Foreign Direct Investment
Foreign Direct Investment
Learning objectives
• Be familiar with current trends regarding FDI in the world economy.
• Understand the different theories of foreign direct investment.
• Appreciate how political ideology shapes a government’s attitudes towards FDI.
• Understand the benefits and costs of FDI to home and host countries.
• Be able to discuss the range of policy instruments that governments use to influence FDI.
• Articulate the implications for management practice of the theory and government policies associated with FDI.
The focus of this chapter is foreign direct investment (FDI). The growth of foreign direct investment in the last 25 years has been phenomenal. FDI can take the form of a foreign firm buying a firm in a different country, or deciding to invest in a different country by building operations there.
With FDI, a firm has a significant ownership in a foreign operation and the potential to affect managerial decisions of the operation.
The goal of our coverage of FDI is to understand the pattern of FDI that occurs between countries, and why firms undertake FDI and become multinational in their operations as well as why firms undertake FDI rather than simply exporting products or licensing their know-how.
The opening case describes the international growth of Spain’s Telefonica. Until the 1990s, Telefonica was a typical state-owned firm. Today, it has expanded into Latin America and Europe. The closing case explores Mittal Steel’s expansion from a small, family-run operation in India, to being the world’s largest steel company headquartered in Rotterdam.
OUTLINE OF CHAPTER 7: FOREIGN DIRECT INVESTMENT
Opening Case: Spain’s Telefonica
Introduction
Foreign Direct Investment in the World Economy Trends in FDI The Direction of FDI The Source of FDI The Form of FDI: Acquisitions versus Greenfield Investments The Shift to Services
Country Focus: Foreign Direct Investment in China
Theories of Foreign Direct Investment Why Foreign Direct Investment? The Pattern of Foreign Direct Investment The Eclectic Paradigm
Management Focus: Foreign Direct Investment by Cemex
Political Ideology and Foreign Direct Investment The Radical View The Free Market View Pragmatic Nationalism Shifting Ideology
Management Focus: DP World and the United States
Benefits and Costs of FDI Host Country Benefits Host Country Costs Home Country Benefits Home Country Costs International Trade Theory and FDI
Government Policy Instruments and FDI Home Country Policies Host Country Policies International Institutions and the Liberalization of FDI
Implications for Managers The Theory of FDI Government Policy
Chapter Summary
Critical Thinking and Discussion Questions
Closing Case: Cemex’s Foreign Direct Investment
CLASSROOM DISCUSSION POINT
Ask students for examples of foreign firms that have invested in the U.S. Jot them down on the board.
Then, discuss why these companies invested in the U.S. Try to follow the framework presented in the text, and refer back to the board during the presentation of the material.
Next, explore what the investment means for the U.S.
OPENING CASE: Spain’s Telefonica
The opening case explores the international growth of Telefonica, a Spanish telecommunications firm. For decades, Telefonica had operated as a typical state-owned enterprise, but privatization and deregulation changes that path in the 1990s. Telefonica began to aggressively pursue expansion opportunities in Latin America where it quickly became the number 1 or 2 player in nearly every country. Later, Telefonica turned its sights on Europe where its acquisitions helped transform the company into the second biggest mobile phone operator in the world. Discussion of the case can revolve around the following questions:
1. Reflect on the various market entry strategies used by Telefonica. What type of entry strategy did Telefonica use in its expansion into Latin America? Why did Telefonica choose this approach over other forms of market entry?
2. Why was Latin America such an attractive market for Telefonica? How important were the historical ties between the region and Spain to Telefonica’s decision to invest?
3. Where do you think the best opportunities for future growth lie for Telefonica? Why?
Another Perspective: Telefonica’s web site is available at {http://www.telefonica.com/en/home/jsp/home.jsp}.
Another Perspective: Telefonica has expanded it alliance with China’s Unicom. To learn more, go to {http://www.businessweek.com/globalbiz/content/jul2008/gb2008079_485740.htm}.
LECTURE OUTLINE
This lecture outline follows the Power Point Presentation (PPT) provided along with this instructor’s manual. The PPT slides include additional notes that can be viewed by clicking on “view”, then on “notes”. The following provides a brief overview of each Power Point slide along with teaching tips, and additional perspectives.
Slide 7-3 What Is Foreign Direct Investment?
Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country. Once a firm undertakes FDI it becomes a multinational enterprise.
Another Perspective: Each year Fortune magazine publishes a list of the 500 largest global corporations in the world. Fortune calls its list the "Global 500." This list can be accessed at {http://money.cnn.com/magazines/fortune/global500/2009/index.html}. The article contains an excellent discussion of the role of global firms in the world economy.
FDI can take the form of a greenfield investment where a wholly new operation is established in a foreign country, or it can take place via acquisitions or mergers with existing firms in the foreign country.
Another Perspective: Another web site that provides an excellent discussion of the role of multinational corporations in the world economy is available at {http://www.oecdobserver.org/news/fullstory.php/aid/446/The_trust_business.html}.
The flow of FDI refers to the amount of FDI undertaken over a given time period, while the stock of FDI refers to the total accumulated value of foreign-owned assets at a given time. Outflows of FDI are the flows of FDI out of a country, and inflows of FDI are the flows of FDI into a country.
Slides 7-6-7-9 Trends in FDI
There has been a marked increase in both the flow and stock of FDI in the world economy over the last 30 years.
While the United States remains a top destination for FDI flows, South, East, and Southeast Asia, and particularly China, are now seeing an increase of FDI inflows, and Latin America is also emerging as an important region for FDI.
Another Perspective: FDI in China continues to be strong, and India is emerging as another hotspot for FDI. To learn more about these markets go to {http://www.businessweek.com/globalbiz/content/mar2009/gb20090318_214447.htm}.
Slides 7-11-7-12 The Source of FDI
Since World War II, the U.S. has been the largest source country for FDI. The United Kingdom, the Netherlands, France, Germany, and Japan are other important source countries.
Another Perspective: Since the recent global recession, Great Britain has seen its economic position in the Europe Union and within the global economy shift. To learn more about the country’s changing fortunes, go to {http://www.businessweek.com/globalbiz/content/feb2009/gb20090224_856591.htm}.
Slide 7-13 The Form of FDI: Acquisitions Versus Greenfield Investments
Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments.
Slide 7-14 The Shift to Services
FDI is shifting away from extractive industries and manufacturing, and towards services.
Slides 7-15 Why Foreign Direct Investment?
Why do firms choose FDI instead of exporting or licensing? Internalization theory (also known as market imperfections theory) suggests that licensing has three major drawbacks.
Slides 7-16 The Pattern of Foreign Direct Investment
Knickerbocker looked at the relationship between FDI and rivalry in oligopolistic industries (industries composed of a limited number of large firms) and suggested that FDI flows are a reflection of strategic rivalry between firms in the global marketplace.
Vernon argued that firms undertake FDI at particular stages in the life cycle of a product they have pioneered.
According to the eclectic paradigm, in addition to the various factors discussed earlier, it is important to consider: • location-specific advantages - that arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets and • externalities - knowledge spillovers that occur when companies in the same industry locate in the same area
Slide 7-18 Political Ideology and Foreign Direct Investment
Ideology toward FDI ranges from a radical stance that is hostile to all FDI to the non-interventionist principle of free market economies. Between these two extremes is an approach that might be called pragmatic nationalism.
The radical view argues that the MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries.
According to the free market view, international production should be distributed among countries according to the theory of comparative advantage.
Pragmatic nationalism suggests that FDI has both benefits, such as inflows of capital, technology, skills and jobs, and costs, such as repatriation of profits to the home country and a negative balance of payments effect.
Recently, there has been a strong shift toward the free market stance creating: • a surge in FDI worldwide • an increase in the volume of FDI in countries with newly liberalized regimes
Slide 7-19 Benefits of FDI
Government policy is often shaped by a consideration of the costs and benefits of FDI.
There are four main benefits of inward FDI for host countries: resource transfer effects; employment effects; balance of payments effects, and effects on competition and growth.
Slides 7-21 Host Country Costs
There are three mains costs from inward FDI for the host country: the possible adverse effects of FDI on competition within the host nation; adverse effects on the balance of payments; and the perceived loss of national sovereignty and autonomy.
Slide 7-22 Home Country Benefits
The benefits of FDI for the home country include: the effect on the capital account of the home country’s balance of payments from the inward flow of foreign earnings; the employment effects that arise from outward FDI; and the gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country.
Slide 7-23 Home Country Costs
The home country’s balance of payments can suffer from the initial capital outflow required to finance the FDI; if the purpose of the FDI is to serve the home market from a low cost labor location; and if the FDI is a substitute for direct exports.
International trade theory suggests that home country concerns about the negative economic effects of offshore production (FDI undertaken to serve the home market) may not be valid.
Slide 7-24 Government Policy Instruments and FDI
Home countries and host countries use various policies to regulate FDI.
Another Perspective: The World Bank offers information on the business environment in different countries. To explore the information, go to {http://www.worldbank.org/}, click on “countries”, and select the country in question.
Governments can both encourage and restrict FDI
Another Perspective: India has recently revised its regulations regarding FDI raising concerns among some analysts. To learn more about India’s new regulations go to {http://www.businessweek.com/globalbiz/content/feb2009/gb20090213_539478.htm}.
To encourage inward FDI, governments offer incentives to foreign firms to invest in their countries, while they restrict inward FDI through ownership restraints and performance requirements.
Slide 7-26 International Institutions and the Liberalization of FDI
The World Trade Organization is trying to establish a universal set of rules designed to promote the liberalization of FDI.
Slide 7-27-7-28 Implications for Managers
Managers need to consider what trade theory implies, and the link between government policy and FDI.
The direction of FDI can be explained through the location-specific advantages argument associated with John Dunning.
A host government’s attitude toward FDI is an important variable in decisions about where to locate foreign production facilities and where to make a foreign direct investment.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: In 2004, inward FDI accounted for some 24% of the gross fixed capital formation in Ireland, but only .6% in Japan. What do you think explains the difference in FDI inflows into the two countries?
ANSWER 1: One approach to this question is to look at government policy: Ireland is FDI-friendly while Japan has discouraged inward FDI. Both are trade-dependent economies with few natural resources, but Ireland appears far less mercantilist in attitude than does Japan. Ireland has a well-educated, relatively low cost workforce and an abundant supply of labor, while Japan’s workforce, also well-educated, is expensive.
QUESTION 2: Compare and contrast these explanations of FDI: internalization theory, Vernon's product life cycle theory, and Knickerbocker's theory of FDI. Which theory do you think offers the best explanation of the historical pattern of FDI? Why?
ANSWER 2: Knickerbocker's theory suggests that firms imitate other firms in oligopolistic industries, and will "follow the leader" in undertaking FDI in certain countries, as sort of strategic defensive moves. This theory does not explain why the first firm undertakes FDI, nor why it chooses to do this rather than to export or license. The product life cycle theory suggests that firms invest in foreign countries when demand in that country will support local production or when cost pressures make it necessary to locate production in low cost locations. While this theory does explain why some FDI takes place, it does not explain why FDI is preferred over licensing or exporting. The market imperfections explanation more directly confronts these issues, and explains why FDI may be preferable to other alternatives for expanding business activities. It identifies the importance and difficulty of transferring know-how and describes some of the impediments to exporting. By explaining better exactly why a firm may undertake FDI, the market imperfections model is probably the best explanation of the historical pattern of horizontal FDI.
QUESTION 3: Read the Management Focus on Cemex and then answer the following questions:
a) Which theoretical explanation, or explanations, of FDI best explains Cemex’s FDI?
b) What is the value that Cemex brings to the host economy? Can you see any potential drawbacks of inward investment by Cemex in an economy?
c) Cemex has a strong preference for acquisitions over greenfield ventures as an entry mode. Why?
d) Why do you think Cemex decided to exit Indonesia after failing to gain majority control of Semen Gresik? Why is majority control so important to Cemex?
e) Why do you think politicians in Indonesia tried to block Cemex’s attempt to gain majority control over Semen Gresik? Do you think Indonesia’s best interests were served by limiting Cemex’s FDI in the country?
ANSWER 3:
a) Cemex is a cement company. Consequently, exporting is difficult because of the weight of the product. If Cemex wants to expand into new markets, the company would either need to license a local company or make an investment in the market directly. Cemex’s success is due in part to its top notch customer service, and relationship with distributors. Because these advantages could be difficult to transfer, the company will probably choose to invest directly. Students should reflect on these factors as they consider the various theories to explain Cemex’s FDI.
b) Cemex is the third largest cement company in the world, and a powerhouse in Mexico where it controls 60 percent of the market. Cemex is highly focused on efficient manufacturing and customer service. Distributors are rewarded for their sales, as are users. The primary benefit Cemex brings to host countries involves these competitive advantages. Cemex acquires companies and then transfers technological, management, and marketing know-how to the new units, improving their performance. The company has brought several acquired companies back to full production, increasing employment opportunities in the host country as well.
c) Cemex has successfully acquired established cement makers in many countries. By acquiring companies rather than establishing them from the ground up, Cemex can avoid some of the delays that could occur in the start-up phase, while at the same time, capitalize on the benefits of an established market presence.
d) Much of Cemex’s success appears to be built around its customer service and attention to distributors. Indeed, it could be argued that what sets Cemex apart from its competitors, or its competitive advantage, is its superior way of dealing with external stakeholders. It is significantly easier to duplicate this sort of advantage in a wholly owned operation than in a joint venture or through licensing arrangements.
e) In 2006, Cemex announced that it would be pulling out of Indonesia. Cemex entered the Indonesian market in 1998, as part of an IMF sponsored privatization program. Cemex purchased a 25 percent stake in Semen Gresik, a government owned cement maker. Cemex’s decision to pull out was a result of a dispute with the Indonesian government. When Cemex has entered the market, it had been promised a majority position in Semen Gresik in 2001. However thanks to the efforts of various special interest groups, permission was never granted. Whether the decision to pull out was in the best interests of the country is difficult to say. Certainly it would seem that Semen Gresik could learn from Cemex, and utilize its knowledge to improve its own operations. However, allowing a foreign company to control an industry that is necessary to a country could be detrimental to the nation.
Another Perspective: Cemex’s web site is available at {http://www.cemex.com}.
QUESTION 4: You are the international manager of a US business that has just invented a revolutionary new personal computer that can perform the same functions as existing PCs but costs only half as much to manufacture. Several patents protect the unique design of this computer. Your CEO has asked you to formulate a recommendation for how to expand into Western Europe. Your options are (a) to export from the US, (b) to license a European firm to manufacture and market the computer in Europe, and (c) to set up a wholly owned subsidiary in Europe. Evaluate the pros and cons of each alternative and suggest a course of action to your CEO.
ANSWER 4: In considering expansion into Western Europe, an international manager might consider three options: FDI, licensing, and export. With export, assuming there are no trade barriers, the key considerations would likely be transport costs and localization. While transport costs may be quite low for a relatively light and high value product like a computer, localization can present some difficulties. Power requirements, keyboards, and preferences in models all vary from country to country. It may be difficult to fully address these localization issues from the US, but not impossible. Since there are many computer manufacturers and distributors in Europe, there are likely to be a number of potential licensees. But a licensing arrangement implies that valuable technological information may have to be disclosed and that the firm’s competitive advantage may be lost if the licensees uses or disseminates this proprietary knowledge improperly. FDI (setting up a wholly owned subsidiary) is clearly the most costly and time consuming approach, but the one that best guarantees that critical knowledge will not be disseminated and that localization can be done effectively. FDI will also place you in the market into which you want to sell and allow you to be near the consumer. Given the fast pace of change in the personal computer industry, it is difficult to say how long this revolutionary new computer will retain its competitive advantage. If the firm can protect its advantage for a period of time, FDI may pay off and help assure that critical knowledge is not lost. If the innovation is not core and can be easily copied, then licensing would allow the firm to get the quickest large scale entry into Europe and make as much as it can before losing advantage.
CLOSING CASE: Lakshmi Mittal and the Growth of Mittal Steel
Summary
The closing case examines the growth of Mittal Steel from a small, family owned company based in India to the world’s largest steel company headquartered in Luxembourg. Mittal Steel’s growth strategy involved acquiring companies in distress at low prices, improving their efficiency, and capitalizing on a growing demand for steel. Mittal Steel also used its growing power in the industry to drive down the prices of raw materials. Mittal Steel’s most recent acquisition involved European steel maker Areclor, which was acquired in a hostile takeover in 2007 to create ArcelorMittal. Today, the firm boasts sales of $110 billion and a net income of $10.2 billion. Discussion of the case can revolve around the following questions:
QUESTION 1: What forces drove Mittal Steel to start expanding across national borders?
