can be easily harmed if quality, safety, labor, or hygiene standards are not met appropriately by the contract partner abroad. The financial risk for the OEM, licensor and franchisor is also relatively low because they do not invest in their own property for manufacturing and operations abroad.
• Third, intermediate control modes include mainly strategic alliances and IJVs, where the partners agree to share resources such as knowledge and equity (in the case of an IJV) with the aim of supplementing each other’s needs (Hollensen et al. 2011). Cooperative modes of market entry, such as IJVs, are categorized as hybrid forms because cross-border activities, such as management involvement, financial flow, and the corresponding investment risk, are balanced between the partners, depending on equity, majority, or minority IJV capital-share structures (Meissner 1995).
• Fourth, high-control modes comprise FDIs in the form of wholly owned subsidiaries (WOS), which in­volves full control over operations in the foreign market (Hollensen et al. 2011). The WOS (hierarchical market entry mode) provide the most control but, in parallel, also require a substantial commitment of resources abroad with a corresponding increase of financial risk (Sanchez-Peinado, Pla-Barber, & Hebert 2007). Examples of WOS are research and development laboratories, sales and distributions branches, and manufacturing plants in the target foreign country.

FDIs, such as greenfield investment in the target foreign market, route the management efforts and the flow of financial capital from the home country to the foreign country. The investment volume becomes concentrated in the foreign market, and the corresponding risk increases due to the regional distance and environmental circumstances that are naturally unfamiliar compared to the home market surroundings. The foreign market environment has a direct impact on a firm’s entry mode strategy in terms of the desired control and the per­ceived financial risk. Political uncertainties are not conducive to the establishment of WOS. Uncertainties in a country regarding the protection of intellectual property rights, for example, reduce the attractiveness of license agreements (Delios & Beamish 1999).

3. A Two-Step Decision Process Approach Towards an International Market Entry

The decision about how foreign markets should be entered naturally depends on the firm’s resource avail­ability. Additionally, in light of globalized value-added activities and trade patterns, the management’s pref­erence concerning target foreign markets and relevant market entry modes is often influenced by external stakeholders. For example, if an important customer of the firm establishes a factory in a foreign country, it may lead the supplying firm to ‘follow the customer’ in order to avoid another competitor’s entrance into the business relationship.

Foreign governments may insist for several reasons, such as control or access to modern technologies, on the establishment of an ‘equal joint venture’ with a local firm. In many Asian countries, usually due to a lack of personal network relationships with relevant business stakeholders, it is difficult to initiate local business operations as a foreign firm. In these cases, it is advisable to search for a local partner. Once a partner is found and, for example, an international joint venture is agreed upon, the firm is confronted with the challenge of sharing technological and managerial knowledge. As time goes by, through assimilation and learning, the local partner may become a serious competitor – as many multinationals have experienced to their regret. As a consequence of the discussion above, a firm that seeks international business should carefully evaluate beforehand the possible outcomes of its selected market entry mode, which is a very complex management task. In order to facilitate the challenging decision-making process for an international market entry, a two- step approach is introduced in the following section.

3.1. Step One – Setting Strategic Priorities

As a first step, the management sets its strategic priorities in terms of the (1) degree of hierarchical control, (2)market entry timing, (3) proximity to the market, and (4) financial risk.

(1) Degree of hierarchical control of firm operations

The management should evaluate whether rather tight or loose control mechanisms concerning its operations in the target foreign country are required. The decisional process should consider elementary issues from the management’s perspective such as the following.

• Necessity to protect advanced technological or managerial knowledge
  • If yes, tight control mechanisms, such as a WOS, are recommended, while cooperative (hybrid) forms, such as IJVs, are less appropriate.
• Strategic market importance in terms of volume and growth rates
  • The more important these considerations are, the more desirable it is to be in the market through a WOS instead of serving the market from a distance (e.g., exports).
• Degree of the firm’s international market experience
  • The less experienced the management in international business, the higher the risk that, for example, an IJVpartner may take advantage of the firm (opportunistic behavior).
• Foreign government regulation
  • The foreign government may favor (e.g., an FDI) or restrict (e.g., export-related non-tariff barriers) a certain market entry mode. Environmental analysis of the target foreign country is of vital importance to make the most favorable decision.
• The firm’s resources (e.g., financial, human)
  • The choice of a market entry strategy naturally depends on the firm’s resource assets. Building up and running a wholly owned sales and distribution network in the target foreign market comes along with the advantage of direct hierarchical control of the firm’s operations, which, however, requires considerable resource cushions.

