INTERNATIONAL BUSINESS AND TRADE

Republic of the Philippines

President Ramon Magsaysay State University
(Formerly Ramon Magsaysay Technological University)
College of Accountancy and Business Administration
Iba, Zambales, Philippines
Tel/Fax No.: (047) 811-1683

College/Department College of Accountancy and Business Administration

Course Code AE 5
Course Title INTERNATIONAL BUSINESS AND TRADE
Semester & Academic
First Semester AY 2021-2022
Year
Author JOHN REY MERCURIO

CHAPTER VI
MODES OF ENTERING INTERNATIONAL BUSINESS
OBJECTIVES
After studying this unit, you should be able to:
 Explain how firms choose which foreign markets to enter and at
the factors that are important in determining the best timing and
scale of entry
 Discuss the choice of entry mode
 Describe the role of strategic alliances
DISCUSSION:
Introduction
The choice for entering foreign market is another major issue with which
international business must wrestle. The various modes for serving foreign markets
are exporting, licensing or franchising to host country firms, establishing joint
ventures with a host country firms, setting up a new wholly owned subsidiary in
host country to serve its market, or acquiring an established enterprise in the host
nation to serve the market. The optimal entry mode varies by situation depending

johnreymercurio 1
 INTERNATIONAL BUSINESS AND TRADE

on factors like transport costs, trade barriers, political risks, economic risks, and
firm strategy.
Modes of Entry
Firms can use six different modes to enter foreign markets: exporting,
turnkey projects, licensing, franchising, establishing joint ventures with a host-
country firm, or setting up a new wholly owned subsidiary in the host country.
Each entry mode has advantages and disadvantages. Managers need to consider
these carefully when deciding which to use.
Exporting
- Using domestic plant as a production base for exporting goods to foreign
markets is an excellent initial strategy for pursuing international sales.
Exporting is the marketing and direct sale of domestically-produced goods
in another country. Exporting is a traditional and well-established method of
reaching foreign markets. Since exporting does not require that the goods to
be produced in the target country, no investment in foreign production
facilities is required. Most of the costs associated with exporting take the
form of marketing expenses.
Exporting commonly requires coordination among four players:
1. Exporter,
2. Importer,
3. Transport provider, and
4. Government.
Advantages of Exporting Some of them are discussed as under:
1. It minimizes both risk and capital requirements and it is conservative way to
test the international waters. With an export strategy the manufacturer can
limit its involvement in foreign markets by contracting with foreign
wholesalers experienced in importing to handle the entire distribution and
marketing function in their countries or regions of the world.
2. Exporting may help a firm achieve experience curve and location
economies. By manufacturing the product in a centralized location and
exporting to other national markets, the firm may realize substantial

johnreymercurio 2
 INTERNATIONAL BUSINESS AND TRADE

economies from its global sales volume. This is how Sony came to dominate
the global TV market.
Disadvantages of Exporting The following are the disadvantages of exporting:
1. Exporting from the firm’s home base may not be appropriate if there are lower-
cost locations for manufacturing the product abroad (i.e. if the firm can realize
location economies by moving production elsewhere.)
2. High transport costs can make exporting uneconomical, particularly for bulk
products. One way of going around is to manufacture bulk products regionally.
3. Tariff barriers can make exporting uneconomical. Similarly, the threat of tariff
barriers by the host-country government can make it very risky.
4. Exporting through local agent may not be good proposition since foreign agents
often carry the products of competing firms and so have divided loyalties.
Licensing
- Licensing makes sense when a firm with valuable technical know-how or a
unique patented product has neither the internal organizational capability nor
the resources to enter the foreign markets. Licensing essentially permits a
company in the target country to use the property of the licensor. Such
property usually is intangible, such as trademarks, patents, and production
techniques. The licensee pays a fee in exchange for the rights to use the
intangible property and possibly for technical assistance.
Advantages of Licensing The advantages of licensing are as follows:
1. Licensing has the advantage of avoiding the risks of committing resources to
country markets that are unfamiliar, present considerable economic uncertainty or
are politically volatile. By licensing the technology or the production rights to
foreign-based firms, the firm does not have to bear the costs and risks of entering
foreign markets on its own, yet it is able to generate income from royalties.
2. Licensing is often used when a firm wishes to participate in a foreign market but
is prohibited from doing so by barriers to investment.
3. Licensing is frequently used when a firm possesses some intangible property
that might have business applications, but it does not want to develop those
applications itself.