ANSWER 1: Mittal Steel began as a family-run operation in India based in the early 1970s. However, because of various restrictive government regulations and strong competition from a state-owned firm, SAIL, and the large, privately-owned Tata Steel, Mittal Steel felt its best prospects for growth lay outside India. In 1975, Mittal Steel began its first foreign venture by building a steel making plant from scratch in Indonesia.
QUESTION 2: Mittal Steel expanded into different nations through mergers and acquisitions, as opposed to greenfield investment investments. Why?
ANSWER 2: The vast majority of Mittal Steel’s expansion has taken place via acquisitions and mergers. At the time Mittal Steel was beginning its foreign expansion, the steel industry was in the throes of a twenty-five year slump, and many companies were in distress. Lakshmi Mittal, CEO, believed there was value in these distressed companies, and that with an injection of capital and a shift toward greater efficiency, the firms could be viable operations. Most students will probably suggest that the cost of building similar operations from scratch (greenfield investments) would probably be considerably higher. Moreover, by acquiring companies rather than establishing them from the ground up, Mittal Steel could avoid some of the delays that could occur in the start-up phase, while at the same time, capitalize on the benefits of an established market presence.
QUESTION 3: What benefits does Mittal Steel bring to the countries that it enters? Are there any drawbacks to a nation when Mittal Steel invests there?
ANSWER 3: Most students will probably agree that because Mittal Steel has focused on acquiring distressed companies and turning them around, its presence in a foreign market would probably be viewed as beneficial. Some students however, may note that Mittal Steel’s most recent acquisition, Arcelor did generate a strong negative reaction from management and politicians who resisted the efforts of a foreign firm to take over an organization that was important to the European market. Indeed, some students may suggest that Europe and other countries are now vulnerable to the whims of a foreign company – a company that may or may not make decisions that benefit the local market.
QUESTION 4: What are the benefits to Mittal Steel from entering different nations?
ANSWER 4: By being a player in multiple markets, Mittal Steel has diversified its income streams, and reduced its dependence on any single market. In addition, its global presence enables it to control to some extent the price of raw materials in the industry. Many students will probably also recognize that the prospects for growth in the steel industry almost imply growing across borders, simply because of limited demand within any single market.
QUESTION 5: The acquisition of Arcelor was very acrimonious, with many politicians objecting to it. Why do you think they objected? Were their objections reasonable?
ANSWER 5: In 2006, the shareholders of Arcelor, a European firm formed through the merger of steel makers from three European countries, approved the acquisition of Arcelor by Mittal Steel. Many politicians, who saw the acquisition as a threat to their countries, objected vehemently to the merger. Most students will probably suggest that their opposition to the deal probably related to concerns that Mittal Steel had no particular loyalty to Europe and would simply make decisions that improved the value of the firm, regardless of their effects on the local market. Many students will probably suggest the concerns of the politicians were valid, bit may also point out that because Mittal Steel has moved its headquarters to Rotterdam, it too was a European company. In addition, students may point out that Arcelor’s shareholders believed the acquisition should go ahead.
Another Perspective: ArcelorMittal’s web site is available at {http://www.arcelormittal.com/}.
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:
Title: After Chrysler Deal, Fiat to Face Tough U.S. Car Market
Run Time: 8:04
Abstract: This video explores the challenges facing Chrysler as it emerges from bankruptcy will new owners, a new leader, and a new agenda.
Key Concepts: global strategy, foreign direct investment, globalization, pressures for cost reductions, global economy, global production and sourcing, foreign direct investment
Notes: Italian car maker Fiat’s recent acquisition of a large share of Chrysler is the start of a new chapter for the troubled U.S. auto company. For Chrysler, the deal was an important component in its restructuring. The company had been in bankruptcy, weighed down with billions of dollars of debt and labor costs. The new, leaner Chrysler Group which will be owned jointly by Fiat, the U.S. government, the Canadian government, and the United Auto Workers union, will be led by the head of Fiat, Sergio Marchionne. Under the new ownership structure, the governments will own 10 percent of the company, Fiat will own 35 percent, and the union will control the remaining 55 percent of the organization.
Marchionne, who is highly regarded in Italy and indeed Europe, joined Fiat five years ago and not only helped turn the company away from financial disaster, but helped make it into one of the stronger auto companies today. Many analysts believe that Marchionne’s experience at Fiat will serve him well as he takes on the challenges facing Chrysler. At Fiat, Marchionne focused on keeping costs in check, working closely with unions, and developing a product line designed to attract customers. Fiat is important to Chrysler’s future for several reasons. One key reason is Marchionne’s experience in turning around a troubled company. Fiat also brings knowledge of small-car platform technology and the engine technology that will allow Chrysler to meet strict new environmental regulations. Perhaps most important to Chrysler however, are Fiat’s design skills. Like the Fiat of a few years ago, Chrysler has been struggling with high costs and union demands, as well as tough new CAFÉ regulations. In addition though, Chrysler has been losing customers because of its dull product line. In fact, Francesco Guerrera of the Financial Times, feels that Chrysler’s inability to design exciting cars is at the root of its problems. John Wolkonowitz of HIS Global Insight agrees, and suggests that Fiat could be the key to Chrysler regaining its position as a design leader – a position it once held in the 1990s.
For now, most analysts believe that Chrysler will continue to focus on improving efficiency by eliminating unnecessary layers of management and closing dealerships. Already, the firm has closed 800 dealerships. Factories that had been closed as part of the bankruptcy process are expected to reopen in the near future. In fact, there is some urgency to the process at this point because of concerns that if the company does not become operational soon, both customers and employees will begin to move away. One of the key challenges for Chrysler in the weeks ahead will be managing the various, and perhaps conflicting, interests of its many stakeholders. Because the stakeholders are expected to be quite vocal with their demands, compromise may become the name of the game.
Discussion Questions:
1. Fiat has emerged as a sort of knight in shining armor for Chrysler. The Italian automaker has acquired 35 percent of the troubled U.S. company and will now call the shots as the auto maker reemerges from bankruptcy. In addition to a much needed influx of funds, what does Fiat bring to Chrysler? How can Fiat help Chrysler become a global player once again?
2. Comment on the new ownership structure at the Chrysler Group. How might the fact that the group is now owned by various parties from various countries influence decision making at the firm? Why have analysts suggested that it is critical for Chrysler to get back to regular operating levels quickly?
3. Fiat’s acquisition of one third of Chrysler means that the American company will now be led by an Italian CEO. What challenges do you see for the restructured Chrysler Group as it tries to mesh operating styles and organizational cultures?
4. The SWOT analysis is a management tool used by many organizations to identify firm strengths and weakness, as well as opportunities the firm could capitalize on, and threats it should be aware of. Reflect on the newly restructured Chrysler Group. Based on what you know about the new Chrysler as well as the auto industry in general develop a SWOT analysis for the firm.
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following from International Business DVD Volume 5:
Title 7: Wal-Mart’s Success in China
Abstract: This video explores Wal-Mart’s success in China as both a buyer and as a seller.
Key Concepts: foreign direct investment, trade, global economy, globalization, levels of economic development, global strategy
Notes: Most Americans are probably aware that many of the products they buy are made in China. However, many Americans might be surprised to know that the U.S. retail giant Wal-Mart is actually China’s eighth largest trading partner. In fact, about 70 percent of the products sold in a Wal-Mart store are manufactured in China. In 2004, Wal-Mart’s purchases from China were estimated to be about $18 billion. Wal-Mart’s relationship with China is not a one-way street though. Wal-Mart has successfully opened several stores in China that attract crowds of shoppers. One man even bought his house so that he could be close to the store.
Chinese exports to the United States are attractive to Americans because of their low prices. Experts also note that the low prices also help hold down inflation rates in the United States. The Chinese are able to sell their products cheaply because of the low wage rates in China. In 2002 for example, the average Chinese factory worker made just $0.64 per hour as compared to the $21 per hour earned by an American factory worker. While some Americans raise concerns about the possibility of more manufacturing jobs being shifted to China, experts agree that those jobs have already left the United States, and will not return. If the Chinese do not manufacture the goods, another low-cost Asian country will.
China’s exports to the United States are also important to Americans because they give the Chinese the income to buy American-made goods like airplanes and cars. Roads in China are now clogged with American-made cars, and shopping districts advertise American products like McDonald’s, KFC, Pepsi, and Coca–Cola. The Chinese are likely to continue to buy more and more products labeled “Made in America” thanks to new legislation that further opens the Chinese market to American companies. U.S. companies like Wal-Mart now have permission to build as many stores as they want, wherever they want. America’s love affair with Wal-Mart and the inexpensive Chinese-made goods it sells is strong, and now it seems the legendary retailer has captured the hearts of the Chinese as well.
Discussion Questions:
1. What type of investment does Wal-Mart have in China? Why do you think Wal-Mart followed this strategy? What are the benefits to China of Wal-Mart’s investment?
2. Approximately 70 percent of everything Wal-Mart sells is made in China. Why does Wal-Mart buy so much from China?
3. Explain the three approaches to foreign direct investment. Which approach best reflects China’s attitude toward foreign investment? What does your answer imply for companies seeking to expand into China?
4. What actions can China take to ensure that it continues to attract inward foreign direct investment? What challenges do you see for China as it courts new investment?
5. China has attracted significant investment from foreign companies including Wal-Mart in recent years. How has its trade and investment affected economic and social development in China?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following exercises:
Exercise 1
The World Investment Report published annually by UNCTAD provides quick electronic access to comprehensive statistics on the operations of the largest transnational corporations. Gather a list of the top 10 non-financial transnational corporations from south-east Europe and the Commonwealth of Independent States (CIS). Provide a summary of the countries and industries represented. Do you notice any common traits from your analysis?
Exercise 2
Your venture capital firm is considering a partnership with entrepreneurs in Asian-Pacific countries which make it easy to do business. The owner of your company suggests that you prepare a report based on information from the Country Brand Index. How many countries have you identified? After using the same resource to evaluate Asian-Pacific countries that are ideal for doing business, which countries will you suggest for developing partnerships and investing venture capital?
Answers to Exercises
Exercise 1
The data source can be accessed by searching the term “World Investment Report” at http://globaledge.msu.edu/ResourceDesk/. The link to the World Investment Report is found under the globalEDGE category “Research: Statistical Data Sources”. On this website, the list of members top transnational corporations can be found under the “Largest TNCs” link, located on the left or at the top of the page. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “World Investment Report”
Resource Name: UNCTAD: Largest Transnational Corporations
Website: http://www.unctad.org/Templates/Page.asp?intItemID=2443&lang=1 globalEDGE™ Category: “News & Periodicals: Publications”
Exercise 2
The Country Brand Index website provides both business- and tourist-related information concerning the countries of the world. This resource can be accessed by searching “Country Brand Index” at http://globaledge.msu.edu/ResourceDesk/. The link to is found under the globalEDGE category “Reference: Travel/Living Abroad”. On this website, both categories described in the exercise can be found, located at the bottom of the page. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “Country Brand Index”
Resource Name: Country Brand Index
Website: http://www.countrybrandindex.com/ globalEDGE™ Category: “Reference: Travel/Living Abroad”
Entry Strategy and Strategic Alliances
Learning objectives
• Explain the three basic differences that firms contemplating foreign expansion must make: which markets to enter, when to enter those markets, and on what scale.
• Outline the advantages and disadvantages of the different modes that firms use to enter foreign markets.
• Identify the factors that influence a firm’s choice of entry strategy.
• Evaluate the pros and cons of acquisitions versus greenfield ventures as an entry strategy.
• Evaluate the pros and cons of entering into strategic alliances.
This chapter is concerned with three closely related topics: the decisions of which markets to enter, when to enter those markets, and on what scale.
When a firm that wishes to enter a foreign market, it has several options, including exporting, licensing or franchising to host country firms, setting up a joint venture with a host country firm, or setting up a wholly owned subsidiary in the host country to serve that market. Each of these options has its advantages and each has its disadvantages.
Strategic alliances have become more frequent. They may be seen as one way for firms to enter into cooperative agreements between actual or potential competitors. The term "strategic alliances" is often used rather loosely to include a wide range of arrangements between firms, including cross-share holding deals, licensing arrangements, formal joint ventures, and informal cooperative deals.
The magnitude of the advantages and disadvantages associated with each entry mode are determined by a number of different factors, including transport costs and trade barriers, political and economic risks, and firm strategy.
The opening case discusses General Electric’s changing perspective on the value of joint ventures as a market entry mode. In the past, General Electric has avoided joint ventures and the shared control they imply when entering foreign markets, but more recently, the company has embraced the entry mode as a means of acquiring knowledge of the local market. The closing case explores JCB’s market entry strategy in India.
OUTLINE OF CHAPTER 14: ENTRY STRATEGY AND STRATEGIC ALLIANCES
Opening Case: General Electric’s Joint Ventures
Introduction
Basic Entry Decisions Which Foreign Markets? Timing of Entry Scale of Entry and Strategic Commitments Summary
Management Focus: Tesco’s International Growth Strategy Management Focus: The Jollibee Phenomenon—A Philippine Multinational
Entry Modes Exporting Turnkey Projects Licensing Franchising Joint Ventures Wholly Owned Subsidiaries
Selecting an Entry Mode Core Competencies and Entry Mode Pressures for Cost Reductions and Entry Mode
Greenfield Venture or Acquisition? Pros and Cons of Acquisitions Pros and Cons of Greenfield Ventures Greenfield or Acquisition?
Strategic Alliances The Advantages of Strategic Alliances The Disadvantages of Strategic Alliances Making Alliances Work
Management Focus: Cisco and Fujitsu
Chapter Summary
Critical Thinking and Discussion Questions
Closing Case: JCB in India
CLASSROOM DISCUSSION POINT
Ask students to find several examples of companies expanding into new markets. Students can use publications like the Wall Street Journal or Business Week as sources. Then ask students to consider why the companies involved chose the form of market entry involved.
Try to get students to think about the trade-offs involved with the various forms of market entry. Jot their responses on the board using the framework presented in the text.
Finally, refer back to the discussion during the presentation of the material so students recognize the trade-offs companies make.
OPENING CASE: General Electric’s Joint Ventures
The opening case explores General Electric’s change in strategy. For years, General Electric entered new markets using wholly owned operations that it built from the ground up. Today however, the company has moved to a joint venture approach. Discussion of the case can revolve around the following questions:
1. General Electric has traditionally followed a strategy of expanding into new markets using wholly owned greenfield ventures. More recently however, the company has shifted to a strategy of forming joint ventures with local companies. Explain why General Electric has made this strategic shift.
2. What are the disadvantages of General Electric’s new strategy of using joint ventures to enter foreign markets?
Another Perspective: To explore General Electric’s international operations in more depth, go to {http://www.ge.com/}.
Another Perspective: To extend this case, consider {http://www.businessweek.com/innovate/content/may2008/id20080515_212057.htm?chan=search}.
LECTURE OUTLINE FOR CHAPTER
This lecture outline follows the Power Point Presentation (PPT) provided along with this instructor’s manual. The PPT slides include additional notes that can be viewed by clicking on “view”, then on “notes”. The following provides a brief overview of each Power Point slide along with teaching tips, and additional perspectives.
Slides 14-3 Basic Entry Decisions
Firms expanding internationally must decide which markets to enter, when to enter them and on what scale, and which entry mode to use. Entry modes include exporting, licensing or franchising to a company in the host nation, establishing a joint venture with a local company, establishing a new wholly owned subsidiary, or acquiring an established enterprise.
Slide -14-4 What Influences Entry Mode Choice
Several factors affect the choice of entry mode including transport costs, trade barriers, political and economic risks, costs, and firm strategy.
Slide 14-5 Which Foreign Markets?
The choice of foreign markets will depend on their long run profit potential.
Slides 14-6- 14-8 Timing of Entry
Once attractive markets are identified, the firm must consider the timing of entry. Entry is early when the firm enters a foreign market before other foreign firms, and late when the firm enters the market after firms have already established themselves in the market.
First mover advantages are the advantages associated with entering a market early. First mover disadvantages are disadvantages associated with entering a foreign market before other international businesses.
Slide 14-10 Scale of Entry and Strategic Commitments
After choosing which market to enter and the timing of entry, firms need to decide on the scale of market entry. Large-scale entry may keep rivals out and may stimulate indigenous competitive response. Small-scale entry allows time to learn about the market and reduces risk exposure.