(2) Market entry timing

The management needs to decide whether a fast or delayed foreign market entry is favorable to the firm. The decisional process on timing of the market entry should consider issues such as these.

• The need to follow an important customer or competitor abroad
  • The decision depends on the firm’s integration in industry networks. The more important a bilateral relationship -for example, to a customer – the more desirable for the firm to follow the customer abroad.
• The threat of fast technological product substitution
  • The shorter the product and technology life-cycles, the more advisable it is for the firm to enter various foreign countries simultaneously instead of an incremental (country-by-country) market entry, which is time consuming.
• First-mover (technological leader) or latecomer advantages
  • Fast entry into global markets is desirable for firms offering technologically advanced products. It helps to develop a technological leadership positioning. Technological latecomers (for example, targeting a cost leadership positioning) may take advantage of a delayed market entry, using the time to learn from the mistakes of the first movers and make things better.
• Intensity of industry competition
  • Competitive global markets may require fast market entry activities in order not to leave foreign market shares to the firm’s competitors.
• Investment volume
  • Large investments – for example, in product developments or operations – naturally demand higher sales volumes, which can be realized through global market entries that help reduce the return-on- investment time framework.
• Monitoring
  • The management needs to evaluate the risk of losing control due to hasty entry activity or poor partner selection against the potential advantages and drawbacks related to a delayed market entry.

(3) Proximity to the market

Concerning the firm’s market proximity, the management should evaluate whether its foreign engagements should be located rather close or distant to its customers abroad. The decision is influenced by the following.

• Product and service
  • Standardized products and services favor contractual market entry modes, such as exports. Different customer expectations in the target foreign market in terms of product features, design, and service often require a local presence of the firm (e.g., its own distribution and sales network). Particularly in markets where customers’ behavior and attitudes are difficult to evaluate from a distance, the firm may prefer FDI.
• Strategic importance of the foreign target market
  • Attractive forecasts for a foreign market, identified by market volumes and promising growth rates, recommend a local presence instead of serving the market from a distance.
• Logistics
  • Flexible order management, transportation lead times, and logistics costs influence the firm’s market entry. For example, heavy and bulky products may favor local assembly activities in the target foreign market.
• Reputation
  • A firm may want to build up a local brand in the target foreign market, which helps to attract customers. Particularly in markets where customers favor domestic companies, the management may decide to launch its own operations in order to develop a local image.
• Foreign government
  • Export-related trade barriers are avoided if, instead, the management considers local assembly activities (e.g., OEM or joint venture partners). The management may also consider whether there are FDI incentives granted in the target local market.

(4) Financial risk

Concerning the financial risk, the firm’s decisional process should consider the following facets.

• Financial cash and debt-to-equity ratio
  • Market entry through FDI is naturally more costly than contractual market entry modes (e.g., licensing). Firms with low debt-to-equity ratios and available financial cushions can better manage FDI-related uncertainties, which usually happen in the course of time. Smaller firms and firms with less financial potential should favor market entry strategies through contracting or cooperation.
• Product and industry margins
  • In industries indicating rather low margins, the firm’s management may favor contractual forms, such as franchising, licensing or OEM, because fixed costs are lower than with FDIs.
• Time horizon of expected return on investment
  • The longer the time period needed for the investment to be paid back, the higher the firm’s uncertainty and corresponding financial risk. Cooperative forms of market entry, such as joint ventures, may serve as an alternative to reduce the financial burden of the firm.
• Expected reactions of local competitors
  • Local competitors may reduce the average prices in their home market, hoping to create an entry barrier for foreign firms. Cooperative forms of market entry, such as a strategic alliance with a local partner, help to gain better access to information about local competitors’ activities in the target foreign market.

After reviewing the discussion above, the next step for the management is to make the decision about which of the market entry strategy alternatives should be selected.

