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CASE STUDY II.4Skagen Designs: becoming an international player in designed watches

Towards the end of 2006 Charlotte and Henrik Jorstcan look back at 15 hectic but successful years. Theircompany was founded in an apartment in New York,from where its first marketing efforts took place. Thetwo entrepreneurs started selling relatively expensivewatches bearing a logo that American companiesmight use as company presents. During the Gulf Crisishowever it was very difficult to sell watches in that pricerange. In 1990 Charlotte and Henrik visited a watch fairin Basel in order to find a manufacturer who was ableto produce the watches at a lower cost price. Theyfound a Danish-owned company, Comtech Watches,with headquarters in Aarhus and a clock and watchfactory in Hong Kong.

In 1992 Charlotte and Henrik had an annual turnoverof US$800,000, primarily through an advertisement onthe back page of a big mail-order catalogue for Father’sDay. Since then events followed each other in quicksuccession. In 1995 the chain store Bloomingdale’sincluded the Skagen Design watches in its assortmentand other retail chains like Macy’s, Nordstrom andWatch World have followed. In addition, the watchesare sold in big gift and design shops.

In 1998 Skagen Designs had an annual turnover ofalmost US$30 million; in 2005 turnover had increasedto approximately US$70 million.

Skagen designs – the story in brief

1986 Party at Carlsberg. Even if Henrik Jorst hasbrought his girlfriend, he manages to make CharlotteKjølbye his neighbour at dinner, and they fall head overheels in love. Shortly after the party Carlsberg sendsHenrik to New York. From New York Henrik managesCarlsberg’s USA sales. Charlotte stays on for a yearand a half in Denmark keeping in close contact withHenrik on the phone.1986 Charlotte joins Henrik in the United States and reigns as Miss Carlsberg for the summer and fall months. After a Danish colleague sends them a few of his sample corporate watches to sell in the United States, Charlotte and Henrik embark ontheir dream of starting their own business and beginworking in the world of watches. They are married in May.

1990 Henrik quits his job at Carlsberg. Charlottewalks New York trying to sell the Danish Jacob Jensenwatches to watchmakers. They have hardly any money.Charlotte gives birth to their daughter Christine.1991 The Jorsts design a few sample corporatewatches and exhibit them at the New York Premium andIncentive Show in the Spring. At this fair, severalretailers notice the watches and wonder why the twoDanes present them as corporate watches and notbranded goods. The retailers state that if the watcheswere available without the corporate logos they wouldpurchase them for their stores. During the summer theyproduce 800 copies of four different watches with thename Skagen Denmark. A few months later all watchesare sold out and an additional amount was produced.1992 Sitting at the dinner table Henrik and Charlottedesign 30 different models, all labelled ‘Skagen

Charlotte and Henrik JorstSkagen Designs.

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PART II DECIDING WHICH MARKETS TO ENTER310

Denmark’. In a New York street Charlotte meets one ofthe managers from the mail order giant ‘The SharperImage’. She takes a chance, and yes, he features theSkagen watches on the back page of the Father’s Daycatalogue. Everything is sold out. From the apartment inNew York Henrik and Charlotte have a turnover ofUS$800,000.1993 There are not many states in the United Stateswhere business taxes are almost equal to zero. InFlorida and Nevada this is, however, the case. One daythey fly to Incline Village at Lake Tahoe – one of theworld’s best ski resorts. They lose their hearts and buy a house that is much too expensive, but big. The company moves into every room from kitchencupboards to garage. They still do it all by themselves.Charlotte gives birth to their daughter Camilla.1995 Five years after starting the company. Now, itbecomes really big. Bloomingdale’s takes the watcheson trial. Sold out – on one single day. They engageemployees in a small, rented office not far from theirhome at the lake. After a year the office is too small, andafter another year the same happens again.1998 The magazine Inc. puts Skagen Designs on the list of the 250 fastest growing, privately ownedcompanies. During five years the turnover hasincreased by almost 1,200 per cent. Finally, the rest ofthe company moves out of the villa at Lake Tahoe. Newheadquarters are opened in Reno, Nevada. An office isopened in Denmark to handle European distributionand an additional 80 stores throughout Denmark beginselling the Skagen Denmark line.1999 The number of employees is approaching 100. Inc. magazine’s ‘Inc. 500’ lists the company as oneof the fastest-growing companies in the United States.Henrik gives Charlotte a horse as present for their ten-year wedding anniversary. The family moves from LakeTahoe to a large house of 650 square metres on theoutskirts of Reno. It is situated on the top of a hill with a beautiful view of the Sierra Nevada Mountains.Skagen begins its ongoing presence in major maga-zines such as InStyle and GQ. Distribution begins inthe United Kingdom.2000 Distribution begins in Germany and theNetherlands.2001 Skagen Designs exhibits for the first time atBaselWorld – The Watch and Jewellery Show in Basel,Switzerland.2002 Distribution begins in additional countriesincluding Finland, Iceland, Ukraine and Kuwait.2003 More countries join the Skagen Designs teamand distribution begins in Belgium, Serbia, Montenegro,United Arab Emirates, Norway, France and Italy.2004 To handle increasing growth, the European HQ office in Copenhagen moves to a larger facility. The

European HQ targets large department stores inGermany and France.2005 The former Director of Sales and ProductDevelopment, Scott Szybala is appointed as President.Scott’s responsibilities are to oversee the daily oper-ations as well as the strategic direction for SkagenDesigns, reporting directly to Charlotte and Henrik,who continue to be closely involved in the company’sproduct development and sales.2006 Skagen Designs becomes an official sponsor of Team CSC, one of the best teams in professionalcycling, with a record-breaking number of victories.Today, Henrik and Charlotte still approve all productsthat Skagen designs.2009 Skagen continues its expansion into product( jewellery and sunglasses) and geographical markets,for example in Eastern Europe and the Far East.