Slide 14-11 Which is Best?
There are no “right” decisions when deciding which markets to enter, and the timing and scale of entry, just decisions that are associated with different levels of risk and reward.
Slide 14-12-14-13 Entry Modes
The six entry modes are exporting, turnkey projects, licensing, franchising, joint ventures, and wholly owned subsidiaries.
Slides 14-14 Exporting
Exporting avoid costs of investing in new location and may help achieve experience curve and location economies. Exporting faces challenges from tariff barriers, transportation costs, control over marketing, and local low-cost manufacturers.
Another Perspective: The Business Link {http://www.canadabusiness.ca/eng/} provides information companies should know before they begin exporting. Students can click on the various topics to learn more about export financing, export plans, dealing with risk, and so on.
Slides 14-15 Turnkey Projects
Turnkey projects allow a company to get a return on knowledge assets and are less risky than conventional FDI. The disadvantages are that there is not long-term interest in the location, the project may create a competitor, and process technology may be selling a competitive advantage.
Another Perspective: To learn more about how one company, Ashoka Technologies, organizes turnkey projects for clients go to {http://www.turnkey-projects.com/turnkey-plants.html}.
Slides 14-16 Licensing
Licensing does not bear the costs and risks of investment and avoids political/economic restrictions in a country.
Slides 14-17 Franchising
Franchising reduces costs and risks, avoids political and economic restrictions, and allows for quicker expansion. Disadvantages include loss of control over quality.
Slides 14-18 Joint Ventures
Joint ventures benefit from the local partner's knowledge, shared costs, and reduced risk.
Disadvantages include loss of control over technology and conflict between partners.
Another Perspective: 1000ventures, available at {http://www.1000ventures.com/business_guide/jv_main.html} is a web site that offers a wealth of information about joint ventures.
Slides 14-19 Wholly Owned Subsidiaries
Wholly owned subsidiaries offer the most control and the highest level of risk and cost.
Slides 14-22 Selecting an Entry Mode
The optimal choice of entry mode involves trade-offs.
Slide 14-23 Core Competencies and Entry Mode
The optimal choice of entry mode for firms pursuing a multinational strategy depends to some degree on the nature of their core competencies.
Slide 14-24 Pressures for Cost Reductions and Entry Mode
When pressure for cost reductions is high, firms are more likely to pursue some combination of exporting and wholly owned subsidiaries.
Slide 14-26 Greenfield Ventures or Acquisitions
Firms can establish a wholly owned subsidiary in a country through a greenfield strategy (building a subsidiary from the ground up) or through an acquisition strategy.
Slides 14-27 Pros and Cons of Acquisitions
Pros: quick, preemptive, possibly less risky. Cons: disappointing results, overpay, optimism/hubris, culture clash, failure of synergies
Slide 14-28 Pros and Cons of Greenfield Ventures
Greenfield ventures allow the firm to build the subsidiary it wants, but it is slow, risky, and may involve preemption by competitors.
Acquisition is quicker, so a consideration if there are competitors ready to enter.
Slide 14-30 Strategic Alliances
Strategic alliances refer to cooperative agreements between potential or actual competitors.
Slide 14-31 The Advantages of Strategic Alliances
Strategic alliances facilitate entry into a foreign market, allow firms to share the fixed costs (and associated risks) of developing new products or processes, bring together complementary skills and assets that neither partner could easily develop on its own, can help a firm establish technological standards for the industry that will benefit the firm.
Strategic alliances can give competitors low-cost routes to new technology and markets, but unless a firm is careful, it can give away more than it receives.
The firm must be certain that the partner is one that can help the firm achieve its goals and not act opportunistically to exploit the alliance purely for its own ends.
Slides 14-32 Making Alliances Work
The success of an alliance is a function of partner selection, alliance structure, and manner in which the alliance is managed.
Another Perspective: The Association of Strategic Alliance Professionals {http://www.strategic-alliances.org/} is an organization devoted to the formation of successful strategic alliances. The organization is supported by a number of well-known global companies, and provides information on the involvement of the companies in strategic alliances.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: Reread the Management Focus on Tesco. Then answer the following questions:
a) Why did Tesco’s initial international expansion strategy focus on developing nations?
b) How does Tesco create value in its international operations?
c) In Asia, Tesco has a long history of entering into joint venture agreements with local partners. What are the benefits of doing this for Tesco? What are the risks? How are those risks mitigated?
d) In March 2006, Tesco announced that it would enter the United States. This represents a departure from its historic strategy of focusing on developing nations. Why do you think Tesco made this decision? How is the U.S. market different from others Tesco has entered? What are the risks here? How do you think Tesco will do?
ANSWER 1:
a) Tesco’s global expansion strategy has been rather unique in the grocery industry. Rather than competing head-to-head with established retailers in developed markets like the United States and Western Europe, Tesco chose to pursue markets with strong growth potential, but little current competition. The strategy allows the company to use its expertise to grow international market share, without incurring the costs of establishing itself in already crowded markets.
b) The keys to Tesco’s success in its international operations is its ability to spot markets with strong underlying growth trends, identify existing companies in those locations that have a deep understanding of the local market, form a joint venture with those companies and transfer its expertise in the industry to the venture, and later buy the partner out. The strategy is highly successful, supplementing the company’s UK earnings with an additional ₤7.6 billion in revenues in 2007. Tesco is now the number four company in the global grocery industry.
c) Tesco’s strategy of entering foreign markets via joint ventures has proven to be highly successful. The company is able to bring its expertise in retailing as well as its financial strength to the venture where it is paired with the partner’s knowledge of the local market. Local managers are hired to run the operations, with only support coming from expatriate managers. This format allows Tesco to use its core strengths to get into the market, and then later, after the ventures have become established, buy out its partner.
d) Most students will probably agree that while Tesco’s entry into the crowded market in the United States represents a departure from its traditional strategy of focusing on developing nations with little existing competition, the strategy still reflects the company’s traditional strategy in that the format the company has chosen to use, Tesco Express, still avoids the head-to-head competition that the company has steered clear of in developing markets. In that sense, the strategy could prove to be highly successful. The company can enter the market using its Tesco Express format, avoid major competition while it gains brand recognition and experience in the market, and then later, expand into the traditional grocery business.
Another Perspective: Students can go to Tesco’s corporate home page {http://www.tescocorporate.com/} for up-to-date information about the company’s global expansion plans.
Another Perspective: To extend this feature, consider {http://www.businessweek.com/globalbiz/content/apr2009/gb20090421_205044.htm}.
QUESTION 2: Licensing propriety technology to foreign competitors is the best way to give up a firm's competitive advantage. Discuss.
ANSWER 2: The statement is basically correct - licensing proprietary technology to foreign competitors does significantly increase the risk of losing the technology. Therefore licensing should generally be avoided in these situations. Yet licensing still may be a good choice in some instances. When a licensing arrangement can be structured in such a way as to reduce the risks of a firm's technological know-how being expropriated by licensees, then licensing may be appropriate. A further example is when a firm perceives its technological advantage as being only transitory, and it considers rapid imitation of its core technology by competitors to be likely. In such a case, the firm might want to license its technology as rapidly as possible to foreign firms in order to gain global acceptance for its technology before imitation occurs. Such a strategy has some advantages. By licensing its technology to competitors, the firm may deter them from developing their own, possibly superior, technology. And by licensing its technology the firm may be able to establish its technology as the dominant design in the industry. In turn, this may ensure a steady stream of royalty payments. Such situations apart, however, the attractions of licensing are probably outweighed by the risks of losing control over technology, and licensing should be avoided
QUESTION 3: Discuss how the need for control over foreign operations varies with firms’ strategies and core competencies. What are the implications of the choice of entry mode?
ANSWER 3: If a firm’s competitive advantage (its core competence) is based on control over proprietary technological know-how, licensing and joint venture arrangements should be avoided if possible so that the risk of losing control over that technology is minimized. For firms with a competitive advantage based on management know-how, the risk of losing control over the management skills to franchisees or joint venture partners is not that great. Consequently, many service firms favor a combination of franchising and subsidiaries to control the franchises within particular countries or regions. The subsidiaries may be wholly owned or joint ventures, but most service firms have found that joint ventures with local partners work best for controlling subsidiaries.
QUESTION 4: A small Canadian firm that has developed some valuable new medical products using its unique biotechnology know-how is trying to decide how best to serve the European Union. Its choices are given below. The cost of investment in manufacturing facilities will be a major one for the Canadian firm, but it is not outside its reach. If these are the firm’s only options, which one would you advise it to choose? Why?
a. Manufacture the product at home and let foreign sales agents handle marketing.
b. Manufacture the products at home and set up a wholly owned subsidiary in Europe to handle marketing.
c. Enter into a strategic alliance with a large European pharmaceutical firm. The product would be manufactured in Europe by the 50/50 joint venture and marketed by the European firm.
ANSWER 4: If there were no significant barriers to exporting, then option (c) would seem unnecessarily risky and expensive. After all, the transportation costs required to ship drugs are small relative to the value of the product. Both options (a) and (b) would expose the firm to less risk of technological loss, and would allow the firm to maintain much tighter control over the quality and costs of the drug. The only other reason to consider option (c) would be if an existing pharmaceutical firm could also give it much better access to the market and potentially access to its products and technology, and that this same firm would insist on the 50/50 manufacturing joint venture rather than agreeing to be a foreign sales agent. The choice between (a) and (b) boils down to a question of which way will be the most effective in attacking the market. If a foreign sales agent can be found that is already quite familiar with the market and who will agree to aggressively market the product, the agent may be able to increase market share more quickly than a wholly owned marketing subsidiary that will take some time to get going. On the other hand, in the long run the firm will learn a great deal more about the market and will likely earn greater profits if sets up its own sales force.
CLOSING CASE: JCB in India
The closing case explores the joint venture between Britain’s JCB, a manufacturer of construction equipment, and Indian engineering conglomerate, Escorts. The two companies linked up to make back hoe loaders for the Indian market. The joint venture was a first for JCB, and proved to be hugely successful, gaining 80 percent of the market. However, JCB felt the arrangement limited its expansion opportunities, and recently bought out its partner. Today, JCB is a major player in the construction equipment market in both India and China. The following questions can be helpful in directing the discussion.
QUESTION 1: What was the strategic rationale underlying JCB’s entry into India in 1979, and China in 2005? Given that capital to fund expansion is limited, does it make more sense for JCB to expand its presence in these markets, as opposed to more developed markets, such as those of Western Europe?
ANSWER 1: When JCB entered the Indian market in 1979, the company felt the market was primed for growth, and that the potential in the market was too large to ignore. By entering the market early, JCB hoped to establish a foothold in the market and an advantage over competitors.
QUESTION 2: Why do you think JCB chose to enter India via a joint venture, as opposed to some other entry mode?
ANSWER 2: JCB entered the Indian market in 1979 via a joint venture with Escorts. The decision to enter via a joint venture arrangement was prompted by high tariff barriers that made JCB’s traditional strategy of exporting its product to foreign locations difficult. Given that JCB was primarily an exporter and had little experience operating in foreign locations, the joint venture arrangement offered the company a means of serving the Indian market without incurring all the risk involved in setting up a wholly owned operation.
QUESTION 3: Why did JCB not simply license its technology to Escorts?
ANSWER 3: JCB’s technology provided the company with a key competitive advantage. JCB avoided licensing arrangements because it felt that such arrangements did not give it the control over its technology that was needed. JCB feared that licensing its technology to Escorts could eventually make Escorts a direct competitor.
QUESTION 4: What were the potential disadvantages of JCB’s joint venture with Escorts?
ANSWER 4: JCB was concerned that the joint venture limited its ability to expand. The company did not want to share its proprietary technologies that were at the core of its competitive advantage with Escorts, and feared that without complete control over the venture, it could not properly serve the rapidly growing Indian market.
QUESTION 5: What were the benefits of gaining full control of the Indian joint venture in 2002? Can you think of any drawbacks?
ANSWER: While the joint venture between JCB and Escorts was successful, JCB chose to buy out its partner. JCB took advantage of new government regulations to initially buy a majority position in the venture in 1999, and later in 2002, buy it outright. Most students will probably agree that the main benefit of gaining full control of the venture was that JCB could now transfer its leading edge technologies to the venture without fearing that it could be creating a future competitor. Furthermore, since JCB had full control over the venture, it could continue its expansion in India. Some students may wonder though whether the company has taken on too much risk in the Indian market.
Another Perspective: Students can go to {http://www.jcb.com/} for additional information on the company.
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:
Title: As U.S. Automakers Struggle, Fiat Seizes Expansion Opportunities
Run Time: 7:05
Abstract: This video explores the attempt by Italian automaker Fiat, to become a bigger global player through the purchase of General Motors’ Opel division, and the acquisition of 35 percent of ailing U.S. automaker, Chrysler.
Key Concepts: globalization, international trade, international strategy, corporate culture, global expansion, market entry
Notes: The global auto industry may soon see some major changes. Italian automaker Fiat is hoping to become a bigger player in the industry, and unlike its U.S. counterparts which are struggling to survive, Fiat is ready to expand. The company is currently in the process of acquiring up to a third of ailing Chrysler, and is in talks about a potential purchase of General Motors’ Opel division. If both acquisitions proceed Fiat, which is presently the world’s ninth-largest auto company, will become the fifth-largest automaker in the world.
Until now, Fiat, a highly diversified company with divisions in everything from ski resorts to agricultural equipment, has been only a minor player in the United States. However, CEO Sergio Marchionne believes that in order to survive, that situation must change. Marchionne feels that Fiat’s long-term competitiveness depends on its ability to expand its reach in the United States and indeed, in Europe. It seems that Marchionne, who feels the company’s current sales of 1.5 million vehicles is too small to enable Fiat to be a viable global player, wants to become a force to be reckoned with. Acquiring 35 percent of Chrysler in addition to Opel would give the company sales of 5.5 million vehicles, well above the 3.5 million level that Marchionne feels is necessary to be a strong global player. Some analysts wonder though, whether Fiat is getting in over its head.
David Kiley of Businessweek, worries that Fiat is trying to do too much at once. Fiat’s strategy involves the acquisition of highly distressed companies – a strategy that may prove to be difficult in the current economy. Kiley finds it telling for example, that other key players in the industry like Toyota and BMW have shied away from the opportunities that Fiat is currently pursuing. Kiley points out that acquiring a new company means that Fiat not only gains new assets and market position, but it also means that Fiat inherits a new corporate culture – one that may be vastly different from its own. BMW actually has first hand experience in the challenges of trying to mesh another company with existing operations. The company unsuccessfully tried to integrate Rover with its own operations in the 1990s only to later sell it off. Now, BMW and Toyota are looking to grow organically rather than via acquisition. Kiley also wonders whether Fiat will be able to overcome the negative perceptions many consumers currently have of Chrysler and its products. The most recent Consumer Reports, a key source of buying information for many American consumers, does not recommend that consumers purchase any Chrysler-made products.
Discussion Questions:
1. Fiat is currently trying to buy both a piece of Chrysler and General Motors’ Opel division. Why does Fiat want to make these acquisitions? What advantages would they bring to Fiat?
2. Some experts worry that Italian automaker Fiat may be moving too quickly with its global expansion strategy. Reflect on the risks involved with Fiat’s acquisition strategy. How might a deal with Opel affect Fiat’s ability to proceed with its effort to successfully integrate part of Chrysler?
3. Fiat is currently a minor player in the U.S. auto market. Discuss how the deal with Chrysler could change that position. What role, if any, might the U.S. government play in promoting Fiat has the industry’s lifesaver?
4. What are the challenges associated with growing via acquisition versus growing organically? In your opinion, does the fact that Fiat is a highly diversified company give it any advantage with its current plans to acquire General Motors’ Opel division and 35 percent of Chrysler?
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following from International Business DVD Volume 5:
Title 12: Tesco in the U.S.A.
Abstract: This video explores British retailer Tesco’s attempt to break into the very difficult grocery store business in the United States
Key Concepts: international strategy, international marketing, standardization versus adaptation, globalization, foreign market entry, competitive advantage
Notes: British retailer Tesco is attempting to do what no other foreign retailer has managed to yet – break into the U.S. grocery business. Tesco is opening six stores in California under the Fresh & Easy name. The effort is the company’s first venture into the U.S. market, and the company is hoping to revolutionize the grocery business in the United States.