3.2. Step Two – Selection of the Appropriate Market Entry Mode

Each foreign market entry mode has different implications for a firm’s degree of hierarchical control, the financial resources the management has to commit, its target market proximity, and the market entry timing framework. Figure 3.10 provides an overview of the portfolio of available market entry strategies as they are postioned depending on the strategic decision determinants.

It is of vital importance that the firm’s management be aware of the opportunities and challenges of business expansion into a foreign country. Advantages and drawbacks result from the selection of the market entry mode, taking into account the firm’s internal resources and external environmental conditions. The firm’s management chooses its market entry mode, which depends on the strategic priorities outlined in phase one (setting strategic priorities), and are categorized as (1) contracting modes (market mechanisms), (2) cooper­ative modes (hybrid forms), and (3) FDI (hierarchical organization).

3.2.1. Contracting Modes (Market Mechanisms)

Generally, a market transaction through contracting (for example, indirect exports via a commissioner) al­lows a fast foreign market entry but does not provide the management with sufficient hierarchical control mechanisms. From a historical perspective, exports belong to the most common entry mode, practiced by merchants and later by manufacturing firms. Firms with less international business experience or limited re­sources may choose contracting forms such as exports because the financial risk tends to be relatively lower than, for example, in the case of FDI. Table 3.1 summarizes the relevant contracting forms for an international market entry and the corresponding suitable business categories.

Within the group of contracting modes, indirect exports tend to be realized faster than, as an example, OEM because of the necessity of increased local involvement for OEM (e.g., search for suitable firm abroad, quality assurance activities). The main disadvantages derive from the distance to the foreign markets and their cus­tomers. Table 3.2 summarizes relevant strategic decision determinants in terms of market entry rapidity, the degree of hierarchical control, financial risk, and proximity from the exporter’s point of view. The illustration also provides checkpoints that indicate when an export strategy are advisable and what potential strategic risks – from the exporter’s perspective – are involved.

Market entry through contractual forms, such as license and franchising agreements, can be also realized within a relatively short period of time compared to FDI. Worldwide markets can be penetrated efficiently through the transfer of knowledge (license) or an entire business concept (franchising) to local contract part­ners. Both methods are suitable for firms with limited resources (e.g., to build up manufacturing or service network facilities) because the major part of investments in operations is done by the contracted firm (e.g., franchisee), which also takes on the entrepreneurial risk of running the business in the foreign markets. Li­censing is often desirable in industries driven by rapidly changing technologies. The major disadvantage of licensing and franchising derives from limited hierarchical control of the contracted firm, which involves the potential risks of harming the business concept or damaging the reputation of the licensor or franchisor. Moreover, the contracted partner abroad may develop its own knowledge and expertise through learning and collecting experiences during the course of the contractual relationship. Efficient absorptive capabilities of the contract partner may result in the development of a new competitor.

Table 3.3 summarizes relevant strategic decision determinants in terms of market entry rapidity, the degree of hierarchical control, financial risk, and proximity to the market from the licensor’s and franchisor’s point of view. The illustration also provides checkpoints that indicate when a licensing and franchising strategy is desirable and what potential strategic risks – from the licensor’s and franchisor’s perspective – are involved.

The contractual market entry strategy of original equipment manufacturing (OEM) is particularly applied by larger firms and multinational enterprises (MNEs) aiming to increase their global capacities, which usually comes along with the attempt to reduce production costs. Major drawbacks of OEM come from the limited hierarchical control of the contracted partner firm abroad, which produces the product in its own facilities under the name of the OEM brand. Through managerial learning and technological assimilation from the OEM, there is a risk that a new competitor is developed abroad. Table 3.4 summarizes relevant strategic deci­sion determinants in terms of market entry rapidity, the degree of hierarchical control, financial risk, and the market proximity from OEM’s point of view. It also provides checkpoints that indicate when an OEM strategy is advisable and what potential strategic risks – from the OEM’s perspective – are involved.

