• International Marketing

Lecture 02: International

Business, Entry Modes, and
Theories
• Prof. Biswarup Ghosh
• Vinod Gupta School of Management
• Indian Institute of Technology Kharagpur

1
 International Business Introduction

• International business involves carrying out the business activities across the
national borders of a country.
• Activities are carried out at global or transnational level.
• Marketing mix and strategy are designed according to international target
audience.
• Business can be carried out in different modes (to be discussed in upcoming
slides).

2
 Objectives of International Business
• To increase profitability of the business.
• To avail growth opportunities in the foreign markets.
• Removing domestic market constraints.
• Reduce risk (to diversify) from dependence on the single market for
revenues.
• Earn foreign exchange.
• Gain economies of scale.
• To benefit from tax heavens and other foreign government
• schemes.
3
 International Business: Modes of Entry

• Exporting
• Licensing agreement
• Franchise
• Joint venture
• Setting up a new foreign subsidiary/subsidiaries
• Acquisitions of existing operations

Above list is taken from Madura, J. (2020). International financial management.

Cengage Learning. However, the content detail is prepared from various sources. 4
 International Business: Exporting

• Exporting firm export (sends) its products to the foreign consumers.

• Exporting has two ways of carrying out transactions:

• Direct exporting;
• Indirect exporting.

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 1. Direct exporting: the exporters directly deal with
foreign customers.
• They can build connections with customers.
• However, direct exporting may be a costly for
exporter (Documentation and International
Direct and involvement).

Indirect 2. Indirect exporting: exporting firms do not directly

deal with the foreign
Exporting clients (customers).
• Intermediaries are the dealing hands.
• No direct relation between exporter and foreign
customers.
• Exporter is dependent on intermediaries for market
intelligence
and relations with customers in foreign markets.
 Advantages: Disadvantages:
1. Free from 1. Tariff and non-tariff
investment barriers may affect
related foreign trade.
Pros. and restrictions in 2. Conflict in supply
Cons. of foreign markets. chain partners, and
Exporting 2. Economic and conflict with
lesser resource intermediaries.
requirement. 3. Complexity in
3. Helps gaining supply chains.
foreign market
intelligence.
 • Contractual agreement between licensor and
licensee.

• Licensor grants to the licensee, to use it’s

International brand name, trademark, technology, patent,
or any other form of intellectual property.
Business:
Licensing • Licensee manufactures the products under
(utilizing) the licensor’s technology or brand
name etc.

• Agreement involves financial consideration

(royalty) to be paid by licensee to the licensor.
 Advantages:
1. Licensee saves money and effort using already
existing technology.
2. Technology may be well established and renowned,
hence, benefits the licensee in gaining market.
3. Licensor gets paid for every product sold
(manufactured) by licensee.
4. Licensee may provide market intelligence to
Pros. and Cons. of licensor.
5. Licensor steer clear of trade barriers and
Licensing restrictions on foreign investment.

Disadvantages:
1. Licensor may have undue negotiation powers.
2. Limited market opportunities and non-exclusive
licenses may become problem for licensee.
3. Possibility of future competition from licensee.
4. Potential conflict of interest between two parties.

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 Franchising a contractual agreement
between the two parties, namely the
franchisor and the franchisee.
International Franchisee operates business under
Business: the name of franchisor.
Franchise
Example of the franchisor companies
are: Domino’s, Archies, Lens Kart,
KFC

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 Advantages:
1. Low financial risk.
2. Avoid tariff barriers.
3. Low market potential cost.

Disadvantages:
Pros. and Cons. of
1. Costly interdependence between
Franchise franchisee and franchisor.
2. Franchisor may be very huge and
dominating.
3. Limited market profits.

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 • Joint venture involves two parties jointly
setting up and operating a business.
• One firm is generally native to the foreign
market, however, other is from the foreign
market.
International • Foreign firm brings technology and get
Business: Joint experience of native firm of operating in
domestic market in return.
Venture
• Xerox and Fuji
• Example: Xerox Corp. and Fuji Co. (of Japan)
formed a joint venture that allowed Xerox to
enter the Japanese market while also allowing
Fuji to enter the photocopying sector.

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 Pros. and Cons. of Joint Venture
Advantages:
1. Mutual benefit of technology and local market handling experience transfer.
2. Collective sourcing of the required financial capital.