Internal policiesSkagen Designs has its name from the Danish fishingvillage of Skagen; a popular retreat for artists fromaround the world. Many say this place has the perfectsource of natural light and those who visit find itsunique charm to be a mix between nature-given andman-made romanticism. This region has inspired notonly the brand name, but also the Jorst design philo-sophy. The colours, shapes and simplicity inspire thedesign team. The design team is on the pulse of currentfashions, with regular visits to design centres aroundthe world including Switzerland, Italy, France, New Yorkand Hong Kong. Skagen Designs tries to stay true to its classic design philosophy and is never content tofollow established trends.

The Skagen Designs’ logo symbolizes the meetingof the Skagerak and the Kattegat seas that surroundthe village of Skagen.

Charlotte and Henrik have divided the work betweenthem. Charlotte is primarily in charge of sales andmarketing, while Henrik is in charge of the company’sfinance and administration.

In the United States the watches are sold at verycompetitive prices compared with other designwatches: typically at a level of US$100–120.

The core competences of Skagen Designs areassessed as follows:

� Development of new watch concepts following thefashion trend with ‘the finger on the pulse’.

� Human resource policy – both Charlotte and Henrikspend a lot of time walking around and commu-nicating with employees and to let them feel thatSkagen Designs is one big team with the samefamily-oriented values in all parts of the worldwideorganization.




311CASE STUDY II.4 SKAGEN DESIGNS

� Quick and flexible management decisions.� New products are introduced five times a year

(November, January, March, May and August)providing retailers with seasonal updates and givingconsumers the opportunity to update the style foreach season.

� Well-developed partnerships with the ‘upstream’specialists in the Far East who are in charge of theproduction at competitive prices.

Marketing the watchesIn the United States Skagen Design products arelaunched through fashion papers like Vogue, InStyleand Accessories. TV shows like Jeopardy and Wheel ofFortune have been sponsored as well as actors in theseries Ally McBeal and The Practice.

The company’s national advertising is also placed inmajor industry publications as well as out-of-homeadvertising opportunities including billboards, buses

and phone kiosks to support peak selling periods suchas spring fashion, Mother’s Day, Father’s day, autumnfashion and Christmas.

In 2006 Skagen Designs became an official sponsorof the professional cycling team CSC. SkagenDenmark’s Team CSC watch collection was comprisedof six new styles of performance-inspired, Swiss-madewatches featuring ultra lightweight and durable titaniumcases and water-resistant leather straps. The Skagensponsorship of the CSC team ended after the 2006season.

CompetitorsAs a fashion company Skagen Designs is competingwith all the major international companies designingwatches – for example, Calvin Klein, Coach, Guess,Gucci, Swatch, Alfex and Jacob Jensen. Most of thesecompanies possess a financial strength many timeslarger than Skagen Designs.

QUESTIONSAs an expert in international marketing Charlotte andHenrik have called you in to get valuable input inconnection with the international expansion of SkagenDesigns. Therefore, you need to answer the followingquestions. If necessary, make your own conditions andremember to state the reasons for your answers.

1. What screening criteria should Skagen Designs usein connection with its choice of new markets for itswatch collection?

2. Make a specific choice of new markets for SkagenDesigns. Table 1 and Table 2 can be used to supportyour argument.

3. Which ‘market entry mode’ should Skagen Designsuse on the chosen markets?

4. Skagen Designs has launched other product lines(e.g. sunglasses, branded items for the home) withvarying success. What should be the guidelines forincluding other product lines in the Skagen Designscollection?

5. Which criteria should Skagen Designs use for itsselection of future sponsor partners?

6. Skagen Designs is considering online sale of itswatches. What problems and possibilities do yousee for the company in this area? On this basis whatare your conclusions?

The Skagen Royal Nights watchSkagen Designs.