Tesco is hoping that by offering fresh and healthy food at affordable prices it will be able to attract U.S. customers. Fresh and Easy stores are small - only about a quarter of the size of a typical U.S. grocery store, but they are designed to allow customers to get as many items as possible in a single shopping trip. Tesco knows the stakes are big. Other retailers like Marks and Spencer and Sainsbury have failed in the United States. Even France’s Carrefour, the second largest retailer in the world after Wal-Mart, found it impossible to crack the U.S. market. Tesco is hoping that its extensive homework will help it succeed.
Before opening its stores in California, Tesco set up a dummy shop to study buyer behavior and even hired a team of anthropologists to live with families and learn about their shopping habits. Tesco wants to be able to set up its stores in such a way that it is as easy and convenient as possible for shoppers to get what they want. Consequently, the layout of the Fresh and Easy stores is quite different from how a Tesco store is typically laid out, and the stores stock more ready-to-go meals designed to attract busy American buyers. Still, Tesco has it work cut out for it. Analysts claim that American shoppers have very high expectations for grocery stores. Merchandising needs to be perfect, the store needs to be laid out in a convenient way, and customer service needs to be good.
Time will tell whether Tesco has finally found the secret to success in the U.S. grocery industry. For now though, the company is focusing on offering the customer everyday low prices – a strategy that seems to have been successful for at least one U.S. retailer.
Discussion Questions:
1. Which entry method did Tesco use to enter the U.S. market? Why was this method chosen over others?
2. Tesco’s new stores in the United States are called Fresh & Easy markets. Why did Tesco adopt the new name for its stores?
3. Consider Tesco’s timing on entering the U.S. market. Why has Tesco waited to enter the market until now? How might the decision to wait to enter the market help Tesco succeed in the United States?
4. What are strategic commitments? What do Tesco’s strategic commitments and scale of entry signal about the company’s plans for the future?
5. Tesco has conducted extensive research on the habits of American shoppers. Why was the research important to Tesco? How will it help the company succeed in the United States?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following exercises:
Exercise 1
A vital element in a successful international market entry strategy is an appropriate fit of skills and capabilities between partners. As such, the Entrepreneur magazine annually publishes a ranking of the top 200 global franchisors seeking international franchisees. Provide a list of the top 10 companies that pursue franchising as a mode of international expansion. Study one of these companies in detail and provide a description of its business model, its international expansion pattern, desirable qualifications in possible franchisees, and the support and training typically provided by the franchisor.
Exercise 2
The U.S. Commercial Service prepares reports known as the “Country Commercial Guide” for countries of interest to U.S. investors. Utilize the Country Commercial Guide for Brazil to gather information on this country’s energy and mining industry. Considering that your company is plans to enter Brazil in the foreseeable future, select the most appropriate entry method. Be sure to support your decision with the information collected.
Answers to the Exercises
Exercise 1
The annual ranking of the top 200 global franchisers can be found by searching the term “entrepreneur” at http://globaledge.msu.edu/ResourceDesk/. This resource is named Entrepreneur Magazine: Top Global Franchises and is found under the globalEDGE category “Research: Rankings”. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “Entrepreneur”
Resource Name: Entrepreneur Magazine: Top Global Franchises
Website: http://www.entrepreneur.com/franchises/topglobal/index.html globalEDGE™ Category: “Research: Rankings”
Exercise 2
The Country Commercial Guides can be accessed by searching for the term “commercial guide” at http://globaledge.msu.edu/ResourceDesk/. The link is located under the globalEDGE category “Research: Multi-Country”. Detailed information regarding marketing U.S. products and services in Brazil can be found by selecting the report for this country and reading the chapter titled “Selling US Products and Services”. A direct link to the Country Commercial Guide for Brazil is also located on the Country Insights page for Brazil at http://globaledge.msu.edu/countryInsights/country.asp?CountryID=107
Search Phrase: “Country Commercial Guide”
Resource Name: Country Commercial Guides for U.S. Investors
Website: http://www.buyusainfo.net/adsearch.cfm?search_type=int&loadnav=no globalEDGE™ Category: “Research: Multi-Country”
OR
globalEDGE™ Location: “Country Insights / Region: Latin America / Brazil”
Resource Name: Brazil
Website: http://globaledge.msu.edu/countryInsights/country.asp?CountryID=107 (site location frequently changes, therefore link through the globalEDGE Country Insights page might be more reliable)
Exporting, Importing and Countertrade
Learning objectives
• Explain the promises and risks associated with exporting.
• Outline the steps managers can take to improve their firm’s export performance.
• Identify the information sources and government programs that exist to help exporters.
• Grasp the basic steps involved in export financing.
• Articulate how countertrade can be used to facilitate exporting.
Previous chapters have presented exporting as just one of a range of strategic options for profiting from international markets. This chapter looks more at the nuts and bolts of how to export.
Exporting is not just for large enterprises; many small firms have benefited significantly from the moneymaking opportunities of exporting.
The volume of export activity in the world economy is increasing as exporting has become easier. The gradual decline in trade barriers under the umbrella of GATT and now the WTO (see Chapter 5) along with regional economic agreements such as the European Union and the North American Free Trade Agreement (see Chapter 8) have significantly increased export opportunities. At the same time, communication and transportation technologies have alleviated the logistical problems associated with exporting.
Firms are increasingly using fax, the World Wide Web, toll-free 800 numbers, and international air express services to reduce the costs of exporting. Consequently, it is no longer unusual to find small companies that are thriving as exporters.
The opening case explores the growth of MD International, a medical equipment export intermediary. The closing case examines why several small companies choose exports as a mean of growth.
OUTLINE OF CHAPTER 15: EXPORTING, IMPORTING AND COUNTERTRADE
Opening Case: MD International
Introduction
The Promise and Pitfalls of Exporting
Management Focus: FCX Systems
Improving Export Performance An International Comparison Information Sources Utilizing Export Management Companies Export Strategy
Management Focus: Exporting with a Little Government Help Management Focus: Export Strategy at 3M Management Focus: Red Spot Paint & Varnish
Export and Import Financing Lack of Trust Letter of Credit Draft Bill of Lading A Typical International Trade Transaction
Export Assistance Export–Import Bank Export Credit Insurance
Countertrade The Incidence of Countertrade Types of Countertrade The Pros and Cons of Countertrade
Chapter Summary
Critical Discussion Questions
Closing Case: Exporting and Growth for Small Business
CLASSROOM DISCUSSION POINT
Ask students if they have ever imported a product. Many students may have done so without realizing it simply by purchasing something from a foreign buyer via eBay. Similarly, many students may have engaged in direct exports when they have sold something to a foreign buyer via eBay.
Ask students to formalize the process by picking a product they would like to export. Then ask students which markets they will target and why. Next, ask students how they could get their product to consumers in that market. What additional information will they need to proceed with their plan?
Organize the responses from students on the board in an export plan format. Then, ask students to visit some of the Department of Commerce web sites to fill in the gaps. Discuss why it is important to get the various pieces of information, and which elements are easier to obtain and why. Refer back to the export plan as the material in the chapter is presented.
Another Perspective: Export.gov has a great web site covering the basics of exporting. Within the site {http://www.export.gov/index.asp} you can click on various topics related to getting ready to export, developing an export plan, finding leads and so on. The site is well worth a visit, and could be used as the basis for an in-class export project.
OPENING CASE: MD International
The opening case explores the success of MD International in Latin America. MD International is an export intermediary for U.S. medical equipment manufacturers. The company has been able to capitalize on falling trade barriers, as well as expanding health care programs in the Latin American region. MD International currently represents more than 30 companies and sells to some 600 regional distributors. Discussion of the case can revolve around the following questions:
1. How has MD International used export assistance programs to support its efforts in Latin America? In your opinion, would MD International have been successful without programs like EXIM’s export financing?
2. What makes MD International attractive to medical equipment manufacturers? How does MD International succeed in the region when many of its clients might not?
3. Why did MD International choose to focus on the Latin American market? How does its strategy of representing multiple manufacturers help insulate the company from economic downturns?
Another Perspective: MD International was recently acquired by Welch Allyn. To learn more about the acquisition and MD International, go to {http://www.welchallyn.com/regions/Latin-America/wamd/en-la/default.htm}.
LECTURE OUTLINE FOR CHAPTER
This lecture outline follows the Power Point Presentation (PPT) provided along with this instructor’s manual. The PPT slides include additional notes that can be viewed by clicking on “view”, then on “notes”. The following provides a brief overview of each Power Point slide along with teaching tips, and additional perspectives.
Slide 15-3 Why Export?
Exporting firms need to ❖ identify market opportunities ❖ deal with foreign exchange risk ❖ navigate import and export financing ❖ understand the challenges of doing business in a foreign market
Slides 15-4 The Problems and Pitfalls of Exporting
Exporting offers the opportunity to take advantage of a bigger market, and the economies of scale that come with producing for a bigger market. However, it is also a more complex market.
Common pitfalls include poor market analysis, poor understanding of competitive conditions, a lack of customization for local markets, a poor distribution program, poorly executed promotional campaigns, problems securing financing, a general underestimation of the differences and expertise required for foreign market penetration, and an underestimation of the amount of paperwork and formalities involved.
Slide 15-6 Improving Export Performance
There are various ways to gain information about foreign market opportunities and avoid the pitfalls associated with exporting.
Another Perspective: The UK Trade and Investment office is devoted to helping companies develop their export business. The web site is available at {https://www.uktradeinvest.gov.uk/ukti/appmanager/ukti/home?_nfls=false&_nfpb=true} Click on “Business Opportunities” to see a sample of a trade lead, or click on “Country Report” to see the types of information available in a typical report on a specific country.
Slide 15-7 Getting Information
A big impediment to exporting is the simple lack of knowledge of the opportunities available. To overcome ignorance firms need to collect information.
Another Perspective: Your students may wonder how firms U.S. firms find buyers in foreign countries. To find foreign customers, exporters often use '"trade leads" that are provided by organizations dedicated towards the activity of matching "buyers" and "sellers" in an international context. An example of a site that provides trade leads is the Export.gov at {http://www.export.gov/index.asp}.
The U.S. Department of Commerce is the most comprehensive source of export information for U.S. firms.
Another Perspective: Students may want to explore the U.S. Department of Commerce’s web site {http://www.commerce.gov/}and click on “Trade Opportunities for U.S. Businesses.”
Another Perspective: The Small Business Administration (SBA) also has an extensive web site {http://www.sba.gov/} with information about exporting to different countries, contacts and leads, and so on.
Slides 15-8 Utilizing Export Management Companies
Export management companies (EMCs) are export specialists that act as the export marketing department or international department for client firms.
Another Perspective: The FITA Directory of Export Management Companies web site {http://fita.org/} provides information on export management companies, and also trade leads and international market research.
Slide 15-9 Reducing the Risk of Exporting
Firms can reduce risk by carefully choosing their export strategy, and following some basic guidelines. Firms should hire an EMC or export consultant, to help identify opportunities and navigate through the tangled web of paperwork and regulations so often involved in exporting, focus on one, or a few markets at first, enter a foreign market on a fairly small scale in order to reduce the costs of any subsequent failures, recognize the time and managerial commitment involved, develop a good relationship with local distributors and customers, hire locals to help establish a presence in the market, be proactive, and consider local production.
Another Perspective: A great web site to visit to determine whether a company is ready to export is the International Trade Centre, run by UNCTAD/WTO. If you go to the site {http://www.intracen.org/ec/welcome.htm }you can use the interactive quiz to gauge export readiness. Click on “Export Fitness Checker”, then on “Use the Export Fitness Checker online” to see the quiz.
Slide 15-10-15-11 Export and Import Financing
Firms engaged in international trade face a problem - they have to trust someone who may be difficult to track down if they default on an obligation.
Including a third party in a transaction adds an element of trust to the relationship.
Slide 15- 12 Letter of Credit
A letter of credit is issued by a bank at the request of an importer and states that the bank will pay a specified sum of money to a beneficiary, normally the exporter, on presentation of particular, specified documents.
Slide 15-13 Draft
A draft is simply an order written by an exporter instructing an importer, or an importer's agent, to pay a specified amount of money at a specified time.
Slide 15-14 Bill of Lading
The bill of lading is issued to the exporter by the common carrier transporting the merchandise.
Slides 15-16 A Typical International Trade Transaction
The typical international trade transaction involves 14 steps as outlined in Figure 15.4.
Slide 15-18 Export Assistance
There are two forms of government-backed assistance available to exporters:
1. Financing aid is available from the Export-Import Bank
2. Export credit insurance is available from the Foreign Credit Insurance Association
The Export-Import Bank (Eximbank) is an independent agency of the U.S. government that provides financing aid to facilitate exports, imports, and the exchange of commodities between the U.S. and other countries.
Export credit insurance protects exporters against the risk that the importer will default on payment. In the U.S., export credit insurance is provided by the Foreign Credit Insurance Association (FICA).
Slide 15-19 Countertrade
Countertrade refers to a range of barter-like agreements that facilitate the trade of goods and services for other goods and services when they cannot be traded for money.
Countertrade began in the 1960s primarily in the Soviet Union and Eastern bloc countries. Its popularity increased during the 1980s when many developing countries that were short of hard currencies used countertrade instead. More recently, its use increased after the 1997 Asian financial crisis.
Slides 15-20-15-21 Types of Countertrade
There are five distinct versions of countertrade:
1. barter
2. counterpurchase
3. offset
4. compensation or buyback
5. switch trading
Slides 15-23-15-24 Pros and Cons of Countertrade.
The main attraction of counter trade is that it gives a firm a way to finance an export deal when other means are not available. Countertrade is unattractive because it may involve the exchange of unusable or poor-quality goods that the firm cannot dispose of profitably.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: A firm based in Washington State wants to export a shipload of finished lumber to the Philippines. The would- be importer cannot get sufficient credit from domestic sources to pay for shipment, but insists that the finished lumber can quickly be resold in the Philippines for a profit. Outline the steps that the exporter should take to effect the export of this shipment to the Philippines?
ANSWER 1: The steps are as follows:
The Philippine importer places an order with the American exporter, and asks the American if he would be willing to ship under a letter of credit.
The American exporter agrees to ship under a letter of credit, and specifies relevant information such as prices, delivery terms, and the like.
The Philippine importer applies to the Bank of Manila (or some other international bank) for a letter of credit to be issued in favor of the American exporter for the merchandise the importer wishes to buy.
The Bank of Manila issues a letter of credit in the Philippine importer's favor and sends it to the American exporter's bank, the Bank of Seattle.
The Bank of Seattle advises the American exporter of the opening of a letter of credit in his favor.
The American exporter ships the goods to the Philippine importer on a common carrier.
The American exporter presents a 90 day time draft to the Bank of Seattle, drawn on the Bank of Manila in accordance with the Bank of Manila's letter of credit and accompanied by the bill of lading. The American exporter endorses the bill of lading such that the title to the goods goes with the holder of the document - which at this point in the transaction is the Bank of Seattle.
The Bank of Seattle presents the draft and documents to the Bank of Manila. The Bank of Manila accepts the draft, taking possession of the documents and promising to pay the now accepted draft in 90 days.
The Bank of Manila returns the accepted draft to the Bank of Seattle.
The Bank of Seattle tells the American exporter that they have the accepted bank draft, which is payable in 90 days.
The exporter sells the draft to the Bank of Seattle for a discount from the face value and receives the discounted cash value of the draft in return.
The Bank of Manila notifies the Philippine importer of the arrival of the documents. It agrees to pay the Bank of Manila in 90 days. The Bank of Manila releases the documents so that the Philippine importer can take possession of the shipment.
In 90 days the Bank of Manila receives the importer's payment so that it has funds to pay the maturing draft.
In 90 days the holder of the matured acceptance, in this case the Bank of Seattle, presents it to the Bank of Manila for payment. The Bank of Manila pays.
(If the exporter feels confident in and can completely trust the purchaser in the Philippines, then a much simpler procedure than this could be followed.)
Another Perspective: Trade Port provides a Global trade Tutorial on export financing. The tutorial is available at {http://www.tradeport.org/tutorial/financing}. The site provides excellent details on the process, and is well worth a visit.
QUESTION 2: You are the assistant to the CEO of a small textile firm that manufactures high-quality, premium priced, stylish clothing. The CEO has decided to see what the opportunities are for exporting and has asked you for advice as to the steps the company should take. What advice would you give to the CEO?