Disadvantages:
1. Conflict due to cross-product offerings when one of the
firms are operating independently as well.
2. One party may be very dominating over other.
3. Top management philosophy and styles may create
conflict.
4. Other reasons for differences (1) (2)
(1) Further read: Fey, C. F., & Beamish, P. W. (2000). Joint venture conflict: the case of Russian
international joint ventures. International business review, 9(2), 139-162.
(2) Readers may also refer to Times of India news article about the Hero Honda separation:
Hero, Honda split terms finalized - Times of India (indiatimes.com)
https://timesofindia.indiatimes.com/business/india-business/hero-honda-split-terms- 13
finalized/articleshow/7109297.cms
 • One company in foreign may acquire firm in
International foreign country.
Business:
• Example: Facebook acquired WhatsApp and
Acquisitions of Wall Mart acquired Flipkart
Existing
• Benefit: acquirer will get a running business.
Operations This saves a lot of time and effort of strategic
management, if, all goes well.
• Limitations:
• May involve huge capital investment.
• May be difficult and cost ineffective if major
modification is required.

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International
Business: • Acquiring a business in foreign country may require huge
capital investment.
Establishing • Moreover, operations of the existing firm may need major
modifications.
New Foreign • Due to above two hurdles, a firm may consider setting up
Subsidiaries a new subsidiary in the foreign market rather than
acquiring a running business.
• Limitations:
• Setting up subsidiary may be involve long gestation
period.

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 Theories of • The following are the theories of international trade:
• Mercantilism
International • Absolute advantage theory
Trade • Comparative advantage theory
• Factor endowment theory
• Product life cycle theory
MERCANTILISM

• Wealth of Nations: more accumulation of gold and silver, more the wealth
• Objective: to obtain favourable balance of payment by increasing exports and
minimizing imports. Excess exports will result in inflow of precious metal.
• Belief: mercantilism is backed by the belief of ‘protectionism’ (protection of domestic
markets from foreign companies).
• Rationale: exports make a state progressive.
• Restrictions and favouritism .
 MERCANTILISM
• Mercantilist Country is the country that wants to
maximize exports and minimize the imports.
Mercantilist • Target countries are where mercantilist wanted to
Country sell there products and benefit from the trade.
• Green arrow represents that outflow (exports) will
(Mother be beneficial for mother country, however, at the
Country) cost of target countries (zero sum game).
• Red arrow represents that
inflow (imports) are not
considered as progressive.
X
• Cross indicates restriction
over movement of goods
Target Target between two colonies.
Country 1 Country 2 Restrictions benefit mother
(Colony1) (Colony2) country and results in a
zero sum game.

18
 Criticism of Mercantilism

• Prices change in proportion to the quantity of money. So wealth

doesn’t remain constant (1).
• Mercantilism ignores the benefits of trade.
• Constant ‘favourable (surplus) balance of trade’ is not practically
achievable in long run.
• Mercantilism wrongly postulates that increase in money supply
makes everyone rich, however, it may not be true in reality. (2)

(1) As more bullion flows into a country, supply of the bullion would increased. Increased supply will eventually lead to
decreased price of bullion relative to other goods.
(2) Increased supply may result in devaluation of currency (bullion) and results in increased inflation. 19
Theory of Absolute Advantages (Adam Smith)

• Absolute advantage is when a country can produce large quantities

of a good (single good) at same cost, or same quantity at the lower
cost than the competitors.
Theory of Absolute Advantages

• Theory of absolute advantage was proposed by Adam Smith. Smith argued that
one country enjoy absolute advantage in the production of one commodity
whereas other country in different commodity.

• Adam Smith argues that a country should produce the products in which they
have absolute advantage (specialization).

• The theory argues that free trade is beneficial.

• Export what you specialize, import what others give cheaper.

Assumptions of Absolute Advantage Theory

• Production cost is measured in terms in units of labour required in

production of a commodity.
• Labour is mobile within the country, but, immobile between the
nations.
• There are only two countries and two commodities.
• Trade takes place if one country specializes once commodity and
another specializes in second.

22
 Example of Absolute Advantage Theory
Man-hours required to produce one unit of wheat and cloth
US India
Wheat 3 10
Cloth 6 4
Assumption: there are only two countries.
Answer the questions below with a lens of absolute advantage
theory.

What should US produce?

What should India produce?
What should India import from US and not produce?
What should US import from India and not produce in home
markets ?
How is absolute advantage feasible?

• Produce with fewer quantity of labour.

• Labour is cheaper, thus production becomes cheaper.

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Factors driving the Absolute Advantage

• Natural advantage (natural resources, geographical and weather

conditions)
• Acquired advantage (technology, skilled labour)
• Country size
• Availability of labour

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Comparative Advantage Theory

• Propounded by David Ricardo, Taussing, and others.