johnreymercurio 3
 INTERNATIONAL BUSINESS AND TRADE

Disadvantages of Licensing
Licensing has the following disadvantages:
1. The big disadvantage of licensing is the risk of providing valuable technological
know-how to foreign companies and thereby losing some degree of control over its
use; monitoring licenses and safeguarding the company’s proprietary know-how
can prove quite difficult in some cases.
2. Competing in a global market may require a firm to coordinate strategic moves
across countries by using profits earned in one country to support competitive
attacks in another. By its very nature, licensing limits a firm’s ability to do this. A
licensee is unlikely to allow a multinational firm to use its profits (beyond those
due in the form of royalty payments) to support a different licensee operating in
another country.
3. Technological know-how constitutes the basis of many multinational firms’
competitive advantage. Most firms wish to maintain control over how their know-
how is used, a firm can quickly lose control over its technology by licensing it.
Franchising
- Franchising is basically a specialized form of licensing in which the
franchiser not only sells intangible property (normally a trademark) to the
franchisee, but also insists that the franchisee agree to abide by strict rules as
how it does business. The franchiser will also often assist the franchisee to
run the business on an ongoing basis.
Advantages of Franchising
- Franchising has much the same advantages as licensing. The franchisee
bears most of the costs and risks of establishing foreign locations; the
franchiser has to expend only the resource to recruit, train, and support
franchisees. Thus, using a franchising strategy, a service firm can build a
global presence quickly and at a relatively low cost and risk, as McDonald’s
has.
Disadvantages of Franchising
- The big problem a franchiser faces is maintaining quality control; foreign
franchisees do not always exhibit strong commitment to consistency and

johnreymercurio 4
 INTERNATIONAL BUSINESS AND TRADE

standardization, perhaps because the local culture does not stress or put
much value on the same kinds of quality concerns.
Contract Manufacturing
- To attempt to have the best of both worlds, more and more companies are
adopting an import strategy which uses contract manufacturing abroad.
Instead of simply ordering products as needed, the company enters into a
contract with the foreign supplier, which fixes production amounts and
delivery times and allows the supplier to maintain hands-on management of
the production-process.
Benefits of Contract Manufacturing
In contractual agreements between a principal and a foreign market-based
manufacturer who produces branded products, both the principal and sub-
contractor expect to benefit.
1. For the principal, contract manufacturing offers access to raw materials and
cheap labor supply, flexible production planning, and the opportunity to
circumvent restrictive employment legislation in the host country.
2. For the sub-contractor, there are a number of benefits; the opportunity to create
and sustain additional employment, and manufacture to international standards.
3. In cases where manufactured products are re-exported to third markets, contract
manufacturing is encouraged by the host government as it contributes to improved
balance of trade.
Limitations of Contract Manufacturing
It may be very difficult to find suitable sub-contractors in the host market
whose facilities, equipment and know-how are compatible with the requirements of
the principal.
1. The principal may not have direct supervisory control over the manufacturing
process. This can lead to serious problems of quality control.
2. Contract execution and supply of merchandise may be disrupted either by local
political upheavals or industrial relations difficulties in the host market.

johnreymercurio 5
 INTERNATIONAL BUSINESS AND TRADE

3. For a sub-contractor largely dependent on the principal, termination of contract

by the principal could cause short-term difficulties and might lead to bankruptcy in
the long run.
Turnkey Projects
- Firms that specialize in the design, construction, and start-up of turnkey
plants are common in some industries. In a turnkey project, the contractor
agrees to handle every detail of the project for a foreign client, including the
training of operating personnel. At completion of the contract, the foreign
client is handled the “key” to a plant that is ready for full operation-hence
the term turnkey. This is a means of exporting process technology to other
countries. Turnkey projects are most common in the chemical,
pharmaceutical, petroleum refining, and metal refining industries, all of
which use complex, expensive production technologies.
Advantages of Turnkey Projects
Turnkey projects have the following advantages:
1. Turnkey projects are a way of earning great economic returns from the asset.
The strategy is particularly useful where FDI is limited by host-government
regulations. For example, the governments of many oil-rich countries have set out
to build their own petroleum refining industries, so they restrict FDI in their oil and
refining sectors. But because many of these countries lacked petroleum
technology; they gained it by entering into turnkey projects with foreign firms than
had the technology.
2. A turnkey strategy can also be less risky than conventional FDI. In a country
with unstable political and economic environments, a longer-term investment
might expose the firm to unacceptable political and/or economic risks (e.g., the risk
of nationalization or of economic collapse).
Disadvantages of Turnkey Projects
Some of the disadvantages of turnkey projects are mentioned below:
1. The firm that enters into a turnkey deal will have no long-term interest in the
foreign country. This can be a disadvantage if that country subsequently proves to
be a major market for the output of the process that has been exported.

