Session 5

Global Enterprise and Competition66.511.202Fall 2007

Ashwin Mehta, Visiting Faculty

Session 5

Competitive Strategies: Modes of Entry and FDI

Session 5

Enron India

What risks did Enron face going into the Dabhol project?

• Political risk: expropriation of investment

• Political risk: renegotiation of contracts after investment

• Contract risk: problems with local partners

• Currency risk• Market risk: costs of energy and

demand for electric power• Recovery of investment costs (FDI)

Session 5

Enron India

How did Enron prepare for the risks of the project?

• Long term contracts: purchase agreement, Maharashtra State Electrical Board was a credible buyer

• Political risk: participation of Overseas Private Investment Corp, US Export-Import Bank, International Finance Corp.

• Revenues tied to US dollar

• Partners GE and Bechtel

• Substantial research

Session 5

Enron India

How could Enron have dealt with risk more effectively?

• Enron could have relied less on FDI• Enron could have emphasized

transactions, making arrangements for construction, power supply contracts, and technology transfer

• More reliance on local partners to construct and operate project

• Greater participation of other Indian institutions

Session 5

Enron India

Why did Enron choose ownership (FDI)?

• To exercise control over assets in investment projects

• To control technology due to limits on intellectual property rights

• To improve operational effectiveness

• To learn about market for future projects

• To avoid expected contract risk

Session 5

International Strategy

StrategyOptions

ExportingLicensing

FranchisingJoint Ventures

AcquisitionsGreen-Field Development

Production SharingTurnkey Operations

BOT ConceptManagement Contracts

Session 5

International Markets Entry Mode

Experimental – selected exportingComfort levelsMinimal cultural/political differences (little or no psychic distance)

Active Involvement – systematic approachIdentify International marketsAllocate resources

Global involvement – broad business activitiesDevelop Competitive advantage

Cyclical, causal process:

Market knowledge leads to Commitment decisionsMarket commitments Results from Current Activities

Before, an incremental processNow, Rapid Internationalization a more preferred approach

knowledge, tools, facilitating institutionsManagers are more prepared (outsourcing, technology transfers)Partnering/alliances

Session 5

Product related factorsProduct offering range/scopeProduct life cycle stage and market strategiesNeed for adaptationForeign-based partners (advantages?, risks?)

Market based factorsStrategies for target marketsAvailable distribution channelsPsychic distanceExperience levelGeographical coverage (# of locations/countries)Relative priority of each market

Organizational FactorsCommunicationControlAmount of assets/resources committed leads to type of Control

e.g. direct selling, manufacturing, R&D require high control

Entry mode is affected by

Session 5

Global Market Assessment

Importance of Market researchAT&T’s missed opportunity in China

Many sources, including US and State level departmentsDo not rely on a single source

Trade fairs, trade delegations, direct promotion, collaborate with suppliers and distributorsSome questions to ask:

· Which countries offer the best prospects? · In which foreign markets can company products be sold profitably? · Does the foreign market require any modification of the product? · What distribution channels and arrangements should be employed in selling to a particular country? · How sensitive is market demand to product price? · What should the landed and retail prices be? · What sales volume and margins can be expected in each

market? · What performance criteria should be used to monitor company

activity in each foreign market?

Session 5

Portfolio Matrix for Plotting Products by Country

Harvest/Divest Combine/License

Invest/Grow Dominate/Divest Joint Venture

Lo

wH

igh

High Low

Competitive Strengths

Co

un

try

Att

ract

iven

ess

Selective Strategies

Session 5

FDIFDI includes cross-border business investment and M&A.

(not portfolio investment)

World FDI inflows:

$209 billion (1990) (Cross-border M&A: $151 b.)

$1,492 billion (2000) (Cross-border M&A: $1,144 b.)

$735 billion (2001) (Cross-border M&A: $594 b.)

$651 billion (2002) (Cross-border M&A $ 370 b.)

$560 billion (2003) (Cross-border M&A $ 297 b.)

Compare with world total gross fixed capital formation: $7,294 b.

(2003)

Session 5

FDI• World FDI inward stock: $8,245 billion (2003)

• Sales of foreign affiliates: $17,580 billion (2003)(Compare with international trade of $9,228 billion (2003)

• Gross product of foreign affiliates: $3,706 billion (2003)(Compare with world GDP of $36 trillion in 2003).

• Total assets of foreign affiliates: $30,362 billion (2003)

• Employment of foreign affiliates: Over 54 million people (2003 estimated)

Data from United Nations World Investment Report and UNCTAD website

Session 5

FDI

2003 $ Billions

FDI inflows FDI outflows

Developed countries

367 570

Developing countries

172 36

Central and Eastern Europe

21 7

Session 5

International modes of entry and value at risk

• FDI – whether M&A or company growth – puts full value at risk.