ANSWER 2: This question is designed to stimulate classroom discussion and/or to encourage your students to “think” about the export process in completing a written answer for this question. There are a number of approaches that can be pursued in answering this question. The first step might be to tap into some of the government information sources that are available, free of charge, to see if international markets are available for the company’s product. There are also a number of resources on the Internet, mentioned throughout the text that can assist companies in learning about the foreign market potential of their products. Another approach would be to contact an export management company for assistance. While this approach may involve some cost, it may be the fastest way to get “up and running” in regard to initiating an export program.
QUESTION 3: An alternative to using a letter of credit is export credit insurance. What are the advantages and disadvantages of using export credit insurance as opposed to a letter of credit for (a) exporting a luxury yacht from California to Canada, and (b) exporting machine tools from New York to Ukraine?
ANSWER 3: Exporters prefer to get letters of credit from importers. However, when the importer is in a strong bargaining position and able to play competing suppliers off against each other, an exporter may have to forgo a letter of credit. The lack of a letter of credit exposes the exporter to the risk that the foreign importer will default on payment. The exporter can insure against this possibility by buying export credit insurance. Students may suggest that in the case of the luxury yacht, should the importer fail to make payment, the clearly defined laws of Canada would make it easier to go after the importer than would be the case with the machine tools in the Ukraine, and that therefore a letter of credit is less important for the yacht exporter. On the other hand, students may note that there is probably more competition in machine tools as compared to luxury yachts and that the exporter of machine tools may lose the sale if the exporter insists on a letter of credit.
QUESTION 4: How do you explain the continued existence of counter trade? Under what scenarios might its popularity increase still further by the year 2015? Under what scenarios might its popularity decline?
ANSWER 4: Countertrade becomes popular when foreign exchange markets are limited or importers do not have access to the foreign exchange (low reserves) they need to fund their purchases. Currency crises and monetary instability are two conditions that lead to countertrade. As long as countries lack hard currencies and foreign exchange reserves, yet have an interest in trade, countertrade is likely. If countries erect trade barriers that decrease world trade, or if the monetary systems of many countries strengthen significantly, then countertrade may decrease.
QUESTION 5: How might a company make strategic use of countertrade schemes to generate export revenues? What are the risks associated with pursuing such a strategy?
ANSWER 5: Countertrade is an alternative means of structuring an international sale when conventional means of payment are difficult, costly, or nonexistent. The governments of developing countries sometimes insist on a certain amount of countertrade. Thus, if a firm is unwilling to enter a countertrade agreement, it may lose an export opportunity to a competitor that is willing to make a countertrade agreement. Companies willing to entertain countertrade as a means of financing, will have an advantage over those firms that prefer traditional forms of financing. Firms engaging in countertrade must be willing to invest in an in-house trading department dedicated to arranging and managing countertrade deals, and must be aware of the quality of the products received in countertrade deals.
CLOSING CASE: Exporting and Growth for Small Businesses
The closing case explores how three small companies, Morgan Motors, Wadia, and Malden Mills, have successfully increased their sales and profits through exports. Morgan Motors, a British sports car manufacturer ships 70 percent of its production overseas. Wadia, a Michigan-based producer of high end compact disc players relies on exports for 70 to 80 percent of its sales. Malden Mills, an American manufacturer of high technology textiles earned over half of its 2006 sales from exports. The following questions can be helpful in directing the discussion.
QUESTION 1: What are the main benefits of exporting for companies like Morgan and Wadia?
ANSWER 1: Both Morgan Motors and Wadia made the decision to export for similar reasons. Morgan Motors makes sports cars for a very small market niche. The size of the niche in Britain is too small for the company to survive, so Morgan had to expand into other markets to remain in business. Wadia shares a similar predicament. Wadia produces premium priced compact disc players for audiophiles. Its product is so specialized that just 20 percent of its sales come from the local marketplace. Students will probably recognize that for both of these companies survival meant foreign expansion, and that by targeting similar niches in foreign markets, they could grow their sales.
QUESTION 2: What would be the outlook for a company like Morgan Motors if it neither exported nor imported?
ANSWER 2: Most students will probably conclude that without the ability to import and export, companies like Morgan Motors are unlikely to succeed. Morgan Motors sells just 30 percent of its production in its domestic market. Without the revenues from foreign markets, the company’s profits would drop significantly. Moreover, since Morgan Motors imports major components for its cars from foreign companies like Bosch and BMW, not being able to import would also hamper the company’s ability to build its vehicles.
QUESTION 3: What are the impediments to exporting success faced by companies such as Morgan and Wadia? What steps can these companies take to improve their probability of succeeding in export markets?
ANSWER 3: Exporting can present numerous challenges for small companies like Morgan and Wadia. Like their larger counterparts, small companies need to conduct the same types of market research, organize financing, absorb foreign exchange risk, and so on. Both Morgan and Wadia have taken advantage of export assistance provided by various organizations like export agencies and export financing companies. One small company, Malden Mills, took advantage of market research offered by the South Carolina Export Consortium, and a working capital loan guarantee from the U.S. Export-Import Bank.
QUESTION 4: Is it legitimate for local and national government agencies to use taxpayer money to help small companies export?
ANSWER 4: Small companies employ an increasing number of people in today’s market. Therefore, most students will probably agree that it is important for government to support the operations of small companies. However, not all students are likely to agree that taxpayer funds should be used to support export programs. Some students will probably suggest that by supporting the export programs of small companies, the government is in effect helping to create domestic jobs, and boost the local economy – a clear benefit to a country’s citizens. Other students however, may argue that taxpayer money should be used to create programs that will reach a wider population – especially if the success of export programs cannot be guaranteed.
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:
Title: Brazil Seeks to Break New Ground in Global Marketplace
Brazil Looks to World Market
Run Time: 11:21
Abstract: This video explores Brazil’s booming economy and its efforts to become the world’s largest producer of ethanol, and a leading exporter of agricultural products.
Key Concepts: globalization, economic differences, political differences, comparative advantage, global competition, outsourcing production, World Trade Organization, subsidies
Notes: Evidence of Brazil’s recent economic success is everywhere – from manufacturing to agriculture. Today, Brazil is home to the world’s third largest aviation manufacturer, Embraer, a company that nearly went under in the early 1990s. Brazil is also the world’s largest producer of soy. Much of the crop is exported to China where it is converted to tofu. In addition, Brazil is the world’s leading exporter of coffee, sugar, beef, orange juice, poultry, and tobacco. Brazil also leads the world in ethanol production. Brazil’s ethanol, unlike the corn-based ethanol produced in the United States, is a byproduct of its sugar crop. Brazil is so far ahead of other countries like the United States in its ethanol production that 90 percent of new cars in Brazil run entirely on ethanol, and its production has spawned the development of an entire industry to support its production.
Brazil’s rise to the top is a result of privatization efforts, determination, and talent. Optimism and confidence about the future is widespread. Horacio Forjaz, Executive Vice President for Emraer notes for example, that prior to its privatization, Embraer lacked credibility and a competitive product line. It was not until 1994, after it was privatized, that the company recognized there was an opportunity to produce jets designed to fly between 50 and 130 passengers on regional routes. Today, the company, which counts JetBlue, Delta, and Virgin Australia among its customers, has orders that will keep it at full production for the next six years. Executive say that it represents a new Brazil that is globally confident and prominent. Brazil’s farmers have recognized the importance of global markets for growth. Rodrigo Varsato, Agricultural Engineer, claims that technology is critical to the nation’s success in agriculture. He points out that unlike the United States or China, Brazil is uniquely positioned for further growth in agriculture because the country has land for expansion.
Brazil is using its new found success to bargain with other nations. The country is taking on the United States and Europe at the Doha Round of trade talks where it is pushing for the elimination of agricultural subsidies paid to developed country farmers and other protectionist policies that effectively limit the development of agriculture in developing countries. Celso Amorim, Foreign Minister, is confident that Brazil can change the way negotiations take place in the World Trade Organization, to one where the perspectives of the developing world are taken more seriously. Already, Brazil may have a trump card of sorts. The country is the world’s largest producer of ethanol, which sells at about half the price of gasoline. Ethanol is available at over 30,000 stations across the country, and is produced from the country’s abundant sugar crop. To date, tariffs have kept the product out of the United Sates, but Jose Luis Olivero, vice president of Dedini, a supplier of equipment to the industry, believes that the situation will change. He notes that the United States cannot continue its dependence on imported oil, and that Brazil, as the world’s most competitive producer of ethanol, is perfectly situated to take advantage of the market. Despite the country’s success, some critics have suggested that Brazil needs to pay closer attention to the home market, and less attention to the global market. Brazil’s government though, discounts the criticism noting that the country now has a vibrant middle class, and a dramatic decline in the number of people at the lower end of the socioeconomic spectrum.
Discussion Questions:
1. Explain the importance of agriculture to Brazil’s current success. What role will agriculture play in Brazil’s future? What are the implications of this for other countries? How might countries like the United States react if Brazil is successful in its quest for the elimination of agricultural subsidies paid to developed country farmers?
2. How has Brazil’s position as the world’s largest exporter of soy and other agricultural products helped U.S. companies?
3. Reflect on Brazil’s efforts to take on a bigger role in the global economy. In your opinion, are critics who argue that country should be more inwardly focused right? Why or why not? How might Michael Porter consider this situation?
4. Brazil is a frontrunner in the use of biofuel. Explain, using the theory of comparative advantage, how Brazil has achieved this position, and what it means for the country.
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following from International Business DVD Volume 5:
Title 11: Work Trade with Great Britain and Brazil
Abstract: This video explores the trading relationship between Great Britain and Brazil, and how the British Consul is helping to improve the relationship through trade delegations.
Key Concepts: globalization, trade, small business
Notes: Great Britain and Brazil have been trading partners for some 200 years. At one point Great Britain was one of Brazil’s top five trading partners. Today though, Great Britain has dropped to number thirty-six. In fact, Great Britain has gone from being an influential important trading partner to accounting for just two percent of Brazil’s trade. The British Consul would like to change this situation, and so is putting together a trade delegation comprised of people from Northeast Britain who would like the opportunity to form lasting relationships with Brazilian companies.
Members of the trade delegation meet to learn more about the opportunities in Brazil, and to learn about doing business in the country. Brazil is considered to be an attractive market mainly because of its size and scale. Delegates want to capitalize on the market’s 185 million people. The consul also helps delegates clearly define and identify how they can do business in Brazil. Each delegate has a different goal. One delegate for example wants to find work placement positions for students, while another is looking for retailers to stock his product. One delegate is looking for a joint venture partner. Most delegates agree that being part of the trade delegation is beneficial because they can work with people who have contacts in Brazil and know the market. Getting an introduction can be important in Brazil where building relationships can be an essential part of a business deal.
Four weeks later, the trade delegation appears to have been a success. One delegate found the jobs placements she was looking for, and another was working with a distributor for his product. The delegate who had been seeking a joint venture was in talks with a potential partner. In general, the delegates were able to close some knowledge gaps, and improve their chances for success in Brazil.
Discussion Questions:
1. How has the relationship between Great Britain and Brazil changed over the last 200 years? What makes Brazil an attractive market for British firms today?
2. Why are opportunities like the trade delegation set up by the British Consul so important to small companies that want to expand internationally? What type of assistance do they provide?
3. Discuss the typical behavior of small firms when they export. Do small firms typically take a proactive or a reactive approach to exporting? What does participation in the trade delegation suggest about the participants?
4. How can small firms improve their export performance? What role does the British Consul play in helping firms succeed in foreign markets?
5. As part of its program, the British Consul is setting up a mentor program for trade delegates. As a business person who is new to the Brazilian market place, what does the mentor program mean to you?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following exercises:
Exercise 1
Exporting is an important way for small and large companies to introduce products and develop new markets. In fact, the Internet is rich with resources that offer guidance to companies wishing to expand their markets through exporting. The trade tutorials at the globalEDGE website provide links to these resources. Identify five sources and provide a description of the services available for new exporters through each source.
Exercise 2
Understanding the specific terminology used in the export process is necessary prior to your company’s first export venture. Utilize the globalEDGE Glossary of International Business Terms to identify the definitions of the following exporting terms: advance payment, air waybill, bill of lading, certificate of product origin, deferred payment credit, harmonized tariff schedule, voluntary export restraint, and wharfage charge.
Answers to the Exercises
Exercise 1
There are a variety of sources that provide guidance to companies that consider starting exporting. A rich list of those resources can be found by searching the term “exporting” at http://globaledge.msu.edu/ResourceDesk/, or by directly entering the “Trade Tutorials” category under the Global Resources section of the Resource Desk. Each approach will render different results. Some of the websites that provide information for U.S. exporters are: the U.S. Department of Commerce’s “Basic Guide To Exporting”, the U.S. Small Business Administration's “Small Business Guide to Exporting”, and Ralph Jagodka’s “Skills Needed For Effective International Marketing”. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “exporting” globalEDGE™ Category: “Trade: Trade Tutorials”
Resource Name: Multiple Names
Website: Multiple Websites
Exercise 2
An alphabetic list of the terms commonly used in international business can be found under the glossary section of the resource desk, at http://globaledge.msu.edu/resourceDesk/glossary.asp . The definitions of the terms mentioned in the exercise are as follows:
advance payment: Trading method in which the buyer pays for the goods before they are sent out , method is used when buyer is of unknown credit worthiness. air waybill: A nonnegotiable instrument of domestic and international air transport that functions as a bill of lading. bill of lading: A document that establishes the terms and conditions of a contract between a shipper and a shipping company under which freight is to be moved between specified points for a specified charge. certificate of product origin: A document required by certain foreign countries for tariff purpose, certifying the country of origin of specified goods. deferred payment credit: A type of letter of credit which provides for payment some time after presentation of the shipping documents by the exporter. harmonized tariff schedule: A method of classification used by many countries to determine tariffs on imports. voluntary export restraint: One country promises another country to limit its imports; this is often done when the promising country fears increased tariffs or quotas if it does not self-regulate. wharfage charge: A charge assessed by a pier or dock owner for handling incoming or outgoing cargo.
Location: Resource Desk / Glossary
Resource Name: globalEDGE: Glossary of International Business Terms
Website: http://globaledge.msu.edu/resourceDesk/glossary.asp globalEDGE™ Category: “Trade: Trade Tutorials”
Global Production, Outsourcing, and Logistics
Learning objectives
• Explain why production and logistics decisions are of central importance to many multinational businesses.
• Explain how country differences, production technology, and product features all affect the choice of where to locate production activities.
• Discuss how the role of foreign subsidiaries in production can be enhanced over time as they accumulate knowledge.
• Identify the factors that influence a firm’s decision of whether to source supplies from within the company or from foreign suppliers.
• Articulate what is required to efficiently coordinate a globally dispersed production system.
This chapter focuses on two major activities—production and materials management, and attempts to clarify how when they are performed internationally, the cost of value creation can be lowered, and how value can be added by better serving customer needs.
The choice of an optimal manufacturing location must consider country factors, technological factors, and product factors.
Foreign factories can improve their capabilities over time, and this can be of immense strategic benefit to the firm. Managers need to view foreign factories as potential centers of excellence and encourage and foster attempts by local managers to upgrade factory capabilities.
An essential issue in many international businesses is determining which component parts should be manufactured in-house and which should be outsourced to independent suppliers.
The chapter also discusses the contributions of information technology to these activities. This is especially important in the era of the Internet.
The Opening Case examines why India has become a hot production location for automakers, while the Closing Case explores Boeing’s decision to outsource much of the production of its new 787 aircraft.
OUTLINE OF CHAPTER 16: GLOBAL PRODUCTION, OUTSOURCING, AND LOGISTICS
Opening Case: The Rise of the Indian Automobile Industry
Introduction
Strategy, Production, and Logistics
Where to Produce Country Factors Technological Factors Product Factors Locating Production Facilities
Management Focus: Phillips in China
The Strategic Role of Foreign Factories
Management Focus: Hewlett-Packard in Singapore
Outsourcing Production: Make-or-Buy Decisions The Advantages of Make The Advantages of Buy Trade-offs Strategic Alliances with Suppliers
Managing a Global Supply Chain The Role of Just-in-Time Inventory The Role of Information Technology and the Internet
Chapter Summary
Critical Discussion Questions
Closing Case: Building the Boeing 787
CLASSROOM DISCUSSION POINT
Using the auto industry, ask students to reflect on the production decisions of several companies. Why does BMW produce cars in Alabama? Why does General Motors have a plant in China? Why does Nissan have design studios in Southern California? Try to get students to address all of the basic production issues outlined below.
The five basic questions that deal with production are:
1. Where should production be located and should it be concentrated or dispersed?
2. What should be the long-term strategic role of foreign production sites? Should the firm abandon a foreign site if factor costs change, or is there value to maintaining an operation at a given location even if economic conditions change?
