COMMERCE BUSINESS- II. PAPER No.11: INTERNATIONAL BUSINESS MODULE No.3 : MODES OF ENTRY IN INTERNATIONAL

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1 Paper No and Title Module No and Title Module Tag 11: INTERNATIONAL BUSINESS 3: MODES OF ENTRY IN INTERNATIONAL COM_P11_M3

2 TABLE OF CONTENTS 1. Learning outcomes 2. Basic decision regarding entry of a firm 3. Exporting a) Exporting concept b) Advantages of exporting c) Exporting challenges d) Type of export mode i. Indirect export ii. Direct export iii. Cooperative export 4. Foreign investment a) Advantages of foreign investment b) Disadvantages of foreign investment 5. Risks to foreign direct investment a) Economic risk b) Legal risks c) Political risks d) Infrastructure risks

3 1. Learning Outcomes After studying this module, you shall be able to: Identify the basic decisions regarding entry of a firm into international business. Understand exporting as an option for entering a foreign market. Evaluate foreign investment as an entry option based on perceived benefits and potential risks. 2. BASIC DECISION REGARDING ENTRY OF A FIRM INTO INTERNATIONAL BUSINESS A firm expanding internationally must decide on three important issues: 2.1 Which markets to enter? : - First of all Firms need to know the long run profit potential of each possible market. For every firm the most favorable markets are developed and developing nations with free market systems, political stability, low inflation, and low private sector debt. The less lucrative markets are politically unstable developing nations with command economies or developing nations where speculative financial bubbles have led to excess borrowing. On the other hand they seek that markets which have unmet demand because successful firms usually offer products that have not been widely available in the market and that satisfy an unmet need 2.2 When to enter them and on what scale? :- Next decision is to decide the timing of entry. Entry can be early or late, entry is early when an international business enters a foreign market before other foreign firms. But if a firm enters after other international businesses have already established themselves in the market then the entry is late.

4 Firms who enters a market early can gain first mover advantages like: The firm can pre-empt rivals and capture demand by establishing a strong brand name The firm can build up sales volume in that country and ride down the experience curve ahead of rivals and gain a cost advantage over later entrants The firm can create switching costs that bind customers into their products or services by making it difficult for later entrants to win business. Firms who enters a market early has disadvantages also like: When a firm enters a foreign market before other international businesses this may result in pioneering costs (costs that an early entrant has to bear that a later entrant can avoid) like the costs of business failure if the firm makes some major mistakes and the costs of promoting and establishing a product, including the cost of educating the customers 2.3 How to enter them (the choice of entry mode)?:-firms that enter foreign markets on a prominent scale make a vital strategic commitment that changes the competitive playing arena and involves decisions that have a long term impact and are irreversible. On the other hand Small-scale entry can be luring because it allows the firm to gain a learning experience about a foreign market first, but, it gives the firm s a limited exposure of that market. There is no right decision here but we have the decisions that are connected with different levels of risk and return. Entering a big developing nation like China before other international businesses in the firm's industry on a large scale will be related with high levels of risk. The liability of being foreign company is augmented by the lack of prior foreign entrants whose experience can be a valuable guide. On the other hand, the potential long-term rewards of such a strategy are great. The early large-scale entrant gets significant first-mover advantages that will support its long-run position in that market. On the other hand, entering developed nations like Canada, after other MNC s have

5 entered, is required to learn about the market. On a small scale, such an option will be related to lower levels of risk. But, the long-term rewards are likely to be lower because the firm cannot take first-mover advantages. Its future growth may be limited by the small scale entry. 3. Exporting Exporting is the well-established form of operating in foreign markets. Exporting is the marketing of goods produced in one country into another country. At the same time no direct manufacturing is required in a foreign country, major investments in marketing are compulsory. Any company, before committing its resources to project in the export business, must vigilantly assess the benefits and disadvantages of exporting into a new market. 3.1 Advantages of exporting: Increased Sales and Profits: By selling goods and services to a new market, the company can increase sales and boost revenues. Once export development costs have been covered then there is increase in overall profitability because of additional foreign sales over the long term Magnify Domestic Competitiveness: The majority of the companies gain competitiveness in the domestic market before they go international. This helps companies to possess some strategies that will help them internationally Gain Global Market Share: By exporting international companies can participate in the global market and gain their share from the huge international market Diversification: By selling in more than one market allows companies to branch out their business and spread their risk. After entering foreign market Companies will not be affected by the changes of the business cycle of domestic market or of one definite country Low Cost: Entering foreign market will usually increase the scale of production to meet foreign demand. Enlarged production would lower unit costs and help in greater utilization of existing capacities Indemnify for Seasonal Demands: If products or services of the company are used in certain seasons domestically then by entering foreign markets, the demand will be available during different seasons Sell Excess Production Capacity: If companies have excess production capacity for