Management contracts mainly target the delivery of services to a business partner located in the target foreign country. Due to the fact that consulting, training, and education are naturally connected with the language capabilities, communication skills, behaviors, and attitudes of the people involved, a management contract business can be challenging. The more diversified the socio-cultural environment in the target foreign country relative to the home market, the more effort is necessary to make sure that activities are done as planned and processes are implemented appropriately and efficiently.

Turnkey contracts serve as a suitable entry mode for firms with a specific technology, project management, and engineering expertise. On the one hand, turnkey contracts provide an opportunity to enter rather frag­ile political/legal markets that simultaneously contain a risky momentum. On the other hand, margins can be above average because competition in these emerging target markets is often marginal. The right part­ner selection – which, in many larger projects, is the government – is of vital importance and requires ap­propriate international business experience for the management. The direct involvement abroad (e.g., con­struction and start-up of a plant, education of local staff) during the course of incrementally transferring the operations to locals usually requires considerable firm resources to be reserved over a longer period time. Table 3.5 summarizes relevant strategic decision determinants in terms of market entry rapidity, the degree of hierarchical control, financial risk, and proximity to the market from the perspective of the firm provid­ing the management and turnkey contract. The illustration also provides checkpoints that indicate when a management contract and a turnkey contract strategy is desirable and what potential strategic risks are in­volved.

3.2.2. Cooperation (Hybrid Forms of Foreign Market Entry)

Cooperative market entry modes – realized, for example, in an international equity joint venture – share the financial risk and earnings as well as the hierarchical control of operations between the cooperating partners. Firms sometimes are also confronted with foreign government regulations that require the establishment of a joint venture with a local firm in the target foreign country. Both international joint ventures and interna­tional strategic alliances with a local organization usually increase the proximity to the market due to the partner’s local presence. However, considerable time should be reserved for the right partner selection and organization of the bundled activities. As many firms experienced to their regret, synergy effects tend to be overestimated in the course of running the bilateral cooperation. The realization of cooperative market en­try activities tends to be more time consuming than in the case of license agreements, but entry usually is realized faster than in cases of establishing wholly owned operations.

Table 3.6 summarizes relevant strategic decision determinants in terms of market entry rapidity, the degree of hierarchical control, financial risk, and proximity to the market from the perspective of the management seeking to establish an international strategic alliance or an international joint venture. It also provides check­points that indicate when a cooperative strategy is advisable and what potential strategic risks are involved.

3.2.3. Wholly Owned Subsidiary (Hierarchical Forms of Foreign Market Entry)

The foundation of a wholly owned subsidiary through FDI represents one of the most challenging market entry modes. Time is needed for the evaluation and selection of a suitable location (e.g., infrastructure, avail­ability and qualification of staff, operational costs, etc.). Therefore, FDI is rather recommended for interna­tionally experienced firms. The proximity to the market provides direct communication channels to the local customers, which is an important advantage. The integration into the firm’s organization provides direct hier­archical control mechanisms and avoids loss of often strategically valuable knowledge to another firm. Major forms of FDI – whether realized through greenfield investment, equity participation, merger or acquisitions – are either the establishment of a sales branch and distribution network and/or research and development labs and/or wholly owned manufacturing subsidiaries (please compare Table 3.7).

Heavy and bulky products, the regional availability of raw materials, trade barriers, culturally diverse cus­tomer behaviors, or long transportation lead times encourage direct investment in a foreign target market instead of distant-to-the-market business forms, such as exports. However, in some countries foreign acqui­sitions are banned in some sectors or are made difficult by legal restrictions on voting rights or a firm’s cross­holdings – as is the case in Japan (Hennart & Reddy 1997:3).

On the other hand, Japanese firms, when they go abroad, tend to opt for high-control modes when the risk of doing business in the host country is perceived as high or the quality consciousness of the partner is per­ceived as less strict. Instead of attempting to reduce the resource commitment by using a lower control mode (e.g., OEM or franchising), which firms in the western hemisphere often opt for (e.g., Philips, Apple, DELL), Japanese firms favor long-term orientated engagements that secure hierarchical control of their operations (Taylor, Zou, & Osland 2000:146,158-159).

Source: Glowik Mario (2020), Market entry strategies: Internationalization theories, concepts and cases, De Gruyter Oldenbourg; 3rd edition.