3. Should the firm own foreign production or should production be outsourced?
4. How should a globally-dispersed supply chain be managed?
5. Should the firm manage the logistics or outsource their management?
OPENING CASE: The Rise of the Indian Automobile Industry
Summary
The opening case describes India’s evolution as a small car manufacturing hub for several global automakers. By 2012, India is expected to export half a million vehicles a year. South Korea’s Hyundai is leading the charge, exporting over one third of its Indian production. Suzuki and Nissan have both entered the Indian market more recently. Both companies see the Indian market as an important component in their future production and marketing strategies. Discussion of the case can revolve around the following questions:
1. Why did Hyundai initially commit to the Indian market? What benefits does Hyundai currently enjoy as a result of being first to market? What are the drawbacks of being an early market entrant?
2. What makes India an attractive location for auto production? What disadvantages do you see? How do Indian production capabilities fit into the strategies of companies like Hyundai and Nissan?
3. Nissan is planning to hire Indian engineers to develop a new car to compete with Tata’s “People Car.” Why does Nissan want to involve local engineers in the product development process rather than simply transferring an existing design to India?
Another Perspective: Students can explore Tata Motors and Hyundai’s Indian operations in more depth at {http://www.tatamotors.com/} and {http://www.hyundai.co.in/}. To extend this case, consider {http://www.businessweek.com/globalbiz/content/jan2009/gb20090130_425063.htm}, {http://www.businessweek.com/innovate/content/mar2009/id20090318_012120.htm}, and {http://www.businessweek.com/globalbiz/content/dec2008/gb20081222_336390.htm}.
LECTURE OUTLINE FOR CHAPTER
This lecture outline follows the Power Point Presentation (PPT) provided along with this instructor’s manual. The PPT slides include additional notes that can be viewed by clicking on “view”, then on “notes”. The following provides a brief overview of each Power Point slide along with teaching tips, and additional perspectives.
Slide 16-3 Production Issues For Firms
Where should foreign production be located? How should a globally dispersed supply chain be managed?
Slides 16-4 Strategy, Production and Logistics
Firms need to identify how production and logistics can be conducted internationally to: • lower the costs of value creation • add value by better serving customer needs
Slide 16-5-16-6 Improving Quality
To increase product quality, most firms today use the Six Sigma program which aims to reduce defects, boost productivity, eliminate waste, and cut costs throughout a company.
Another Perspective: To extend the discussion on TQM and Six Sigma go to {http://www.motorola.com/content.jsp?globalObjectId=3088}and click on the “Free Six Sigma Lessons” icon.
Slide 16-7 Where to Produce?
Three factors are important when making location decisions:
1. country factors
2. technological factors
3. product factors
Slide 16-8 Country Factors
Country factors that can affect location decisions include: • the availability of skilled labor and supporting industries • formal and informal trade barriers • expectations about future exchange rate changes • transportation costs • regulations affecting FDI
Another Perspective: The United States Central Intelligence Agency maintains a “country profile” on each country in the world. The country profiles provide useful information to companies contemplating doing business in a particular country. The country profiles {https://www.cia.gov/cia/publications/factbook/index.html} are available to the public. Students can use the reports as a basis for comparing different production locations.
Another Perspective: For additional information about a particular country, Yahoo provides an easy-to-search bank of linked sources that provide information about almost every country in the world. The site, {http://www.yahoo.com/Government/Countries/}, is useful to make quick comparisons between countries to gauge their relative attractiveness as production locations.
Slides 16-9-16-10 Technological Factors
The type of technology a firm uses in its manufacturing can affect location decisions.
Three characteristics of a manufacturing technology are of interest:
1. The level of fixed costs
2. The minimum efficient scale
3. The flexibility of the technology
Slide 16-11 What Should a Firm Do?
When fixed costs are substantial, the minimum efficient scale of production is high, and/or flexible manufacturing technologies are available, the arguments for concentrating production at a few choice locations are strong.
Slide 16-14-16-16 Product Factors
Two product factors impact location decisions:
1. The product's value-to-weight ratio
2. Whether the product serves universal needs
Slides 16-20-16-21 Locating Production Facilities
There are two basic strategies for locating manufacturing facilities:
1. concentrating them in the optimal location and serving the world market from there
2. decentralizing them in various regional or national locations that are close to major markets
Slides 16-19-16-20 The Strategic Role of Foreign Factories
The strategic role of foreign factories and the strategic advantage of a particular location can change over time.
Improvement in a facility comes from two sources:
1. Pressure to lower costs or respond to local markets
2. An increase in the availability of advanced factors of production
Slide 16-21 Outsourcing Production: Make-or-Buy Decisions
Should an international business make or buy the component parts to go into their final product? Make-or-buy decisions are important factors in many firms' manufacturing strategies.
Slides 16-22 The Advantages of Make
1. lower costs
2. facilitates investments in highly specialized assets
3. protects proprietary technology
4. facilitate the scheduling of adjacent processes
The benefits of manufacturing components in-house are greatest when: • highly specialized assets are involved • vertical integration is necessary for protecting proprietary technology • the firm is more efficient than external suppliers at performing a particular activity
Slides 16-23 The Advantages of Buy
Buying component parts from independent suppliers:
1. gives the firm greater flexibility
2. helps drive down the firm's cost structure
3. helps the firm capture orders from international customers
Slide 16-25 Strategic Alliances with Suppliers
Firms can capture the benefits of vertical integration without the associated organizational problems by forming long-term strategic alliances with key suppliers. However, these commitments may actually limit strategic flexibility.
Slide 16-26 Managing the Global Supply Chain
Logistics encompasses the activities necessary to get materials to a manufacturing facility, through the manufacturing process, and out through a distribution system to the end user
Another Perspective: Stanford University maintains a web site that is a forum for the dissemination of research and practical advice in the area of global supply chain management. The site supplies current information that can help extend a lecture on global materials management. The site is available at {http://www.stanford.edu/group/scforum/Welcome/index.html}.
Another Perspective: One company that specializes in global supply chain management is EPIQ. To get a better idea of the issues in global supply chain management, students may want to go to the company’s web site {http://www.epiqtech.com/} and explore some of the services the company provides.
Slide 16-27 The Role of Just-in-Time Inventory
The basic philosophy behind just-in-time (JIT) systems is to economize on inventory holding costs by having materials arrive at a manufacturing plant just in time to enter the production process, and not before
Slide 16-28 The Role of Information Technology and the Internet
Web-based information systems play a crucial role in materials management. They allow firms to optimize production scheduling according to when components are expected to arrive.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: An electronics firm is considering how best to supply the world market for microprocessors used in consumer and industrial electronic products. A manufacturing plant costs approximately $500 million to construct and requires a highly skilled work force. The total value of the world market over the next ten years for this product is estimated to be between $10 billion and $15 billion. The tariffs prevailing in this industry are currently low. Should the firm favor concentrated manufacturing or decentralized manufacturing? What kind of location(s) should the firm favor for its plant(s)?
ANSWER 1: The firm should pursue a concentrated manufacturing strategy because (1) the tariffs prevailing in the industry are low, (2) the cost of building a plant to produce the microprocessors is high, and (3) the product's value-to-weight ratio is high. All of these factors favor a concentrated manufacturing strategy. In terms of location, the company should consider three factors: country factors, technology factors, and product factors. First, in terms of country factors, the firm should locate its plant in a country that has a highly skilled pool of workers available. That criterion probably limits the firm to developed nations. Second, in terms of technology factors, the firm is compelled to limit the number of its manufacturing facilities because of the high cost of constructing a plant. Third, in terms of product factors, the firm can manufacturer its product in a central location due to the relatively high value-weight ratio and the universal appeal of the product.
QUESTION 2: A chemical firm is considering how best to supply the world market for sulfuric acid. A manufacturing plant costs approximately $20million to construct and requires a moderately skilled workforce. The total value of the world market for this product over the next 10 years is estimated to be between $20billion and $30 billion range. The tariffs prevailing in this industry are moderate. Should the firm favor concentrated manufacturing or decentralized manufacturing? What kind of location(s) should the firm seek for its plant(s)?
ANSWER 2: This question is a tougher call than the scenario depicted in Question #1. The firm should probably pursue a limited decentralized manufacturing strategy (meaning that the firm should not set up a plant in every country that it sells to, but should set up plants in several "regions" of the world). This strategy makes sense because (1) The tariffs prevailing in the industry are moderate (rather than low), (2) the cost of constructing a facility is relatively modest ($20 million), and (3) only a moderately skilled work force is needed (which is probably available in many low-cost regions of the world). The firm should select its location based on country factors, technology factors and product factors. In terms of country factors, the firm should find locations where semi-skilled labor is inexpensive. In terms of technology factors, the firm is not constrained by high fixed costs, so technology is not a pervasive issue. Finally, product factors favor the firm locating in several locations throughout the world. The company's product has a low value-weight ratio, making it unattractive to produce the product in a central location and export it across the world.
QUESTION 3: A firm must decide whether to make a component part in-house, or to contract it out to an independent supplier. Manufacturing the part requires a non-recoverable investment in specialized assets. The most efficient suppliers are located in countries with currencies that many foreign exchange analysts expect to appreciate substantially over the next decade. What are the pros and cons of (a) manufacturing the component in-house, and (b) outsourcing manufacture to an independent supplier? Which option would you recommend? Why?
ANSWER 3: Manufacturing in-house would reduce the risk of currency appreciation and rising costs from independent suppliers. Specialized asset investment would make the firm dependent on specific suppliers, however, technological know-how would be protected, and improved scheduling would be available. Out-sourcing would be beneficial if the product using the component fails in the market because the supplier will bear the cost of the non-recoverable investment, and flexibility in case a better component can be designed or bought would be preserved. Outsourcing would also lower organizational and coordination costs. Based on what we know, manufacturing in house may be slightly preferred, but other information could tip the decision the other way.
QUESTION 4: Reread the Management Focus on Philips in China then answer the following questions:
a) What are the major benefits to Philips of shifting so much of its global production to China?
b) What are the risks associated with a heavy concentration of manufacturing assets in China?
c) What strategies might Philips adopt to maximize the benefits and mitigate the risks associated with moving so much product development and production activity to developing nations like China?
ANSWER 4:
a) China is an attractive production location for Phillips for several reasons. Perhaps the most important factor is the country’s cheap wages. In addition, the Chinese workforce is well educated, the economy is strong, and many of the company’s suppliers are doing business there. Students should recognize that using China as a global supply base from which to serve the world offers several advantages to Phillips. By having a single production location, the company can capitalize on costs savings that come from economies of scale as well as the low wages in China.
b) Most students will recognize that Philips is taking a risk by concentrating its manufacturing in China. If economic, political, or other types of problems arise in the country, Phillips could be in serious trouble since it will not have alternate locations to fill production gaps.
c) Some students might recommend that Philips consider forming joint ventures with local firms to gain some protection against the threat of nationalization or other adverse moves from a foreign government. Other students may suggest that Philips maintain production facilities in more than one country to offset potential problems in another.
QUESTION 5: Explain how an efficient materials management function can help an international business to compete more effectively in the global market place.
ANSWER 5: Given the complexity involved in coordination of material and product flows in a multinational enterprise (purchases, currency exchange, inbound and outbound transportation, production, inventory, communication, expediting, tariffs and duties), a materials management function can help to assure that these flows take place in the most efficient manner possible. A related advantage is that by having a materials management function, a firm may obtain improved information about the costs of different transport alternatives, and choose to reconfigure some of its flows to better take advantage of these costs. By being better able to utilize just in time techniques, the cost of production can be lowered while the quality is increased. The materials management function can also help an international business to develop information technology systems that allow it to better track the flow of goods throughout the firm.
CLOSING CASE: Building the Boeing 787
Summary
The closing case explores Boeing’s strategy for its new 787 aircraft. Boeing made the decision to outsource much of the production of the 787 in the hopes of significantly reducing the time to get the product to market. Boeing also anticipated that its outsourcing strategy would allow it to generate additional sales from the countries that were partners in the process, and reduce its costs and risks. While Boeing’s strategy worked for some components, for other parts, the strategy was a disaster. Suppliers were late and some produced poor quality parts forcing Boeing to commit additional resources to the project. Discussion of the case can revolve around the following questions.
QUESTION 1: What are the benefits to Boeing of outsourcing so much work on the 7878 to foreign suppliers? What are the potential risks? Do the benefits outweigh the risk?
ANSWER 1: Boeing made the decision to outsource much of the production of the 787 because of the potential gains this strategy could realize. By outsourcing, Boeing hoped to achieve significant costs savings, generate additional sales in the countries where outsourcing partners were located, and decrease the development time by as much as two years. Many students will agree that the potential benefits of this type of strategy are important, but may note that in Boeing’s case, the benefits may not have outweighed the risks. As Boeing found out, benefits are only realized if partners perform as expected. Because many of Boeing’s partners are behind schedule, production of the 787 is as much as a year behind, and Boeing is facing large penalties on delivery contracts to customers.
QUESTION 2: In 2007 and 2008 Boeing ran into several publicized issues with regard to its management of globally dispersed supply chain. What are the causes of these problems? What can a company like Boeing do to make sure that such problems do not occur in the future?
ANSWER 2: In 2007-2008, Boeing announced that delivery of the 787 would be delayed by as much as 12 months. The delay was the result of problems with Boeing’s partners. Companies that had been hired to produce various parts were behind schedule, producing inferior parts, and even outsourcing themselves. Many students will probably suggest that Boeing might have been able to avoid some of its problems with greater oversight and communication with partners. For example, it appears that Boeing was unaware that some partners had actually outsourced work they had been hired to complete. Many students will probably agree with Boeing that there is tremendous potential value in outsourcing production to those firms that are the most efficient producers, but students will probably also point out that for such an effort to be successful, especially on the scale that Boeing is working on, communication and close partnering is essential.
QUESTION 3: Some critics have claimed that by outsourcing so much work, Boeing has been exporting American jobs overseas. Is this criticism fair? How should the company respond to such criticism?
ANSWER 3: The question of whether jobs are being shipped abroad is likely to generate significant debate among students. Some students will probably suggest that through its outsourcing program, Boeing is indeed taking jobs away from U.S. citizens. Other students however, may note that cost savings were a critical issue for Boeing in its decision to outsource work on the 787 project. Without the cost savings, production of the 787 may not have been a viable option. Students may therefore conclude that Boeing’s decision to outsource is actually creating jobs.
Another Perspective: To see where Boeing is with its 787 and its strategy in general, go the {http://www.boeing.com/}. To extend this case, consider {http://www.businessweek.com/bwdaily/dnflash/content/dec2009/db20091222_986652.htm} and {http://www.businessweek.com/bwdaily/dnflash/content/jun2009/db2009064_854140.htm}.
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:
Title: Hanesbrands Relocates Manufacturing to Asia
Run Time: 9:08
Abstract: This video explores the effects of apparel maker Hanesbrands’ strategy to relocate production from North and South America to several Asian countries including Vietnam, Thailand, and China.
Key Concepts: globalization, pressures for cost reductions, global economy, global strategy, global production and sourcing, foreign direct investment, levels of economic development, social responsibility
Notes: At Hanesbrands’ new factory in central Vietnam, workers are busy manufacturing apparel that will be exported to the United States. Hanesbrands opened the factory as part of its strategic plan to shift production to lower cost locations. In addition to this factory, the company has opened four other facilities in Asia that together with the Vietnam factory, employ 6,000 people. Vietnam was a particularly attractive location for investment because of its low cost labor, good infrastructure, low taxes, and proximity to the company’s fabric operations in China.
Workers at the Vietnam plant earn about $80 per month which is about $30 more per month than the country’s legal minimum wage. Hanesbrands also provides its workers with free lunches. In exchange, employees put in six day, 48 hour work weeks and agree not to join a union that is not approved by the Communist party. Hanesbrands is not the only Western company to shift production to Vietnam. In fact, some 10,000 foreign businesses have made investments totaling $40 billion. Vietnam government official Boi Kuk Ching believes that if the current pace of inward investment continues, Vietnam will become an industrial nation by 2020. The effects of the foreign investment can be seen everywhere. Many people are moving out of rural areas where they had survived on subsistence wages to take advantage of the better job opportunities in the urban areas. Consumption is up, and so is the selection of products to buy. However, while the economy may seem more prosperous, there are several disadvantages associated with the influx of investment. Air pollution has increased and housing costs have risen in urban areas. To keep housing expenses down, some people are choosing to squeeze multiple people into a single room. To avoid some of these problems, Doug Leegon, a sociology professor, suggests that Vietnam should make a bigger effort to encourage investment in rural areas as well as in urban areas.