PART II DECIDING WHICH MARKETS TO ENTER312

2003 2004 2005 2006 2007 2008

Retail volume in thousands of units

Belgium 624.98 515.02 714.37 739.44 778.06 819.53

France 5,035.20 4,913.47 4,987.27 4,837.80 4,827.73 4,825.53

Germany 7,501.72 7,452.94 8,217.55 10,284.34 10,918.50 9,859.88

Italy 5,712.08 5,482.23 5,366.33 5,874.31 6,525.52 6,893.24

Netherlands 5,613.00 5,850.00 5,931.00 6,073.00 6,200.00 6,414.00

Spain 12,299.70 12,018.98 11,810.19 11,533.47 11,308.69 10,989.01

Sweden 2,491.00 2,565.00 2,641.00 2,719.50 2,800.00 2,884.00

United Kingdom 17,800.00 17,900.00 18,100.00 18,400.00 16,000.00 15,500.00

Hungary 1,106.19 1,113.93 1,126.19 1,134.07 1,140.87 1,150.00

USA 63,954.47 55,441.04 50,370.68 48,500.85 51,593.56 53,037.50

Mexico 35,690.68 38,721.57 34,946.59 47,598.71 46,780.14 47,851.56

China 57,500.00 60,000.00 61,000.00 61,900.00 59,725.00 64,000.00

India 33,469.00 35,876.98 38,829.72 41,778.67 47,232.00 52,324.80

Japan 9,864.95 9,751.41 9,615.49 9,530.93 9,431.18 9,333.77

Australia 3,189.74 3,505.84 3,604.25 3,817.23 3,920.20 4,001.79

South Africa 23,117.73 21,081.80 26,000.23 15,925.30 18,117.89 16,348.31

Number of watches per 1,000 people

Belgium 61.04 50.18 69.29 71.41 74.86 78.62

France 85.71 83.22 84.04 81.09 80.49 80.04

Germany 91.30 90.60 99.68 124.59 132.13 119.21

Italy 99.03 94.78 92.51 101.03 112.03 118.17

Netherlands 353.82 365.92 368.26 375.06 380.97 392.24

Spain 309.56 299.56 292.26 284.13 277.52 268.82

Sweden 281.11 288.76 296.44 304.19 312.12 320.36

United Kingdom 303.53 303.13 305.59 309.62 268.40 259.19

Hungary 108.22 109.21 110.68 111.82 112.85 114.08

USA 232.45 199.78 180.02 171.95 181.46 185.06

Mexico 363.59 388.41 345.29 463.43 448.98 452.90

China 45.69 47.31 47.79 48.15 46.11 49.07

India 33.19 35.00 37.28 39.51 44.00 48.05

Japan 77.72 76.61 75.45 74.70 73.83 73.00

Australia 166.54 180.59 183.30 192.60 195.87 198.05

South Africa 527.18 470.37 569.51 343.00 381.02 336.62

Source: adapted from Euromonitor and trade sources/national statistics.

Table 1 Volume of different watch markets, 2008




313CASE STUDY II.4 SKAGEN DESIGNS

2003 2004 2005 2006 2007 2008

Belgium 23.91 17.06 20.50 26.20 29.51 30.34

France 934.22 910.42 945.84 1,097.25 1,205.66 1,205.42

Germany 1,429.95 1,519.96 1,762.75 2,699.99 2,846.60 2,954.50

Italy 951.62 918.02 934.11 1,103.06 1,215.72 1,311.61

Netherlands 189.50 191.64 204.00 250.15 275.03 284.86

Spain 804.77 792.48 849.75 1,027.89 1,141.35 1,155.92

Sweden 214.69 198.02 218.48 273.54 312.97 318.41

United Kingdom 960.77 942.91 1,064.11 1,225.10 1,328.51 1,359.78

Hungary 19.56 19.50 21.98 25.40 28.33 29.09

USA 7,477.65 6,486.85 6,321.98 6,426.05 7,118.52 7,206.49

Mexico 200.44 246.59 274.57 303.69 353.17 434.30

China 405.27 500.66 518.67 544.28 604.10 655.09

India 191.37 232.18 288.58 416.40 675.55 975.02

Japan 4,560.11 4,109.99 4,077.30 4,493.29 4,916.32 4,901.23

Australia 171.92 168.72 181.51 226.99 264.75 281.81

South Africa 245.67 221.85 235.62 228.68 323.93 451.58

US$ per capita

Belgium 2.34 1.66 1.99 2.53 2.84 2.91

France 15.90 15.42 15.94 18.39 20.10 19.99

Germany 17.40 18.48 21.38 32.71 34.45 35.72

Italy 16.50 15.87 16.10 18.97 20.87 22.49

Netherlands 11.95 11.99 12.67 15.45 16.90 17.42

Spain 20.25 19.75 21.03 25.32 28.01 28.28

Sweden 24.23 22.29 24.52 30.60 34.89 35.37

United Kingdom 16.38 15.97 17.97 20.62 22.29 22.74

Hungary 1.91 1.91 2.16 2.50 2.80 2.89

USA 27.18 23.38 22.59 22.78 25.04 25.15

Mexico 2.04 2.47 2.71 2.96 3.39 4.11

China 0.32 0.39 0.41 0.42 0.47 0.50

India 0.19 0.23 0.28 0.39 0.63 0.90

Japan 35.93 32.29 32.00 35.22 38.49 38.33

Australia 8.98 8.69 9.23 11.45 13.23 13.95

South Africa 5.60 4.95 5.16 4.93 6.81 9.30

Source: adapted from Euromonitor and trade sources/national statistics.

Table 2 Value of different watch markets, 2008 (US$ million)




Part III Contents

9 Some approaches to the choice of entry mode

10 Export modes

11 Intermediate entry modes

12 Hierarchical modes

13 International sourcing decisions and the role of the sub-supplier

Part III Case studies

III.1 Raleigh bicycles: does the iconic bicycle brand still have a chance on theworld market?

III.2 IKEA: expanding through franchising to the South American market?

III.3 Autoliv airbags: transforming Autoliv into a global company

III.4 IMAX Corporation: globalization of the film business

PART IIIMarket entry

strategiesChs 9–13

PART IIDeciding which markets to enter

Chs 5–8PART I

The decision whether to

internationalize

Chs 1–4

PART IVDesigning the

global marketingprogramme

Chs 14–17 PART VImplementing andcoordinating the global marketing

programme

Chs 18–19

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Once the firm has chosen target markets abroad (see Part II) the question arises as tothe best way to enter those markets. In Part III we will consider the major market entrymodes and criteria for selecting them. An international market entry mode is an institu-tional arrangement necessary for the entry of a company’s products, technology andhuman capital into a foreign country or market.

To separate Part III from later chapters, look at Figure III.1, which shows the classicaldistribution systems in a national consumer market.