6 any reason can p sell their products in a foreign market and not be enforced to give huge discounts or sometime dispose of their excess production Gain New Knowledge and Experience: Going international can help in getting valuable information about new marketing techniques, new technologies and foreign competitors. This knowledge can assist a company in both the markets i.e. domestic as well as foreign businesses. 3.2 Exporting Challenges Challenges which a company face while entering the international market are: Extra Costs: Mostly it takes more time to build up extra markets which is characterized by the longer pay back, high up-front costs for developing new promotional materials and other associated administrative costs associated to market the product can strain the scarce financial resources of companies Product Modification: For exporting, companies have to remould their products to satisfy foreign country security codes, and other import restrictions. Modification is often required to meet the importing country's packaging or labeling requirements Financial Risk: Even if so many methods are available for collections of payments like consignment, open-account, documentary collection and letter of credit but they are more tedious and complicated than for domestic sales. Thus, companies must consider the financial risk implicated in doing international transactions Export Licenses and Documentation: Though the trend is that export licensing requirements should be less but some companies are required to obtain an export license to export their goods and this makes them less competitive. In many cases, the documentation mandatory to export is more than for domestic sales Market Information: Getting information of foreign markets is more difficult and time-consuming than getting information and analyzing domestic markets. And second in less developed countries, reliable information on market characteristics, business practices and cultural barriers may be unavailable. 3.3 TYPE OF EXPORT MODE There are three major type of export mode Indirect export

7 3.3.2 Direct export Cooperative export DIRECT EXPORTING Direct exporting includes selling directly to target customer in market. This can be by the internet and frequent visits for trade, or by establish a branch or company in the target country. Selling directly to customers prevents other businesses taking parts of your margin. However in this approach a large requirement of human and financial resources are required. It takes time to make contacts and build relationships, know the market and carry out marketing. Advantages of direct exporting The Advantages to the exporting firm are: Control of pricing complete control of brand direct understanding of buyers' needs and an ability to customize according to them new opportunities Disadvantages of direct exporting are: Lot of resources are required; time, staff sources and money. Fluency in local languag is required in after-sales commissioning and service. Timely troubleshooting cannot be done remotely and will require additional visits. Requirement of commitment to an in-market presence at some stage so that the business can grow continuously INDIRECT EXPORTING In this selling is through an intermediary. It is a relatively cheap and straightforward way to enter a new market. Intermediaries are agents based in target export market who sell products or services to end users. Intermediary should have in-market experience and contacts. They can help to sell products and services to the end user.

8 Indirect methods have following advantages: Exporters can make use of Contracts - in the operating market or worldwide. Commission rates give high motivation to agents and this helps in getting their cooperation and can enter and capture the market soon. Little expertise is required by exporter. Credit acceptance reduce burden of manufacturer. The disadvantages of using indirect exporting are: Intermediary requires sales support. Intermediary takes a margin. No direct contact with the end customer of manufacturer. Manufacturer will have little control over the actual final transaction. Manufacturer cannot learn about the overseas market, this could slow down long term expansion plans COOPERATIVE EXPORT In this, the firms enter into collaborative agreement with other firms to produce product to export. Small firms do not have sufficient scale economies in manufacturing because of the size of the local market or marketing sources available or the inadequacy of the management. By cooperation, the firms achieve higher economies of scale. 4. Foreign Investment Foreign Investment implies flow of capital from one country to another in exchange for major ownership stakes in domestic companies or other domestic assets. Foreign investment signifies that foreigners take active role in management as a part of their deal. Advantages: Employment will increase by Foreign investment It can lead to technological development through technology transfers. It provides capital from rich countries to capital poor countries. Host country can take advantage of superior R&D and managerial expertise. It helps in Increasing living standards and economic growth. Disadvantages: Loss of control over decision-making, may lead to conflict with Host Company. Flow of profits overseas like payments made to investors, add to the CAD which would increases the borrowing.

9 Unexpected capital in-flight and debt financing can lead to a currency crisis, which causes instability and uncertainty for business and adds to inflationary pressures. 5. Risk to Foreign Direct Investment Greater the risk, lower the level of FDI. So to increase foreign investment we have to manage risk very carefully Following are the risks that affect foreign investment 5.1 Economic risk: Economic risks depends upon host-countries' economic performance e.g. access to international credit; inflation; and participation in international agreements for resolving FDI disputes. Foreign investors are very sensitive to cost and price uncertainties, mainly as effect of inflation and exchange rate fluctuations. Increases in a country's relative costs of production by inflation will decrease the probability that investment will occur in that country 5.2 Legal risks: Legal risks stem from legal environments wherein the FDI laws are irregularly enforced and the limits to enforcement are ambiguous. Legal risks like the quantitative restrictions on foreign firms' investment produce a "suboptimal" pace of entry and investment Legal risks because of tax schedules produce inefficient allocations of capital 5.3 Political risks: Political risks are primarily the expropriation of assets and the reversal of government policies. Political instability will result in decrease in both the volume and rate of investment, even if to different degrees for different industries. 5.4 Infrastructure risks: Political risks mean primarily the expropriation of assets and the reversal of government policies. Infrastructure risks result from incomplete and inferior communications and transportation networks. Firms will delay their investment decisions and wait for more favorable conditions if risks are there in host country. For the emerging economies, to achieve optimal levels of FDI means reducing the risks of investors to distribute FDI among competing location and inefficiently among sectors.

10 Summary While going international, a firm has to face basic decisions. These are: o Which markets to enter o When to enter them and on what scale o How to enter them. Exporting is the marketing of goods produced in one country into another country Advantages of exporting are Low Cost, Diversification, Increased Sales and Profits, Gain Global Market Share etc. Exporting Challenges are Extra Costs, Product Modification, Product Modification, Market Information etc. There are three major type of export mode Indirect export Direct export Cooperative export Foreign Investment means flows of capital from one country to another in lieu of major proprietor stakes in domestic companies or other domestic assets. Following are the risks that affect foreign investment Economic risk Legal risks Political risks Infrastructure risks