In the United States, Hanesbrands has been criticized for shipping jobs offshore. As part of its cost saving strategy, the company has closed 30 plants in the United States, Canada, and Latin America, leaving some 19,000 people without jobs. Scott Nova of the Workers Rights Consortium believes that Hanesbrands and other companies should be more committed to the local communities and workers where they operate. Hanesbrands though, disagrees. In fact, the company claims that it is indeed making a long term commitment to its Asian operations, and that its investments should remain for 20 to 30 years. The company also points out that it had been in North Carolina for a century before making the decision to close its operations there. CEO Richard Noll says that the company’s current actions are simply part of its ongoing strategy to operate where costs are low, invest in innovation, and follow a low price policy. Noll notes that by investing in Vietnam and the other Asian countries, Hanesbrands is bring jobs to the region, and promoting economic growth. Noll’s comments do little to appease former employees in the United States where some have agreed to boycott the company’s products. These disgruntled workers may soon have more company thanks to a recent decision by
Hanesbrands to accelerate its plant closures in the United States in an effort to minimize the effects of the weakened economy.
Discussion Questions:
1. Vietnam has attracted some $40 billion of investments in recent years. Discuss why the country is attracting companies like Hanesbrands. What factors are driving this type of investment? What does the investment mean to Vietnam?
2. Using the framework in your text, discuss Hanesbrands’ global strategy. Is the company’s recent decision to close plants in North and South America driven by pressures for local responsiveness or pressures to lower costs? What type of strategy is Hanesbrands following? In your opinion, will Hanesbrands be successful? Why or why not?
3. Hanesbrands has been criticized for its decision to close plants in North and South America. Discuss the impact of these closures. How should the company respond to the criticism? What, if any, responsibility does Hanesbrands have to Vietnam and the other Asian countries?
4. Compare the compensation of workers in Vietnam to that of workers in the United States. In your opinion, are the workers in Vietnam being fairly compensated by Hanesbrands? Consider the relationship between management and labor. What bargaining power do the workers in Vietnam have?
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following from International Business DVD Volume 5:
Title 16: The Great British Jobs Takeaway – Indian Call Center
Abstract: This video explores the operations of a call center in India, and the benefits of operating the center in India as compared to Britain.
Key Concepts: outsourcing, offshoring, global economy, trade, globalization, levels of economic development, theory of comparative advantage, theory of factor proportions
Notes: At eleven o’clock at night the work day is just beginning for workers at GTL Limited in Mumbai in India. GTL Limited sells life insurance over the telephone. So, while their countrymen may be sleeping these workers are making calls to Britain where it is early evening – a peak time for telephone sales. Workers making sales calls greet call recipients using the local time reference.
Workers at the call center follow a carefully scripted sales pitch and view sample dialogue on their computer screens. Many call centers like GTL Limited require workers to use an English name like James. The workers claim that doing so makes them seem more familiar to their target market. One worker thinks that using his English name makes it easier for British people to relate to him, but does not believe that his employer is trying to fool customers. Some call centers though, also require workers to disguise their location, and indicate to customers that they work in nearby towns.
Call centers like GTL Limited can be found across the city and in other parts of India. Foreign companies have shifted their telephone sales and other activities to India to take advantage of the country’s well-educated, cheap labor force. Workers in India earn just 30 percent of what a British worker might earn. Making the process easier is the fact that jobs at call centers in India are popular. Many of the 1,500,000 graduates each year will seek employment in a call center. In fact, many call centers like GTL Limited actually require their workers to have a degree. British companies know they cannot compete with the inexpensive Indian call centers and so are actively seeking qualified Indian workers instead.
Discussion Questions:
1. Define the term ‘production’. How does the term apply to companies involved in services like life insurance sales?
2. Many firms today are dispersing production to offshore locations. Explain how call centers like the ones in India lower the cost of production for firms. What might lead a firm to buy services like those offered in an offshore call center?
3. In recent years, India has become recognized as a leader in providing customer care services. What makes India such an attractive location for companies looking to outsource their customer care activities?
4. How can the term ‘production’ be used when describing services? How do firms in the services industry use the term? How does it apply to the make-or-buy decision?
5. Adopting an English name is common for many Indians working in call centers. Why is this an important part of their job? What does it imply about the need for local responsiveness in the services industry?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following exercises:
Exercise 1
The globalization of production makes many people more aware of the differences in manufacturing costs worldwide. The U.S. Department of Labor’s Bureau of International Labor Affairs publishes a Chartbook of International Labor Comparisons. Locate the latest edition of this report and identify the hourly compensation costs for manufacturing workers in the U.S., Italy, Mexico, New Zealand, Norway, and Singapore.
Exercise 2
The internationalization of manufacturing has become much more predominant in recent years. In fact, the Industry Week magazine ranks the world’s largest manufacturing companies by sales revenue. Identify the largest Indian and Japanese manufacturing companies as provided in the most recent ranking by paying special attention to the industries in which these companies operate.
Answers to the Exercises
Exercise 1
The Chartbook of International Labor Comparisons can be located by searching for the term “Chartbook of International Labor Comparisons” at http://globaledge.msu.edu/ResourceDesk/. The resource is titled “A Chartbook of International Labor Comparisons” and is located under the globalEDGE Category “Research: Statistical Data Sources”. Hourly compensation costs are listed under the “Competitiveness Indicators for Manufacturing” section of this report. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “Chartbook of International Labor Comparisons”
Resource Name: A Chartbook of International Labor Comparisons
Website: http://www.bls.gov/fls/chartbook.htm globalEDGE™ Category: “Research: Statistical Data Sources”
Exercise 2
The Industry Week magazine ranking can be located by searching for the term “Industry Week” at http://globaledge.msu.edu/ResourceDesk/. The resource is titled “IndustryWeek: IW 1000 - World's Largest Manufacturing Companies” and is located under the globalEDGE Category “Research: Rankings”. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “Industry Week”
Resource Name: IndustryWeek: IW 1000 - World's Largest Manufacturing Companies
Website: http://www.industryweek.com/iwinprint/iw1000/ globalEDGE™ Category: “Research: Rankings”
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Learning objectives
• Be familiar with current trends regarding FDI in the world economy.
• Understand the different theories of foreign direct investment.
• Appreciate how political ideology shapes a government’s attitudes towards FDI.
• Understand the benefits and costs of FDI to home and host countries.
• Be able to discuss the range of policy instruments that governments use to influence FDI.
• Articulate the implications for management practice of the theory and government policies associated with FDI.
The focus of this chapter is foreign direct investment (FDI). The growth of foreign direct investment in the last 25 years has been phenomenal. FDI can take the form of a foreign firm buying a firm in a different country, or deciding to invest in a different country by building operations there.
With FDI, a firm has a significant ownership in a foreign operation and the potential to affect managerial decisions of the operation.
The goal of our coverage of FDI is to understand the pattern of FDI that occurs between countries, and why firms undertake FDI and become multinational in their operations as well as why firms undertake FDI rather than simply exporting products or licensing their know-how.
The opening case describes the international growth of Spain’s Telefonica. Until the 1990s, Telefonica was a typical state-owned firm. Today, it has expanded into Latin America and Europe. The closing case explores Mittal Steel’s expansion from a small, family-run operation in India, to being the world’s largest steel company headquartered in Rotterdam.
OUTLINE OF CHAPTER 7: FOREIGN DIRECT INVESTMENT
Opening Case: Spain’s Telefonica
Introduction
Foreign Direct Investment in the World Economy Trends in FDI The Direction of FDI The Source of FDI The Form of FDI: Acquisitions versus Greenfield Investments The Shift to Services
Country Focus: Foreign Direct Investment in China
Theories of Foreign Direct Investment Why Foreign Direct Investment? The Pattern of Foreign Direct Investment The Eclectic Paradigm
Management Focus: Foreign Direct Investment by Cemex
Political Ideology and Foreign Direct Investment The Radical View The Free Market View Pragmatic Nationalism Shifting Ideology
Management Focus: DP World and the United States
Benefits and Costs of FDI Host Country Benefits Host Country Costs Home Country Benefits Home Country Costs International Trade Theory and FDI
Government Policy Instruments and FDI Home Country Policies Host Country Policies International Institutions and the Liberalization of FDI
Implications for Managers The Theory of FDI Government Policy
Chapter Summary
Critical Thinking and Discussion Questions
Closing Case: Cemex’s Foreign Direct Investment
CLASSROOM DISCUSSION POINT
Ask students for examples of foreign firms that have invested in the U.S. Jot them down on the board.
Then, discuss why these companies invested in the U.S. Try to follow the framework presented in the text, and refer back to the board during the presentation of the material.
Next, explore what the investment means for the U.S.
OPENING CASE: Spain’s Telefonica
The opening case explores the international growth of Telefonica, a Spanish telecommunications firm. For decades, Telefonica had operated as a typical state-owned enterprise, but privatization and deregulation changes that path in the 1990s. Telefonica began to aggressively pursue expansion opportunities in Latin America where it quickly became the number 1 or 2 player in nearly every country. Later, Telefonica turned its sights on Europe where its acquisitions helped transform the company into the second biggest mobile phone operator in the world. Discussion of the case can revolve around the following questions:
1. Reflect on the various market entry strategies used by Telefonica. What type of entry strategy did Telefonica use in its expansion into Latin America? Why did Telefonica choose this approach over other forms of market entry?
2. Why was Latin America such an attractive market for Telefonica? How important were the historical ties between the region and Spain to Telefonica’s decision to invest?
3. Where do you think the best opportunities for future growth lie for Telefonica? Why?
Another Perspective: Telefonica’s web site is available at {http://www.telefonica.com/en/home/jsp/home.jsp}.
Another Perspective: Telefonica has expanded it alliance with China’s Unicom. To learn more, go to {http://www.businessweek.com/globalbiz/content/jul2008/gb2008079_485740.htm}.
LECTURE OUTLINE
This lecture outline follows the Power Point Presentation (PPT) provided along with this instructor’s manual. The PPT slides include additional notes that can be viewed by clicking on “view”, then on “notes”. The following provides a brief overview of each Power Point slide along with teaching tips, and additional perspectives.
Slide 7-3 What Is Foreign Direct Investment?
Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country. Once a firm undertakes FDI it becomes a multinational enterprise.
Another Perspective: Each year Fortune magazine publishes a list of the 500 largest global corporations in the world. Fortune calls its list the "Global 500." This list can be accessed at {http://money.cnn.com/magazines/fortune/global500/2009/index.html}. The article contains an excellent discussion of the role of global firms in the world economy.
FDI can take the form of a greenfield investment where a wholly new operation is established in a foreign country, or it can take place via acquisitions or mergers with existing firms in the foreign country.
Another Perspective: Another web site that provides an excellent discussion of the role of multinational corporations in the world economy is available at {http://www.oecdobserver.org/news/fullstory.php/aid/446/The_trust_business.html}.
The flow of FDI refers to the amount of FDI undertaken over a given time period, while the stock of FDI refers to the total accumulated value of foreign-owned assets at a given time. Outflows of FDI are the flows of FDI out of a country, and inflows of FDI are the flows of FDI into a country.
Slides 7-6-7-9 Trends in FDI
There has been a marked increase in both the flow and stock of FDI in the world economy over the last 30 years.
While the United States remains a top destination for FDI flows, South, East, and Southeast Asia, and particularly China, are now seeing an increase of FDI inflows, and Latin America is also emerging as an important region for FDI.
Another Perspective: FDI in China continues to be strong, and India is emerging as another hotspot for FDI. To learn more about these markets go to {http://www.businessweek.com/globalbiz/content/mar2009/gb20090318_214447.htm}.
Slides 7-11-7-12 The Source of FDI
Since World War II, the U.S. has been the largest source country for FDI. The United Kingdom, the Netherlands, France, Germany, and Japan are other important source countries.
Another Perspective: Since the recent global recession, Great Britain has seen its economic position in the Europe Union and within the global economy shift. To learn more about the country’s changing fortunes, go to {http://www.businessweek.com/globalbiz/content/feb2009/gb20090224_856591.htm}.
Slide 7-13 The Form of FDI: Acquisitions Versus Greenfield Investments
Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments.
Slide 7-14 The Shift to Services
FDI is shifting away from extractive industries and manufacturing, and towards services.
Slides 7-15 Why Foreign Direct Investment?
Why do firms choose FDI instead of exporting or licensing? Internalization theory (also known as market imperfections theory) suggests that licensing has three major drawbacks.
Slides 7-16 The Pattern of Foreign Direct Investment
Knickerbocker looked at the relationship between FDI and rivalry in oligopolistic industries (industries composed of a limited number of large firms) and suggested that FDI flows are a reflection of strategic rivalry between firms in the global marketplace.
Vernon argued that firms undertake FDI at particular stages in the life cycle of a product they have pioneered.
According to the eclectic paradigm, in addition to the various factors discussed earlier, it is important to consider: • location-specific advantages - that arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets and • externalities - knowledge spillovers that occur when companies in the same industry locate in the same area
Slide 7-18 Political Ideology and Foreign Direct Investment
Ideology toward FDI ranges from a radical stance that is hostile to all FDI to the non-interventionist principle of free market economies. Between these two extremes is an approach that might be called pragmatic nationalism.
The radical view argues that the MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries.
According to the free market view, international production should be distributed among countries according to the theory of comparative advantage.
Pragmatic nationalism suggests that FDI has both benefits, such as inflows of capital, technology, skills and jobs, and costs, such as repatriation of profits to the home country and a negative balance of payments effect.
Recently, there has been a strong shift toward the free market stance creating: • a surge in FDI worldwide • an increase in the volume of FDI in countries with newly liberalized regimes
Slide 7-19 Benefits of FDI
Government policy is often shaped by a consideration of the costs and benefits of FDI.
There are four main benefits of inward FDI for host countries: resource transfer effects; employment effects; balance of payments effects, and effects on competition and growth.
Slides 7-21 Host Country Costs
There are three mains costs from inward FDI for the host country: the possible adverse effects of FDI on competition within the host nation; adverse effects on the balance of payments; and the perceived loss of national sovereignty and autonomy.
Slide 7-22 Home Country Benefits
The benefits of FDI for the home country include: the effect on the capital account of the home country’s balance of payments from the inward flow of foreign earnings; the employment effects that arise from outward FDI; and the gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country.
Slide 7-23 Home Country Costs
The home country’s balance of payments can suffer from the initial capital outflow required to finance the FDI; if the purpose of the FDI is to serve the home market from a low cost labor location; and if the FDI is a substitute for direct exports.
International trade theory suggests that home country concerns about the negative economic effects of offshore production (FDI undertaken to serve the home market) may not be valid.
Slide 7-24 Government Policy Instruments and FDI
Home countries and host countries use various policies to regulate FDI.
Another Perspective: The World Bank offers information on the business environment in different countries. To explore the information, go to {http://www.worldbank.org/}, click on “countries”, and select the country in question.
Governments can both encourage and restrict FDI
Another Perspective: India has recently revised its regulations regarding FDI raising concerns among some analysts. To learn more about India’s new regulations go to {http://www.businessweek.com/globalbiz/content/feb2009/gb20090213_539478.htm}.
To encourage inward FDI, governments offer incentives to foreign firms to invest in their countries, while they restrict inward FDI through ownership restraints and performance requirements.
Slide 7-26 International Institutions and the Liberalization of FDI
The World Trade Organization is trying to establish a universal set of rules designed to promote the liberalization of FDI.
Slide 7-27-7-28 Implications for Managers
Managers need to consider what trade theory implies, and the link between government policy and FDI.
The direction of FDI can be explained through the location-specific advantages argument associated with John Dunning.
A host government’s attitude toward FDI is an important variable in decisions about where to locate foreign production facilities and where to make a foreign direct investment.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: In 2004, inward FDI accounted for some 24% of the gross fixed capital formation in Ireland, but only .6% in Japan. What do you think explains the difference in FDI inflows into the two countries?
ANSWER 1: One approach to this question is to look at government policy: Ireland is FDI-friendly while Japan has discouraged inward FDI. Both are trade-dependent economies with few natural resources, but Ireland appears far less mercantilist in attitude than does Japan. Ireland has a well-educated, relatively low cost workforce and an abundant supply of labor, while Japan’s workforce, also well-educated, is expensive.