• Country’s ability to produce Products and Services at a lower opportunity

cost.
 Comparative Advantage Theory

• Assumptions:
• Perfect competition in factors of product markets
• Linear homogeneous production function (constant costs across the volumes of
production)
• Zero transportation costs
• Labour mobility: free movement within, no movement between countries.
• Labour theory of value: cost is determined by utilization of labour per unit of
production.
• Production functions for one commodity vary across countries.

Source: Ingham, B. (2004). International economics: a European focus.

Pearson Education (Chapter 2).
 Illustration of Comparative Advantage
Product Wheat (1 Unit) Linen (1 Unit)

Country
US 20 Units 20 Units
Germany 10 Units 15 Units
Note: Labor cost is set at 10 units for the ease of comparison.

• From the above it is clear that the US has an absolute advantage in

both of the branches but higher comparative advantage in wheat.
• Germany has an absolute disadvantage in both wheat and linen,
but its comparative disadvantage is less in the case of linen.
Hence, the US will specialise in the wheat and Germany in linen

28
Factor Endowment Theory (Heckscher and
Ohlin)

• In commodities that utilise more of their comparatively abundant factor

of production, countries enjoy a comparative advantage.
• Country with plenty of labour will export labor-intensive goods. A country
with plenty of capital will export capital-intensive commodities.
• In commodities that use more of their comparatively scarce factor of
production, countries have a comparative disadvantage.
• Hence, a country with a labour shortage will import labor-intensive
commodities. A country with a scarcity of capital will import capital-
intensive commodities.

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 1. Perfect competition in factor and product
markets.
2. Linear homogeneous production function.
3. Zero transportation costs.
4. Labour mobility: free withing, no between.
Assumptions 5. There are several production
considerations. Various factors have
Factor different intensities in commodities.
Endowment 6. Different countries have the homogeneous
production function for
Theory the same commodity.

Source: Ingham, B. (2004). International

economics: a European focus. Pearson
Education (Chapter 2).
30
 • Even with the most sophisticated leather
preparation and making leather footwear
is still a pretty labor-intensive operation.
Example of • Other items, like as computer memory
chips, require some highly skilled
Factor personnel but rely on large amounts of
cash for manufacture, development, and
Endowment facilities.
• The concept of factor proportions is
extremely valuable for comparing
manufacturing processes.
Product Life Cycle Theory
Product Life Cycle Theory

• The four key elements of the international product lifecycle theory

• Product demand layout
• Product development
• International market competition
• Marketing strategy

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Product Life Cycle Theory

• The demand for a new product is relatively indifferent to price in the early stages of its
life cycle, therefore the pioneering firm can charge a relatively high price.
• Firm improves the products based on the reviews from consumers in domestic
markets.
• As demand for new products develops in foreign countries , the pioneering firm begin
to export the to the foreign markets.
• As the foreign demand grows, the production begins in foreign markets at well.
• Product life matures, hence, cut to cost to survive.
• FDI in low-cost countries to produce at reduced cost.
35
Uppsala theory

• Initially firm operates in the domestic market.

• Later, operations are started overseas via markets which are closely
connected (in terms of culture, religion, geography, etc.).
• Initially, firm uses traditional modes like exports, however, later moves to
more intensified methods of trade through various enter modes.
• Objective of the firm is to produce abroad in all markets.
 Mode of No regular Independent Foreign sales Foreign
Operations export representative subsidiary production
(sporadic s (export and sales
Market export) modes) subsidiary
(Country)
Market A Increasing market commitment
diversification
Market B Increasing geographical

Market C

Market D

⋮
Market N

Source: Forsgren and Johanson (2010)

37
 Basis of Change Aspects and State of
Internationalization

Market Knowledge Commitment Decisions

Market Commitment Current Activities

Source: Johanson and Vahine (1977) 38

 The Establishment chain

Manufacturing
in Foreign
market
Time

Own sales
organization
Agents

Ad Hoc
Exporting

Sales

39
 Transaction Cost Theory
Transactions cost theory predicts when transactions will occur in the market
or in organizations, and hence when new organizations are likely
(Williamson, 1991) (1).

Two types of transactions (2):

1. Transactions to support dealing between buyers and sellers.
2. Transactions to support coordination within the firm.
(1) Cf from International Encyclopedia of the Social & Behavioral Sciences (Second Edition), 2015.
Link to webpage: https://www.sciencedirect.com/topics/social-sciences/transaction-costs-
theory. Accessed on 8 November, 2021.
(2) Wigand, T. Rolf, in Encyclopedia of International Media and Communications, 2003
Link to webpage: https://www.sciencedirect.com/topics/social-sciences/transaction-costs-theory
Transaction Cost Theory

• “Williamson (Nobel Prize Winner for Transaction Cost Theory) says that transactions are broadly the transfer of goods or
services across interfaces”.
• He suggests the internalization (internal) of the transaction within the hierarchy when the transaction costs are high,
• In contrast, buying a good or service on the market was the preferred option while transaction costs were minimal.
• Three dimensions of transactions:
• frequency,
• Asset specificity, or the degree to which transaction-specific
• expenses were incurred.
• Uncertainty.
• The principles of constrained rationality and opportunism
• underpin transaction cost theory.