In this context the chosen market entry mode (here, own sales subsidiary) can beregarded as the first decision level in the vertical chain that will provide marketing anddistribution to the next actors in the vertical chain. In Chapter 17 we will take a closerlook at the choice between alternative distribution systems at the single national level.

Some firms have discovered that an ill-judged market entry selection in the initialstages of its internationalization can threaten its future market entry and expansion activities. Since it is common for firms to have their initial mode choice institutionalizedover time, as new products are sold through the same established channels and newmarkets are entered using the same entry method, a problematic initial entry mode choicecan survive through the institutionalization of this mode. Inertia in the shift process ofentry modes delays the transition to a new entry mode. The reluctance of firms tochange entry modes once they are in place, and the difficulty involved in so doing, makesthe mode of entry decision a key strategic issue for firms operating in today’s rapidlyinternationalizing marketplace (Hollensen, 1991).

For most SMEs the market entry represents a critical first step, but for establishedcompanies the problem is not how to enter new emerging markets, rather how to exploitopportunities more effectively within the context of their existing network of internationaloperations.

PART IIIMarket entry strategies

Introduction to Part III




PART III MARKET ENTRY STRATEGIES316

There is, however, no ideal market entry strategy, and different market entry methodsmight be adopted by different firms entering the same market and/or by the same firmin different markets. Petersen and Welch (2002) found that a firm often combinesmodes to enter or develop a specific foreign market. Such ‘mode packages’ may takethe form of concerted use of several operation modes in an integrated, complementaryway. In some cases a firm uses a combination of modes that compete with each other.Sometimes this occurs when a firm attempts a hostile takeover of an export market. Theexisting local distributor might be able to resist giving up the market, depending on thenature of existing obligations, but the exporter nevertheless may establish a whollyowned sales subsidiary.

As shown in Figure III.2, three broad groupings emerge when one looks at the assort-ment of entry modes available to the firm when entering international markets. There aredifferent degrees of control, risk and flexibility associated with each of these differentmarket entry modes. For example, the use of hierarchical modes (investment modes)gives the firm ownership and thereby high control, but committing heavy resources toforeign markets also represents a higher potential risk. At the same time heavy resourcecommitment creates exit barriers, which diminish the firm’s ability to change the chosenentry mode in a quick and easy way. So the entry mode decision involves trade-offs, asthe firm cannot have both high control and high flexibility.

Figure III.3 shows three examples representing the main types of market entry mode.By using hierarchical modes, transactions between independent actors are substitutedby intra-firm transactions, and market prices are substituted by internal transfer prices.

Many factors should be considered in deciding on the appropriate market entrymode. These factors (criteria) vary with the market situation and the firm in question.

Chapter 9 will examine the different decision criteria and how they influence thechoice among the three main groupings of market entry modes. Chapter 10 (Exportmodes), Chapter 11 (Intermediate modes) and Chapter 12 (Hierarchical modes) willdiscuss in more detail the three main types of entry mode. A special issue for SMEs is

Figure III.1 Examples of different market entry modes and the distribution decision




PART III MARKET ENTRY STRATEGIES 317

how their internationalization process is related to their much bigger customers andtheir sourcing and entry mode decisions. This will be discussed further in Chapter 13.

The simple version of the value chain (see Figure 1.10) will be used to structure thedifferent entry modes in Chapters 10, 11 and 12.

References

Hollensen, S. (1991) ‘Shift of market servicing organization in international markets: a Danish case study’, inVestergaard, H. (ed.), An Enlarged Europe in the Global Economy, EIBA’s 17th Annual Conference,Copenhagen, EIBA.

Petersen, B. and Welch, L.S. (2002), ‘Foreign operation mode combinations and internationalization’, Journalof Business Research, 55, pp. 157–162.

Figure III.2 Classification of market entry modes

Figure III.3 Examples of the different market entry modes in the consumer market







CHAPTER 9Some approaches to the choice of entry mode

Contents

9.1 Introduction9.2 The transaction cost approach9.3 Factors influencing the choice of entry mode9.4 Summary

Case studies

9.1 Jarlsberg9.2 Ansell condoms9.3 Video case study: understanding entry modes into the Chinese market

Learning objectives

After studying this chapter you should be able to:

� Identify and classify different market entry modes.

� Explore different approaches to the choice of entry mode.

� Explain how opportunistic behaviour affects the manufacturer/intermediary relationship.

� Identify the factors to consider when choosing a market entry strategy.




9.1 Introduction

9.2 The transaction cost approach


We have seen the main groupings of entry modes available to companies that wish to takeadvantage of foreign market opportunities. At this point we are concerned with the question:what kind of strategy should be used for the entry mode selection?

According to Root (1994) there are three different rules:

1. Naive rule. The decision-maker uses the same entry mode for all foreign markets. This ruleignores the heterogeneity of the individual foreign markets.

2. Pragmatic rule. The decision-maker uses a workable entry mode for each foreign market.In the early stages of exporting the firm typically starts doing business with a low-riskentry mode. Only if the particular initial mode is not feasible or profitable will the firmlook for another workable entry mode. In this case not all potential alternatives are investigated, and the workable entry may not be the ‘best’ entry mode.

3. Strategy rules. This approach requires that all alternative entry modes are systematicallycompared and evaluated before any choice is made. An application of this decision rulewould be to choose the entry mode that maximizes the profit contribution over thestrategic planning period subject to (a) the availability of company resources, (b) risk and(c) non-profit objectives.

Although many SMEs probably use the pragmatic or even the naive rule, this chapter isinspired mainly by an analytical approach, which is the main principle behind the strategy rule.