Toyota factory, Wal-Mart store

• Managers of an international business choose the mode of entry based on a trade-off between risk versus control in the particular supplier or customer country

• Joint ventures, not only share knowledge, but also share investment costs and value at risk

• Spot or contract sales can substantially reduce value at risk

Session 5

International modes of entry and value at risk

• M&A• Growth• Alliances/

Joint Ventures

• Licenses• Contract• Spot

Increase in

control,

Increase in

commitment

and risk

• Choice of entry mode jointly determines degree of control and extent of risk

• Degree of commitment depends on contractual duration and vertical integration

• With less knowledge of other country’s market, choose lower degree of commitment

• As knowledge increases over time, can increase degree of commitment to get closer to desired entry mode.

• Contractual transactions may give optimal mix of control and commitment

Session 5

Choosing target countries for FDI

• Costs of investment project

• Estimate potential expected returns

• Determine risks associated with revenues and costs in host country -- Best estimates of expected cash flow

• Apply appropriate risk-adjusted discount rate

• Manager considers trade off between risk and return

Session 5

Why is FDI so common in international business?

Advantages of FDI• Production or distribution facilities in a country can reduce costs of trade (transportation, tariff and nontariff barriers, transaction costs, and time) – Toyota in US

• Production within a country takes advantage of domestic sourcing of parts, components, services

• Investment and employment in host country gain political support for the international business:

“quid pro quo investment” – Cemex and Southdown

Session 5

Why is FDI so common in international business?

Advantages of FDI• Closer to customers for manufacturers

• Necessary for retail and wholesale companies – Wal Mart, Carrefour, Ingram Micro

• Take advantage of low-cost labor, highly-skilled labor, and proximity to resources

• Reduce costs of trade from import/export

Session 5

Advantages of vertical FDI

• Coordination advantages through the value chain

• Access to production facilities, sourcing networks and distribution networks

• Keeping technology and intellectual property in-house

• Substitution of internal transactions for market transactions

Session 5

Advantages of Horizontal FDI

• M&A acquisition of competitors for market power or cost savings

• M&A to achieve economies of scale and scope (Daimler/Chrysler, VW)

• M&A to purchase of technology

• M&A to acquire brand names

• Production avoids costs of trade relative to export

• As hedge against demand and supply fluctuations -- Cemex

• Market power in international purchasing (e.g. Vodaphone/Airtouch purchases wireless equipment for its many operations)

Session 5

Disadvantages of FDI

• Risk that firm many not recover investment and returns to investment in supplier country

• FDI increases capital investment, reduces flexibility

• FDI ties business to particular country locations for production or distribution

• Vertical FDI makes the firm more vertically integrated

Session 5

FDI Trends

• Shift of investment mix toward services

About half in 1990, about two thirds in 2000

• Shift of investment to outsourcing abroad (offshoring + outsourcing) – reduction in vertical integration

• Globalization (lower costs of trade) leading to reduction in vertical FDI

• Globalization (market integration) likely to lead to increases in horizontal FDI

UNCTAD World Investment Report 2004

Session 5

Licensing versus FDI

Why is FDI more prevalent than technology licensing?

• Licensing agreements depend heavily on international enforcement of intellectual property rights

• International licensing also entails costs of trade

• International licensing is quite common amongst developed countries, reaching levels up to 1/3 of domestic R&D expenditures

• International licensing experiencing rapid growth

Session 5

Overview and Take-Away Points

• FDI a major feature of international business – composition of FDI undergoing transformation – from vertical to horizontal

• FDI offers advantages in terms of ownership and control and avoiding trade barriers

• Choose target countries based on expected cash flow and costs of investment and discount using risk adjusted rate of return

• Adjust level of investment to reflect expected cash flow and risk-adjusted rate of return

Session 5

Cooperative Strategies

Cooperative Strategies:–Collusion

• Active cooperation of firms to reduce output and raise prices– Explicit– Tacit

Session 5

Strategic Alliance:– Partnership of two or more corporations or

business units to achieve strategically significant objectives that are mutually beneficial.

Agreements between firms to do business together in ways that go beyond normal firm-to-firm dealings but fall short of merger or full partnership

More effective in combating competitive disadvantage than in gaining competitive advantage!

Session 5

Continuum of Strategic Alliances

Mutual Service Consortia

Joint Venture Licensing Arrangement

Weak and Distant

Value-Chain Partnership

Strong and Close

Source: Suggested by R. M. Kanter, “Collaborative Advantage: The Art of Alliances,” Harvard Business Review (July-August 1994), pp. 96–108.