41
 Four Types of Transaction Costs (2)
1. Search Costs
2. Contracting costs
3. Monitoring costs
4. Adaptation costs

(2) Wigand, T. Rolf, in Encyclopedia of International Media and Communications,

2003
Link to webpage: https://www.sciencedirect.com/topics/social-sciences/transaction-
costs-theory 42
 Principles of the TCA model
Country A Country B
Buyer:
Seller: End
Export
Producer customer
Intermediary

}
Friction between the
seller and the buyer
Transaction cost:
• Search cost, contracting cost

• Ex-post cost: monitoring cost, enforcement costs

If ‘transaction costs’ are higher than ‘control cost’ through an internal ‘hierarchical’
system, then
Country A ‘Forward Integration’ Country B
Internal firm:
End-
Seller: producer foreign
customer
subsidiary
43
‘Internationalization’
Ref: Hollenson,S (2003): Global Marketing Edition 3 : Pearson Education
The Network Model of Internationalization

• There are interdependence between various parties taking part in the business.
• There are many measurements for interdependence and relationship dependence degrees.
• For example:
• How much of the total supplies are provided by a suppliers to be called as the main supplier?
• How much of the total purchases are made by a customer to be listed in the important customers
(special privilege list)?

• Interdependence can be studied in form of networks.

 The Network Model of Internationalization

• An industrial system comprise of various firms engaged in the activities

such as:
• Production
• Distribution
• Use of goods and services

• There is a web of the engagements and relationships, called network

• of the relationships between the firms (1).
(1) Johanson, Jan & Mattsson, Lars-Gunnar. (2015). Internationalisation in industrial systems -
A network approach. 10.1057/9781137508829.0011.
 The Network Model of Internationalization

• A firm’s network is crucial factor in internationalization of the firm.

• Depending on the network strength, a firm may decide upon:
• International extension: establishment of new relationships in foreign markets.
• International penetration: development of current network in the existing
markets of operations.
• International integration: enhancement of the coordination of
• positions occupied by the business organization within the foreign
• networks.

(1) Johanson, Jan & Mattsson, Lars-Gunnar. (2015). Internationalisation in industrial systems -
A network approach. 10.1057/9781137508829.0011.
Country A
(Home
country) Sub Governmental Subsupplier
supplier organization subsidiary
Governmental
head office Country E
organization
Production
subsidiary
Head (upstream
Office functions)
Country F

Bank

Country A Illustration:
Network
Model
Sales
subsidiary
Agent
(downstream
functions

Customers Customers
Bank
47
• It is also known as Dunning’s eclectic paradigm or OLI
approach.

• Three metrics for deciding upon mode of entry:

→ Organisation-specific advantages (OSA),
→ Location-specific advantages (LSA), and
→ Internalization-specific advantages (ISA) to understand the
mode of entry.
• Business having all three advantages (metrics) is
suggested to set up a wholly owned subsidiary in the
foreign market.
The Three Advantages

49
 Born Global Firms (BG)

• Qualitatively, a firm can be said to be a BG when revenues from or near its

inception come from operations in the international markets.

• Quantitative Definition: Firms are classified as BGs when they made their
first sales in foreign markets within three years of their inception and derived
at least 25 percent of their turnover outside their home market within that
period (1).

• There are many other definition, these are just two examples.
(1) Manish B. Ganvir Neeraj Dwivedi , (2017)," Internationalization and performance of Indian
born globals Moderating role of presence of foreign equity ", International Journal of Emerging 50
Markets, Vol. 12 Iss 1 pp. 108 - 124
What can support a firm to be born global?

• High-technology or knowledge intensive industry.

• Technologically advance companies with high competitive advantage.
• Potential customers are based in foreign markets.
• Small domestic markets to support economies of scale or feasible
operationalization.

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 Traditional and Born Global Firm
Traditional Born Global
• Initially, sell and develop in domestic markets. • International operations since the
Later, go for internationalization. commencement of the operations.
• Also known as, The Uppsala Internationalization • Also known as early internationalizers, high tech
Model or Stage Model. start-ups.
• Business firms gradually increase their overseas • The firm, from the inception, seeks to take
operations. advantage of competitive strengths for expansion
of the business outside the domestic markets.

New Market

Key
principles Learning
Technological
from
Advances
Overseas

52