The principles of transaction cost analysis have already been presented in Chapter 3 (section3.3). This chapter will go into further details about ‘friction’ and opportunism.

The unit of analysis is the transaction rather than the firm. The basic idea behind thisapproach is that in the real world there is always some friction between the buyer and sellerin connection with market transactions. This friction is mainly caused by opportunisticbehaviour in the relation between a producer and an export intermediary.

In the case of an agent, the producer specifies sales-promoting tasks that the export inter-mediary is to solve in order to receive a reward in the shape of commission.

In the case of an importer, the export intermediary has a higher degree of freedom as theintermediary itself, to a certain extent, can fix sales prices and thus base its earnings on theprofit between the producer’s sales price (the importer’s buying price) and the importer’ssales price.

No matter who the export intermediary may be, there will be some recurrent elements thatmay result in conflicts and opportunistic actions:

� stock size of the export intermediary;� extent of technical and commercial service that the export intermediary is to carry out for

its customers;� division of marketing costs (advertising, exhibition activities, etc.) between producer and

export intermediary;� fixing of prices: from producer to export intermediary, and from the export intermediary

to its customers;� fixing of commission to agents.

Opportunistic behaviour from the export intermediary

In this connection the export intermediary’s opportunistic behaviour may be reflected in twoactivities:

Entry modeAn institutionalarrangement for theentry of a company’sproducts and servicesinto a new foreignmarket. The main typesare export, intermediateand hierarchical modes.




1. In most producer–export intermediary relations a split of the sales promoting costs has been fixed. Thus statements by the export intermediary of too high sales promotionactivities (e.g. by manipulating invoices) may form the basis of a higher payment fromproducer to export intermediary.

2. The export intermediary may manipulate information on market size and competitorprices in order to obtain lower ex-works prices from the producer. Of course, this kind ofopportunism can be avoided if the export intermediary is paid a commission of realizedturnover (the agency case).

Opportunistic behaviour from the producer

In this chapter we have so far presumed that the export intermediary is the one who hasbehaved opportunistically. The producer may, however, also behave in an opportunistic way,as the export intermediary must also use resources (time and money) on building up themarket for the producer’s product programme. This is especially the case if the producerwants to sell expensive and technically complicated products.

Thus the export intermediary carries a great part of the economic risk, and will alwayshave the threat of the producer’s change of entry mode hanging over its head. If the exportintermediary does not live up to the producer’s expectations it risks being replaced byanother export intermediary, or the producer may change to its own export organization(sales subsidiary), as the increased transaction frequency (market size) can obviously bear theincreased costs.

The last case may also be part of a deliberate strategy from the producer: namely, to tapthe export intermediary for market knowledge and customer contacts in order to establish asales organization itself.

What can the export intermediary do to meet this situation?

Heide and John (1988) suggest that the agent should make a number of further ‘offsetting’investments in order to counterbalance the relationship between the two parties. Theseinvestments create bonds that make it costly for the producer to leave the relationship: thatis, the agent creates ‘exit barriers’ for the producer (the principal). Examples of such investmentsare as follows:

� Establish personal relations with the producer’s key employees.� Create an independent identity (image) in connection with selling the producer’s products.� Add further value to the product, such as a BDA (before–during–after) service, which

creates bonds in the agent’s customer relations.

If it is impossible to make such offsetting investments Heide and John (1988) suggest thatthe agent reduces its risk by representing more producers.

These are the conditions that the producer is up against, and when several of these factorsappear at the same time the theory recommends that the company (the producer) internalizesrather than externalizes.

A firm’s choice of its entry mode for a given product/target country is the net result of several,often conflicting forces. The need to anticipate the strength and direction of these forcesmakes the entry mode decision a complex process with numerous trade-offs among alterna-tive entry modes.

CHAPTER 9 SOME APPROACHES TO THE CHOICE OF ENTRY MODE 321

9.3 Factors influencing the choice of entry mode





Generally speaking the choice of entry mode should be based on the expected contribu-tion to profit. This may be easier said than done, particularly for those foreign markets whererelevant data are lacking. Most of the selection criteria are qualitative in nature, andquantification is very difficult.

As shown in Figure 9.1, four groups of factors are believed to influence the entry modedecision:

1. internal factors2. external factors3. desired mode characteristics4. transaction-specific behaviour.

In what follows a proposition is formulated for each factor: how is each factor supposedto affect the choice of foreign entry mode? The direction of influence is also indicated both in the text and in Figure 9.1. Because of the complexity of the entry mode decision thepropositions are made under the condition of other factors being equal.

Internal factors

Firm sizeSize is an indicator of the firm’s resource availability; increasing resource availability providesthe basis for increased international involvement over time. Although SMEs may desire ahigh level of control over international operations and wish to make heavy resource commit-ments to foreign markets, they are more likely to enter foreign markets using export modesbecause they do not have the resources necessary to achieve a high degree of control or to

Figure 9.1 Factors affecting the foreign market entry mode decision





make these resource commitments. Export entry modes (market modes), with their lowerresource commitment, may therefore be more suitable for SMEs. As the firm grows it willincreasingly use the hierarchical model.

International experience

Another firm-specific factor influencing mode choice is the international experience ofmanagers and thus of the firm. Experience, which refers to the extent to which a firm hasbeen involved in operating internationally, can be gained from operating either in a par-ticular country or in the general international environment. International experience reducesthe cost and uncertainty of serving a market, and in turn increases the probability of firmscommitting resources to foreign markets, which favours direct investment in form of whollyowned subsidiaries (hierarchical modes).

