General Appraisal of the Investment Entry Mode

As is true of other entry modes, investment offers both advantages and disadvantages to a company. The probability of a successful investment entry can be enhanced by building on experience gained through prior export to the target country/market. The investment entry decision is a complex process that requires an evaluation of both the investment climate in the target country and the intended investment project.

1. Advantages of Investment Entry

Fundamentally, investment entry involves the transfer to a target country of an entire enterprise. In contrast, exporting is essentially the transfer of products, while licensing is the transfer of technology and other industrial property. By allowing a company to transfer managerial, technical, market­ing, financial, and other skills (its “knowledge assets”) to a target country in the form of an enterprise under its own control, investment entry enables that company to exploit more fully its competitive advantages in the target market.² As we have observed previously, licensing entry does not allow a manufacturer to control the production and marketing of the licensed prod­ucts. And although branch/subsidiary exporting offers the manufacturer full control over marketing, it does not offer the possible logistical advantages of investment entry.

Local production may lower the costs of supplying a foreign target market as compared to export entry, because of savings in transportation and customs duties and/or lower manufacturing costs resulting from less expensive local inputs of labor, raw materials, energy, and so on. Local production may also increase the availability of supply if quotas limit imports or if a company’s supply of export products is constrained by plant capacity in the home country. Investment entry may also enable a manufac­turer to obtain a higher or more uniform quality of supply in the target country than would be possible through licensing an independent local company.

Investment entry can also create marketing advantages. Ordinarily, lo­cal production provides far more opportunity than domestic production to adapt a manufacturer’s product to local preferences and purchasing power. For example, long before they started to downsize automobiles manufac­tured at home, U.S. automobile companies were manufacturing smaller vehicles in Europe in response to higher fuel costs, shorter distances, and other market factors. In addition, investment entry can offer quicker and more reliable delivery of products to middlemen and customers, better provision of after-sales service, direct distribution through a subsidiary’s own sales force, and a local-company image. Last but not least, investment entry usually increases the resources devoted to marketing in the target country, because the manufacturer has more to lose from market failure than with export or licensing entry.

2. Disadvantages of Investment Entry

The advantages of investment entry must be set against its disadvantages. Compared to other modes, investment entry requires substantially more capital, management, and other company resources.’ This higher resource commitment also means higher exposure to risks. Moreover, investment entry is subject to a wider range of political risks than other modes. Be­cause of its high capital requirements and risks, strategic planning for investment entry becomes exceptionally important.

Since the ultimate success of a manufacturing subsidiary is dependent on many political, economic, sociocultural, and market factors, the infor­mation necessary for good entry investment decisions is far greater than for exporting or licensing. To put the matter in another way, the probability of poor investment decisions is magnified by the lack or misinterpretation of information, more so than with alternative entry modes. Other possible disadvantages of investment entry include high startup costs, long payback periods, and the difficulty of disinvestment in the event of failure or a change in strategy.

3. The Time Path of Investment Entry

Because of the demanding information requirements of investment entry, it is usually unwise for a company to make its first entry investment abroad without a prior penetration of the target country through exports. One study of the initial foreign manufacturing subsidiaries of 43 small British companies found that success was correlated with prior export entry. Com­panies that established a subsidiary in a target country without earlier export experience demonstrated the lowest success rating. Moreover, com­panies that had built up a prior export entry with the greatest number of incremental steps (using foreign agents or distributors and later their own sales subsidiaries or branches) showed the highest success rating.⁴ In sum, a company’s first investment abroad is likely to be more successful as a subsequent entry mode than as an initial entry mode. Prior export experi­ence lessens a key uncertainty in the investment entry decision: the sales potential in the target market for the company’s product.

After a company has gained experience from its first investment entry in a target country, the establishment of manufacturing subsidiaries in other target countries without prior export or other entry experience becomes less risky. For the first investment experience instructs a company in the infor­mation it needs to make a good investment decision, develops in-house managers who can better assess the significance of that information, and instills confidence in the company’s ability to manage foreign operations. Subsequent investment entry decisions, therefore, are apt to be made with more intelligence and skill than the first one. It does not follow, however, that investment experience in one country is fully transferable to another country. Investment climates, in particular, vary strikingly across countries. Whenever possible, therefore, a company would be wise to gain experience in a target country through exports before it undertakes an investment entry.

Source: Root Franklin R. (1998), Entry Strategies for International Markets, Jossey-Bass; 2nd edition.