Session 5

International Markets Entry Issues and Concerns:

R&D

Marketing

Logistics

Sourcing

Session 5

Global R&D Network

Configure for cost and manage for value

Distribution of R&D centers:

Rising costsOpening of markets (India, China)Information TechnologyScarcity of scientists and engineers

US/Western Europe/Japan

Proximity to technology/research clusters, markets/customers, qualified workers

In developing countries (India, Eastern Europe)

Lower cost, access to markets, pool of skilled workers

Session 5“Innovation: Is Global the Way Forward?”, Booz, Allen Hamilton & INSEAD, 2005

The Internationalization of R&D: The R&D footprint of most companies is becoming more global, with China and India seeing significant growth

Session 5

Multinational logistics

Logistics: flow of goods and material

multiple borders crossed (laws/regulations of each countrymultiple transportation modes

Complex process and challenging management

Logistics costs – a significant portion of total costs

Multinational transportationInfrastructure (highways, railroads, air, etc.) Modes (ocean shipping, air shipping)Selection (time, predictability, cost, Governmental factors)Inventory issue (order cycle time, customer service levels, storage)

Logistics ManagementCentralizedDecentralizedOutsource

Session 5

Multinational Marketing Issues

· Multinational Marketing Strategies· Market-Related Factors· Mix-Related Factors· Company-Related Factors

4 P’sProduct (positioning, PLM, counterfeit markets, etc.)

Placement (Channels design)

Promotion (advertising, PR, etc.)

Pricing (export pricing, transfer pricing, foreign market pricing, coordination)

Session 5

Multinational Sourcing

Purchasing, Procurement, Acquisition, sourcing/strategic sourcing

Centralized Vs Decentralized function

Worldwide sourcing has increased --- challenges to purchasing managersculture, language, laws, etc.

Why source Worldwidecost, access to technology, quality, more options

Barriers to WW sourcingPaperwork (LOC, Bill of Lading, licenses, etc.)InertiaLogistical challengesSecurity concerns (causing time delays)

Sourcing processEstablish needs/objectives/strategiesRFP’sEvaluation and Selections

Countertrades

Session 5

Modes of Entry and FDIFlextronics in India

© Professor Daniel F. Spulber

Session 5

With fiscal year 2007 revenues of USD$18.9 billion, Flextronics helps customers design, build, ship, and service electronics products for OEMs in the automotive, computing, consumer digital, industrial, infrastructure, medical, and mobile market segments.

Flextronics has a network of facilities in over 30 countries on four continents. This global presence provides design and engineering solutions that are vertically integrated with manufacturing, logistics, and component technologies to optimize customer operations by lowering costs and reducing time to market.

Flextronics

Session 5

Session 5

“Flextronics Design creates innovative, market-leading products for our customers. We partner at any phase of the product development cycle from concept to production launch. Our flexible engagement models allow customers to utilize Flextronics’ global engineering team for complete, full turnkey product development or for a specific contract design service. “

“By balancing stylish product design with the realities of manufacturing in today's global economy, Flextronics helps customers rapidly move from concept to production launch while optimizing resources and reducing costs.”

www.flextronics.com

Flextronics InternationalManufacturing operationBangalore

Session 5

• June, 2004: Flextronics acquires Hughes Software Systems.

• August, 2004, Flextronics acquires Chennai-based Future Software Ltd that provides software solutions to telecom firms.

• November 2004: Flextronics acquires Emuzed, multimedia solutions provider with R&D centres in Bangalore and Chennai.

• December, 2004: Flextronics acquires Deccanet that provides software and hardware design services.

Session 5

Choice of modes of entry

• Flextronics enters India through M&A by acquiring four companies – FDI

• Flextronics further expands its design capabilities by establishing facilities in India – FDI

• Design is vertically integrated with Flextronics manufacturing – vertical FDI

• Acquiring and protecting intellectual property are the main strategic motivations

• Management control and hiring skilled labor are also outcomes of M&A

Session 5

Assignment 3 Due December 13, 2007 GO TO THIS LINK (http://www.strategy-business.com/press/article/16651?pg=all&tid=230), REVIEW THE ARTICLE, DO A WEB RESEARCH ON COMPANIES DISCUSSED IN THE ARTICLE, AND ADDRESS THESE QUESTIONS: (YOU SHOULD WRITE AN INTRODUCTION/CONTEXT BEFORE ADDRESSING THESE QUESTIONS)

1. What are key success factors for a Global product Launch? Use Gillette as a template to discuss your response. Can such a template be applied to other industries? Give one example to support your response

2. Discuss Gillette’s process for a Global launch of Mach3 3. What are Gillette’s post-launch challenges and how are they managing?

YOUR REPORT MUST BE BETWEEN 1000 AND 1500 WORDS AND MUST INCLUDE SOURCES REFERENCED.