Dow and Larimo (2009) conclude from their survey that practitioners should be awarethat not all forms of experience are equal. International experience from similar countries(with low perceived psychic distance) is positively associated with the choice of a high-control entry mode (i.e. entry by wholly owned subsidiary). This indicates that exploitingeach geographic region in succession may be advisable, instead of ‘jumping’ from region toregion. This would maximize the benefits of within-cluster experience.

In developing their theory of internationalization Johanson and Vahlne (1977) assert thatuncertainty in international markets is reduced through actual operations in foreign markets(experiential knowledge) rather than through the acquisition of objective knowledge. Theysuggest that it is direct experience with international markets that increases the likelihood ofcommitting extra resources to foreign markets.

Product/service

The physical characteristics of the product or service, such as its value/weight ratio, per-ishability and composition, are important in determining where production is located.Products with high value/weight ratios, such as expensive watches, are typically used fordirect exporting, especially where there are significant production economies of scale, or if man-agement wishes to retain control over production. Conversely, in the soft drinks and beerindustry, companies typically establish licensing agreements, or invest in local bottling orproduction facilities, because shipment costs, particularly to distant markets, are prohibitive.

The nature of the product affects channel selection because products vary so widely intheir characteristics and use, and because the selling job may also vary markedly. For instance,the technical nature of a product (high complexity) may require service both before and aftersale. In many foreign market areas marketing intermediaries may not be able to handle suchwork. Instead firms will use one of the hierarchical modes.

Blomstermo et al. (2006) distinguish between hard and soft services. Hard services arethose where production and consumption can be decoupled. For example software servicescan be transferred into a CD, or some other tangible medium, which can be mass-produced,making standardization possible. With soft services, where production and consumptionoccur simultaneously, the customer acts as a co-producer and decoupling is not viable. Thesoft-service provider must be present abroad from their first day of foreign operations.Blomstermo et al. (2006) conclude that there are significant differences between hard- andsoft-service suppliers regarding choice of foreign market entry mode. Managers in soft ser-vices are much more likely to choose a high control entry mode (hierarchical mode) than hardservices. It is important for soft-service suppliers to interact with their foreign customers, thusthey should opt for a high degree of control, enabling them to monitor the co-production of the services.

Products distinguished by physical variations, brand name, advertising and after-salesservice (e.g. warranties, repair and replacement policies) that promote preference for oneproduct over another may allow a firm to absorb the higher costs of being in a foreignmarket. Product differentiation advantages give firms a certain amount of impulse in raising





prices to exceed costs by more than normal profits (quasi rent). They also allow firms to limit competition through the development of entry barriers, which are fundamental in the competitive strategy of the firm, as well as serving customer needs better and therebystrengthening the competitive position of the firm compared to other firms. Because theseproduct differentiation advantages represent a ‘natural monopoly’ firms seek to protect theircompetitive advantages from dissemination through the use of hierarchical modes of entry.

External factors

Sociocultural distance between home country and host countrySocioculturally similar countries are those that have similar business and industrial practices, acommon or similar language, and comparable educational levels and cultural characteristics.Sociocultural differences between a firm’s home country and its host country can createinternal uncertainty for the firm, which influences the mode of entry desired by that firm.

The greater the perceived distance between the home and host country in terms of culture,economic systems and business practices, the more likely it is that the firm will shy away fromdirect investment in favour of joint venture agreements or even low-risk entry modes likeagents or an importer. This is because the latter institutional modes enhance firms’ flexibilityto withdraw from the host market, if they should be unable to acclimatize themselvescomfortably to the unfamiliar setting. To summarize, other things being equal, when theperceived distance between the home and host country is great, firms will favour entry modesthat involve relatively low resource commitments and high flexibility. Dow and Larimo(2009) found that the perceived cultural distance (psychic distance) is much more thanHofstede’s cultural dimensions. In particular, language difference seems to be one of the least important factors. Other issues, such as differences in religion, degree of democracy,industrial development and so on, have a much greater impact on entry mode choice.

Country risk/demand uncertaintyForeign markets are usually perceived as riskier than the domestic market. The amount ofrisk the firm faces is a function not only of the market itself but also of its method of involve-ment there. In addition to its investment the firm risks inventories and receivables. Whenplanning its method of entry the firm must do a risk analysis of both the market and its methodof entry. Exchange rate risk is another variable. Moreover, risks are not only economic; thereare also political risks.

When country risk is high a firm would do well to limit its exposure to such risk byrestricting its resource commitments in that particular national domain. That is, other thingsbeing equal, when country risk is high, firms will favour entry modes that involve relativelylow resource commitments (export modes).

Unpredictability in the political and economic environment of the host market increasesthe perceived risk and demand uncertainty experienced by the firm. This in turn disinclinesfirms to enter the market with entry modes requiring heavy resource commitments; on theother hand, flexibility is highly desired.

Market size and growthCountry size and rate of market growth are key parameters in determining the mode ofentry. The larger the country and the size of its market, and the higher the growth rate, themore likely management will be to commit resources to its development, and to considerestablishing a wholly owned sales subsidiary or to participate in a majority-owned jointventure. Retaining control over operations provides management with direct contact andallows it to plan and direct market development more effectively.

Small markets, on the other hand, especially if they are geographically isolated and cannotbe serviced efficiently from a neighbouring country, may not warrant significant attention orresources. Consequently they may be best supplied via exporting or a licensing agreement.