johnreymercurio 6
 INTERNATIONAL BUSINESS AND TRADE

2. The firm that enters into a turnkey project with a foreign enterprise may
inadvertently create a competitor.
3. If the firm’s process technology is a source of competitive advantage, then
selling this technology through a turnkey project is also selling competitive
advantage to potential and/or actual competitors.
Strategic Alliances
- A strategic alliance is a formal relationship between two or more parties to
pursue a set of agreed upon goals or to meet a critical business need while
remaining independent organizations. Strategic alliances are agreements
between companies (partners) to reach objectives of a common interest.
Alliances are among the various options; which companies can use to
achieve their goals; they are based on co-operation between companies.
Stages of Alliance Formation
Alliance Operation:
- Alliance operations involves addressing senior management’s commitment,
finding the caliber of resources devoted to the alliance, linking of budgets
and resources with strategic priorities, measuring and rewarding alliance
performance, and assessing the performance and results of the alliance.
Alliance Termination:
- Alliance termination involves winding down the alliance, for instance when
its objectives have been met or cannot be met, or when a partner adjusts
priorities or re-allocated resources elsewhere.
Contract Negotiation:
- Contract negotiations involves determining whether all parties have realistic
objectives, forming high caliber negotiating teams, defining each partner’s
contributions and rewards as well as protect any proprietary information,
addressing termination clauses, penalties for poor performance, and
highlighting the degree to which arbitration procedures are clearly stated and
understood.

johnreymercurio 7
 INTERNATIONAL BUSINESS AND TRADE

Partner Assessment:
- Partner assessment involves analyzing a potential partner’s strengths and
weaknesses, creating strategies for accommodating all partners’
management styles, preparing appropriate partner selection criteria,
understanding a partner’s motives for joining the alliance and addressing
resource capability gaps that may exist for a partner.
Strategy Development:
- Strategy development involves studying the alliance’s feasibility, objectives
and rationale, focusing on the major issues and challenges and development
of resource strategies for production, technology, and people. It requires
aligning alliance objectives with the overall corporate strategy
Advantages of Strategic Alliance
Many startups decide that the best way to rapidly expand their business is to
enter into strategic alliances with established companies which serve a different but
similar market. The many benefits of strategic alliances are listed below:
1. Access to distribution channels,
2. Access to technology, expertise or intellectual property,
3. As a means to raise capital,
4. New products for your customers,
5. Lower R&D costs,
6. Economies of scale, and
7. Raise brand awareness.
Disadvantages of Strategic Alliance
The problem with strategic alliances is that there are a number of problems
which must be overcome for them to be a success, including:
1. Incoherent goals, with one business not benefiting greatly from the agreement;
2. Insufficient trust, with each partner company trying to get the better deal;
3. Conflicts over how the partnership works;

johnreymercurio 8
 INTERNATIONAL BUSINESS AND TRADE

4. Potential to reduce future opportunities through being unable to enter into

agreements with your partner’s competitors;
5. Lack of commitment to the partnership; and
6. Risk of sharing too much knowledge and the partner company becoming a
competitor.
Mergers and Acquisitions
- Mergers and acquisitions refer to the aspect of corporate strategy, corporate
finance and management dealing with the buying, selling and combining of
different companies that can aid, finance, or help a growing company in a
given industry grow rapidly without having to create another business entity.
- Merger is a tool used by companies for the purpose of expanding their
operations often aiming at an increase of their long-term profitability. There
are 15 different types of actions that a company can take when deciding to
move forward using M&A. Usually mergers occur in a consensual
(occurring by mutual consent) setting where executives from the target
company help those from the purchaser in a due diligence process to ensure
that the deal is beneficial to both parties.
- Acquisitions can also happen through a hostile takeover by purchasing the
majority of outstanding shares of a company in the open market against the
wishes of the target’s board. In the United States, business laws vary from
state to state whereby some companies have limited protection against
hostile takeovers. One form of protection against a hostile takeover is the
shareholder rights plan, otherwise known as the “poison pill”.
Advantages of Mergers and Acquisitions
1. Mergers and acquisitions generally succeed in generating cost efficiency through
the implementation of economies of scale. It may also lead to tax gains and can
even lead to a revenue enhancement through market share gain.
2. The principal benefits from mergers and acquisitions can be listed as increased
value generation, increase in cost efficiency and increase in market share.
3. Mergers and acquisitions often lead to an increased value generation for the
company. It is expected that the shareholder value of a firm after mergers or
acquisitions would be greater than the sum of the shareholder values of the parent
companies.

johnreymercurio 9
 INTERNATIONAL BUSINESS AND TRADE

4. An increase in cost efficiency is affected through the procedure of mergers and

acquisitions. This is because mergers and acquisitions lead to economies of scale.
This in turn promotes cost efficiency. As the parent firms amalgamate to form a
bigger new firm the scale of operations of the new firm increases. As output
production rises there are chances that the cost per unit of production will come
down.
5. An increase in market share is one of the plausible benefits of mergers and
acquisitions. In case a financially strong company acquires a relatively distressed
one, the resultant organization can experience a substantial increase in market
share. The new firm is usually more cost-efficient and competitive as compared to
its financially weak parent organization.
Disadvantages of Mergers and Acquisitions
The disadvantages are:
1. Uncertainty about target’s value.
2. Difficulty in absorbing acquired assets.
3. Infeasible if local market for corporate control is underdeveloped.
4. This strategy adds no capacity to the industry.
5. Labor problems of the host country’s company are also transferred to the
acquired company.

johnreymercurio 10