While unlikely to stimulate market development or maximize market penetration thisapproach enables the firm to enter the market with minimal resource commitment, and frees resources for potentially more lucrative markets.

Direct and indirect trade barriersTariffs or quotas on the import of foreign goods and components favour the establishmentof local production or assembly operations (hierarchical modes).

Product or trade regulations and standards, as well as preferences for local suppliers, alsohave an impact on mode of entry and operation decisions. Preferences for local suppliers, ortendencies to ‘buy national’, often encourage a company to consider a joint venture or othercontractual arrangements with a local company (intermediate modes). The local partnerhelps in developing local contacts, negotiating sales and establishing distribution channels, aswell as in diffusing the foreign image.

Product and trade regulations and customs formalities similarly encourage modes involvinglocal companies, which can provide information about and contacts in local markets and canease access. In some instances, where product regulations and standards necessitate significantadaptation and modification, the firm may establish local production, assembly or finishingfacilities (hierarchical modes).

The net impact of both direct and indirect trade barriers is thus likely to be a shift towardsperforming various functions such as sourcing, production and developing marketing tacticsin the local market.

Intensity of competitionWhen the intensity of competition is high in a host market firms will do well to avoid inter-nalization, as such markets tend to be less profitable and therefore do not justify heavyresource commitments. Hence, other things being equal, the greater the intensity of competi-tion in the host market the more the firm will favour entry modes that involve low resourcecommitments (export modes).

Small number of relevant intermediaries availableIn such a case the market field is subject to the opportunistic behaviour of the few exportintermediaries, and this will favour the use of hierarchical modes in order to reduce the scopefor opportunistic behaviour.

Zara (www.inditex.com) is a fashion retail chain of Inditex Group owned by Spanish tycoon Amancio Ortega.Zara’s preferred entry mode is the hierarchical mode (direct investment), which is used in most Europeancountries, resulting in full ownership of the stores. In 2008, 87 per cent of the Zara stores were own managed.Those markets where the hierarchical model is used, are characterized by high growth potential and relativelow sociocultural distance (low country risk) between Spain and target market.

The intermediate modes (usually joint venture and franchising) are mainly used in countries where the sociocultural distance is relatively high.

Joint venturesThis is a cooperative strategy in which facilities and know-how of the local company are combined with theinternational fashion expertise of Zara. This particular mode is used in large, competitive markets where it is

EXHIBIT 9.1 Zara is modifying their preferred choice of entry mode, depending on the psychic distance to new markets





Desired mode characteristics

Risk-averseIf the decision-maker is risk-averse they will prefer export modes (e.g. indirect and directexporting) or licensing (an intermediate mode) because they typically entail low levels offinancial and management resource commitment. A joint venture provides a way of sharingrisk, financial exposure and the cost of establishing local distribution networks and hiringlocal personnel, although negotiating and managing joint ventures often absorbs consider-able management time and effort. However, modes of entry that entail minimal levels ofresource commitment and hence minimal risks are unlikely to foster the development ofinternational operations and may result in significant loss of opportunity.

ControlMode of entry decisions also need to consider the degree of control that management requiresover operations in international markets. Control is often closely linked to the level of resourcecommitment. Modes of entry with minimal resource commitment, such as indirect exporting,provide little or no control over the conditions under which the product or service is marketedabroad. In the case of licensing and contract manufacturing management needs to ensure thatproduction meets its quality standards. Joint ventures also limit the degree of managementcontrol over international operations and can be a source of considerable conflict where thegoals and objectives of partners diverge. Wholly owned subsidiaries (hierarchical mode) providethe most control, but also require a substantial commitment of resources.

FlexibilityManagement must also weigh up the flexibility associated with a given mode of entry. Thehierarchical modes (involving substantial equity investment) are typically the most costly but the least flexible and most difficult to change in the short run. Intermediate modes (con-tractual agreements and joint ventures) limit the firm’s ability to adapt or change strategywhen market conditions are changing rapidly.

Transaction-specific factors

The transaction cost analysis approach was discussed in Chapter 3 (section 3.3) and earlierin this chapter. We will therefore refer to only one of the factors here.

EquitySome investment of adefined financial value.

difficult to acquire property to set up retail outlets or where there are other kinds of obstacles that requirecooperation with a local company. For example, in 1999 Zara entered into a 50-50 joint venture with theGerman firm Otto Versand, which had experience in the distribution sector and market knowledge in one ofEurope’s largest markets, Germany.

FranchisingZara is choosing this mode for high-risk countries which are socioculturally distant or have small markets witha low sales forecast such as Kuwait, Andorra, Puerto Rico, Panama or the Philippines.

Whatever entry mode Zara is using, the main characteristic of their franchise model is the total integrationof franchised stores with own-managed stores in terms of product, human resources, training, window-dressing, interior design, logistical optimization and so on. This ensures uniformity in store managementcriteria and a global image in the eyes of customer around the world.

Source: adapted from the Zara case study and different public media.




Intermediate modesSomewhere betweenusing export modes(external partners) andhierarchical modes(internal modes).


Tacit nature of know-howWhen the nature of the firm-specific know-how transferred is tacit it is by definition difficultto articulate. This makes the drafting of a contract (to transfer such complex know-how) veryproblematic. The difficulties and costs involved in transferring tacit know-how provide anincentive for firms to use hierarchical modes. Investment modes are better able to facilitatethe intra-organizational transfer of tacit know-how. By using a hierarchical mode the firmcan utilize human capital, drawing upon its organizational routines to structure the transferproblem. Hence, the greater the tacit component of firm-specific know-how, the more a firmwill favour hierarchical modes.

Seen from the perspective of the manufacturer (international marketer), market entry modescan be classified into three groups:

1. export modes: low control, low risk, high flexibility2. intermediate modes (contractual modes): shared control and risk, split ownership3. hierarchical modes (investment modes): high control, high risk, low flexibility.

It cannot be stated categorically which alternative is the best. There are many internal andexternal conditions which affect this choice and it should be emphasized that a manufacturerwanting to engage in global marketing may use more than one of these methods at the sametime. There may be different product lines, each requiring a different entry mode.

TacitDifficult to articulate andexpress in words – tacitknowledge has often todo with complex productsand services, wherefunctionality is very hard to express.

Jarlsberg cheese (www.jarlsberg.com) has been well received in the US market. Nearly 50 years afterentering the United States it is now the importedcheese with the biggest market share of its categoryin the competitive US supermarkets.

However, following the quota which the WTO hasset up between Norway and the United States,Jarlsberg can only sell a limited amount of cheesefrom Norway to the US. The quota on Jarlsberg tothe US is approximately 7,000 tons. To increasesales, a licenced production was set up in Ohio in2000, with an annual production of approximately5,000 tons. Quality control is maintained by using acheese culture produced in Norway (based on asecret recipe from 1956), premium quality milk only,tailor-made production lines and key people educatedwithin dairy technology/science.

The total export of Norwegian cheese to the UnitedStates in 2008 was approximately 8,000 tonnes, ofwhich the majority was Jarlsberg. This means that thequota which the WTO set up between Norway andthe United States was full: Jarlsberg had to find otherways of selling cheese in the United States.

The story

Professor Ole M. Ystgaard and his employees at theNorwegian Agricultural School developed Jarlsbergin the 1950s. The cheese is based on traditions fromSwiss cheese makers, who developed cheese withholes in the 1830s.

Jarlsberg cheese arrived in the United States in1963. In the beginning, the Jarlsberg managementteam travelled around the country to demonstrate

CASE STUDY 9.1Jarlsberg: the king of Norwegian cheeses is deciding about entry modes in new markets

9.4 Summary





how the cheese could be used for everyday mealsand at parties. After just two years Jarlsberg had asales volume of 450,000 kg in the market, and themanagers understood they had a ‘hot’ product.

Jarlsberg has become a high-status product,served by celebrities at high-society parties.

Philadelphia. The second-largest cheese producerfor the US market is ConAgra Foods, which had totalsales of US$13 billion in 2008.

In general, the tendency to consume cheese ishigher in the eastern part of the United States,whereas ‘healthy’ food products are focused onmore in the western part of the country. There is atendency to eat more imported cheese as personalincome increases.

Jarlsberg’s customers and marketingJarlsberg cheese has some snob appeal. Customerswant to show they have good taste and they acceptthe higher price of Jarlsberg compared to othercompetitive products without complaining. The mildand creamy taste appeals to Americans, and manythink that the taste of the traditional Swiss cheese,Emmenthal, is too sharp.

Characteristics of the typical Jarlsberg buyer are:

� female� earning more than US$90,000 per year� over 40 years old.

It is important to buyers that it is an importedcheese. The fact that it is a Norwegian cheese playsa minor role and Norseland does not use this in itsmarketing.

Norseland’s objective is to attract new andyounger consumers for its Jarlsberg cheese. Toachieve this objective it wants to make contracts anddeals with retail chains like 7-Eleven, which also sellssandwiches, etc.

Besides its own sales force of about 25 salespeople, Norseland uses nearly 500 ‘cheese brokers’(distributors), who sell all over the United States.These are external sales representatives who visitshops, retail chains and restaurants in order to selland market products, among them Jarlsberg.

Five years from now Jarlsberg aims to be presentin at least five new countries, either sourced throughthe existing production units (e.g. in USA or Ireland)or supplied from Norway.

QUESTIONS1. Which kind of market entry mode would you

generally suggest for Jarlsberg

(a) in Scandinavia?

(b) in Asia?

2. What are the general motives for choosing a hierarchical mode (own subsidiary) in the UnitedStates?

Norseland Inc.Norseland Inc. was founded in 1978. The purpose ofthe company was to market and distribute Jarlsbergand other Norwegian cheese in the United States.The company is a wholly owned subsidiary of TINENorwegian Dairies, which has the main responsibilityfor the production and marketing of Jarlsbergcheese. In 2002 Norseland had net sales ofUS$130 million, about half of this derived fromimported Norwegian Jarlsberg, 25 per cent fromJarlsberg produced in Ohio and the remainder from sales of products from other companies, amongthem French Unilever Boursin. Norseland’s strategyis to sell exclusive cheeses only, and the companycommands respect in the US retail trade where a 90 per cent distribution coverage has been achieved.Norseland has a regional office in Montreal, Canada,where an additional 1,350 tonnes of Jarlsberg weresold in 2008.

The US cheese marketThe total US market for hard cheese is approximately400,000 tons, but the market also consumes a lot of soft cheese. Though Jarlsberg only has a smallmarket share in the total hard cheese market (in2008 Jarlsberg sold 12,600 tons to the US market)this represents the largest market share in the Swiss-like cheese category.

The largest producer of cheese for the US marketis Philip Morris, including the company Nabiscowhich Philip Morris bought in December 2000. Themost well-known brands from Philip Morris comefrom Kraft, which markets the popular soft cheese,

Tine.




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