QUESTION 2: Compare and contrast these explanations of FDI: internalization theory, Vernon's product life cycle theory, and Knickerbocker's theory of FDI. Which theory do you think offers the best explanation of the historical pattern of FDI? Why?
ANSWER 2: Knickerbocker's theory suggests that firms imitate other firms in oligopolistic industries, and will "follow the leader" in undertaking FDI in certain countries, as sort of strategic defensive moves. This theory does not explain why the first firm undertakes FDI, nor why it chooses to do this rather than to export or license. The product life cycle theory suggests that firms invest in foreign countries when demand in that country will support local production or when cost pressures make it necessary to locate production in low cost locations. While this theory does explain why some FDI takes place, it does not explain why FDI is preferred over licensing or exporting. The market imperfections explanation more directly confronts these issues, and explains why FDI may be preferable to other alternatives for expanding business activities. It identifies the importance and difficulty of transferring know-how and describes some of the impediments to exporting. By explaining better exactly why a firm may undertake FDI, the market imperfections model is probably the best explanation of the historical pattern of horizontal FDI.
QUESTION 3: Read the Management Focus on Cemex and then answer the following questions:
a) Which theoretical explanation, or explanations, of FDI best explains Cemex’s FDI?
b) What is the value that Cemex brings to the host economy? Can you see any potential drawbacks of inward investment by Cemex in an economy?
c) Cemex has a strong preference for acquisitions over greenfield ventures as an entry mode. Why?
d) Why do you think Cemex decided to exit Indonesia after failing to gain majority control of Semen Gresik? Why is majority control so important to Cemex?
e) Why do you think politicians in Indonesia tried to block Cemex’s attempt to gain majority control over Semen Gresik? Do you think Indonesia’s best interests were served by limiting Cemex’s FDI in the country?
ANSWER 3:
a) Cemex is a cement company. Consequently, exporting is difficult because of the weight of the product. If Cemex wants to expand into new markets, the company would either need to license a local company or make an investment in the market directly. Cemex’s success is due in part to its top notch customer service, and relationship with distributors. Because these advantages could be difficult to transfer, the company will probably choose to invest directly. Students should reflect on these factors as they consider the various theories to explain Cemex’s FDI.
b) Cemex is the third largest cement company in the world, and a powerhouse in Mexico where it controls 60 percent of the market. Cemex is highly focused on efficient manufacturing and customer service. Distributors are rewarded for their sales, as are users. The primary benefit Cemex brings to host countries involves these competitive advantages. Cemex acquires companies and then transfers technological, management, and marketing know-how to the new units, improving their performance. The company has brought several acquired companies back to full production, increasing employment opportunities in the host country as well.
c) Cemex has successfully acquired established cement makers in many countries. By acquiring companies rather than establishing them from the ground up, Cemex can avoid some of the delays that could occur in the start-up phase, while at the same time, capitalize on the benefits of an established market presence.
d) Much of Cemex’s success appears to be built around its customer service and attention to distributors. Indeed, it could be argued that what sets Cemex apart from its competitors, or its competitive advantage, is its superior way of dealing with external stakeholders. It is significantly easier to duplicate this sort of advantage in a wholly owned operation than in a joint venture or through licensing arrangements.
e) In 2006, Cemex announced that it would be pulling out of Indonesia. Cemex entered the Indonesian market in 1998, as part of an IMF sponsored privatization program. Cemex purchased a 25 percent stake in Semen Gresik, a government owned cement maker. Cemex’s decision to pull out was a result of a dispute with the Indonesian government. When Cemex has entered the market, it had been promised a majority position in Semen Gresik in 2001. However thanks to the efforts of various special interest groups, permission was never granted. Whether the decision to pull out was in the best interests of the country is difficult to say. Certainly it would seem that Semen Gresik could learn from Cemex, and utilize its knowledge to improve its own operations. However, allowing a foreign company to control an industry that is necessary to a country could be detrimental to the nation.
Another Perspective: Cemex’s web site is available at {http://www.cemex.com}.
QUESTION 4: You are the international manager of a US business that has just invented a revolutionary new personal computer that can perform the same functions as existing PCs but costs only half as much to manufacture. Several patents protect the unique design of this computer. Your CEO has asked you to formulate a recommendation for how to expand into Western Europe. Your options are (a) to export from the US, (b) to license a European firm to manufacture and market the computer in Europe, and (c) to set up a wholly owned subsidiary in Europe. Evaluate the pros and cons of each alternative and suggest a course of action to your CEO.
ANSWER 4: In considering expansion into Western Europe, an international manager might consider three options: FDI, licensing, and export. With export, assuming there are no trade barriers, the key considerations would likely be transport costs and localization. While transport costs may be quite low for a relatively light and high value product like a computer, localization can present some difficulties. Power requirements, keyboards, and preferences in models all vary from country to country. It may be difficult to fully address these localization issues from the US, but not impossible. Since there are many computer manufacturers and distributors in Europe, there are likely to be a number of potential licensees. But a licensing arrangement implies that valuable technological information may have to be disclosed and that the firm’s competitive advantage may be lost if the licensees uses or disseminates this proprietary knowledge improperly. FDI (setting up a wholly owned subsidiary) is clearly the most costly and time consuming approach, but the one that best guarantees that critical knowledge will not be disseminated and that localization can be done effectively. FDI will also place you in the market into which you want to sell and allow you to be near the consumer. Given the fast pace of change in the personal computer industry, it is difficult to say how long this revolutionary new computer will retain its competitive advantage. If the firm can protect its advantage for a period of time, FDI may pay off and help assure that critical knowledge is not lost. If the innovation is not core and can be easily copied, then licensing would allow the firm to get the quickest large scale entry into Europe and make as much as it can before losing advantage.
CLOSING CASE: Lakshmi Mittal and the Growth of Mittal Steel
Summary
The closing case examines the growth of Mittal Steel from a small, family owned company based in India to the world’s largest steel company headquartered in Luxembourg. Mittal Steel’s growth strategy involved acquiring companies in distress at low prices, improving their efficiency, and capitalizing on a growing demand for steel. Mittal Steel also used its growing power in the industry to drive down the prices of raw materials. Mittal Steel’s most recent acquisition involved European steel maker Areclor, which was acquired in a hostile takeover in 2007 to create ArcelorMittal. Today, the firm boasts sales of $110 billion and a net income of $10.2 billion. Discussion of the case can revolve around the following questions:
QUESTION 1: What forces drove Mittal Steel to start expanding across national borders?
ANSWER 1: Mittal Steel began as a family-run operation in India based in the early 1970s. However, because of various restrictive government regulations and strong competition from a state-owned firm, SAIL, and the large, privately-owned Tata Steel, Mittal Steel felt its best prospects for growth lay outside India. In 1975, Mittal Steel began its first foreign venture by building a steel making plant from scratch in Indonesia.
QUESTION 2: Mittal Steel expanded into different nations through mergers and acquisitions, as opposed to greenfield investment investments. Why?
ANSWER 2: The vast majority of Mittal Steel’s expansion has taken place via acquisitions and mergers. At the time Mittal Steel was beginning its foreign expansion, the steel industry was in the throes of a twenty-five year slump, and many companies were in distress. Lakshmi Mittal, CEO, believed there was value in these distressed companies, and that with an injection of capital and a shift toward greater efficiency, the firms could be viable operations. Most students will probably suggest that the cost of building similar operations from scratch (greenfield investments) would probably be considerably higher. Moreover, by acquiring companies rather than establishing them from the ground up, Mittal Steel could avoid some of the delays that could occur in the start-up phase, while at the same time, capitalize on the benefits of an established market presence.
QUESTION 3: What benefits does Mittal Steel bring to the countries that it enters? Are there any drawbacks to a nation when Mittal Steel invests there?
ANSWER 3: Most students will probably agree that because Mittal Steel has focused on acquiring distressed companies and turning them around, its presence in a foreign market would probably be viewed as beneficial. Some students however, may note that Mittal Steel’s most recent acquisition, Arcelor did generate a strong negative reaction from management and politicians who resisted the efforts of a foreign firm to take over an organization that was important to the European market. Indeed, some students may suggest that Europe and other countries are now vulnerable to the whims of a foreign company – a company that may or may not make decisions that benefit the local market.
QUESTION 4: What are the benefits to Mittal Steel from entering different nations?
ANSWER 4: By being a player in multiple markets, Mittal Steel has diversified its income streams, and reduced its dependence on any single market. In addition, its global presence enables it to control to some extent the price of raw materials in the industry. Many students will probably also recognize that the prospects for growth in the steel industry almost imply growing across borders, simply because of limited demand within any single market.
QUESTION 5: The acquisition of Arcelor was very acrimonious, with many politicians objecting to it. Why do you think they objected? Were their objections reasonable?
ANSWER 5: In 2006, the shareholders of Arcelor, a European firm formed through the merger of steel makers from three European countries, approved the acquisition of Arcelor by Mittal Steel. Many politicians, who saw the acquisition as a threat to their countries, objected vehemently to the merger. Most students will probably suggest that their opposition to the deal probably related to concerns that Mittal Steel had no particular loyalty to Europe and would simply make decisions that improved the value of the firm, regardless of their effects on the local market. Many students will probably suggest the concerns of the politicians were valid, bit may also point out that because Mittal Steel has moved its headquarters to Rotterdam, it too was a European company. In addition, students may point out that Arcelor’s shareholders believed the acquisition should go ahead.
Another Perspective: ArcelorMittal’s web site is available at {http://www.arcelormittal.com/}.
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:
Title: After Chrysler Deal, Fiat to Face Tough U.S. Car Market
Run Time: 8:04
Abstract: This video explores the challenges facing Chrysler as it emerges from bankruptcy will new owners, a new leader, and a new agenda.
Key Concepts: global strategy, foreign direct investment, globalization, pressures for cost reductions, global economy, global production and sourcing, foreign direct investment
Notes: Italian car maker Fiat’s recent acquisition of a large share of Chrysler is the start of a new chapter for the troubled U.S. auto company. For Chrysler, the deal was an important component in its restructuring. The company had been in bankruptcy, weighed down with billions of dollars of debt and labor costs. The new, leaner Chrysler Group which will be owned jointly by Fiat, the U.S. government, the Canadian government, and the United Auto Workers union, will be led by the head of Fiat, Sergio Marchionne. Under the new ownership structure, the governments will own 10 percent of the company, Fiat will own 35 percent, and the union will control the remaining 55 percent of the organization.
Marchionne, who is highly regarded in Italy and indeed Europe, joined Fiat five years ago and not only helped turn the company away from financial disaster, but helped make it into one of the stronger auto companies today. Many analysts believe that Marchionne’s experience at Fiat will serve him well as he takes on the challenges facing Chrysler. At Fiat, Marchionne focused on keeping costs in check, working closely with unions, and developing a product line designed to attract customers. Fiat is important to Chrysler’s future for several reasons. One key reason is Marchionne’s experience in turning around a troubled company. Fiat also brings knowledge of small-car platform technology and the engine technology that will allow Chrysler to meet strict new environmental regulations. Perhaps most important to Chrysler however, are Fiat’s design skills. Like the Fiat of a few years ago, Chrysler has been struggling with high costs and union demands, as well as tough new CAFÉ regulations. In addition though, Chrysler has been losing customers because of its dull product line. In fact, Francesco Guerrera of the Financial Times, feels that Chrysler’s inability to design exciting cars is at the root of its problems. John Wolkonowitz of HIS Global Insight agrees, and suggests that Fiat could be the key to Chrysler regaining its position as a design leader – a position it once held in the 1990s.
For now, most analysts believe that Chrysler will continue to focus on improving efficiency by eliminating unnecessary layers of management and closing dealerships. Already, the firm has closed 800 dealerships. Factories that had been closed as part of the bankruptcy process are expected to reopen in the near future. In fact, there is some urgency to the process at this point because of concerns that if the company does not become operational soon, both customers and employees will begin to move away. One of the key challenges for Chrysler in the weeks ahead will be managing the various, and perhaps conflicting, interests of its many stakeholders. Because the stakeholders are expected to be quite vocal with their demands, compromise may become the name of the game.
Discussion Questions:
1. Fiat has emerged as a sort of knight in shining armor for Chrysler. The Italian automaker has acquired 35 percent of the troubled U.S. company and will now call the shots as the auto maker reemerges from bankruptcy. In addition to a much needed influx of funds, what does Fiat bring to Chrysler? How can Fiat help Chrysler become a global player once again?
2. Comment on the new ownership structure at the Chrysler Group. How might the fact that the group is now owned by various parties from various countries influence decision making at the firm? Why have analysts suggested that it is critical for Chrysler to get back to regular operating levels quickly?
3. Fiat’s acquisition of one third of Chrysler means that the American company will now be led by an Italian CEO. What challenges do you see for the restructured Chrysler Group as it tries to mesh operating styles and organizational cultures?
4. The SWOT analysis is a management tool used by many organizations to identify firm strengths and weakness, as well as opportunities the firm could capitalize on, and threats it should be aware of. Reflect on the newly restructured Chrysler Group. Based on what you know about the new Chrysler as well as the auto industry in general develop a SWOT analysis for the firm.
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following from International Business DVD Volume 5:
Title 7: Wal-Mart’s Success in China
Abstract: This video explores Wal-Mart’s success in China as both a buyer and as a seller.
Key Concepts: foreign direct investment, trade, global economy, globalization, levels of economic development, global strategy
Notes: Most Americans are probably aware that many of the products they buy are made in China. However, many Americans might be surprised to know that the U.S. retail giant Wal-Mart is actually China’s eighth largest trading partner. In fact, about 70 percent of the products sold in a Wal-Mart store are manufactured in China. In 2004, Wal-Mart’s purchases from China were estimated to be about $18 billion. Wal-Mart’s relationship with China is not a one-way street though. Wal-Mart has successfully opened several stores in China that attract crowds of shoppers. One man even bought his house so that he could be close to the store.
Chinese exports to the United States are attractive to Americans because of their low prices. Experts also note that the low prices also help hold down inflation rates in the United States. The Chinese are able to sell their products cheaply because of the low wage rates in China. In 2002 for example, the average Chinese factory worker made just $0.64 per hour as compared to the $21 per hour earned by an American factory worker. While some Americans raise concerns about the possibility of more manufacturing jobs being shifted to China, experts agree that those jobs have already left the United States, and will not return. If the Chinese do not manufacture the goods, another low-cost Asian country will.
China’s exports to the United States are also important to Americans because they give the Chinese the income to buy American-made goods like airplanes and cars. Roads in China are now clogged with American-made cars, and shopping districts advertise American products like McDonald’s, KFC, Pepsi, and Coca–Cola. The Chinese are likely to continue to buy more and more products labeled “Made in America” thanks to new legislation that further opens the Chinese market to American companies. U.S. companies like Wal-Mart now have permission to build as many stores as they want, wherever they want. America’s love affair with Wal-Mart and the inexpensive Chinese-made goods it sells is strong, and now it seems the legendary retailer has captured the hearts of the Chinese as well.
Discussion Questions:
1. What type of investment does Wal-Mart have in China? Why do you think Wal-Mart followed this strategy? What are the benefits to China of Wal-Mart’s investment?
2. Approximately 70 percent of everything Wal-Mart sells is made in China. Why does Wal-Mart buy so much from China?
3. Explain the three approaches to foreign direct investment. Which approach best reflects China’s attitude toward foreign investment? What does your answer imply for companies seeking to expand into China?
4. What actions can China take to ensure that it continues to attract inward foreign direct investment? What challenges do you see for China as it courts new investment?
5. China has attracted significant investment from foreign companies including Wal-Mart in recent years. How has its trade and investment affected economic and social development in China?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following exercises:
Exercise 1
The World Investment Report published annually by UNCTAD provides quick electronic access to comprehensive statistics on the operations of the largest transnational corporations. Gather a list of the top 10 non-financial transnational corporations from south-east Europe and the Commonwealth of Independent States (CIS). Provide a summary of the countries and industries represented. Do you notice any common traits from your analysis?
Exercise 2
Your venture capital firm is considering a partnership with entrepreneurs in Asian-Pacific countries which make it easy to do business. The owner of your company suggests that you prepare a report based on information from the Country Brand Index. How many countries have you identified? After using the same resource to evaluate Asian-Pacific countries that are ideal for doing business, which countries will you suggest for developing partnerships and investing venture capital?
Answers to Exercises
Exercise 1
The data source can be accessed by searching the term “World Investment Report” at http://globaledge.msu.edu/ResourceDesk/. The link to the World Investment Report is found under the globalEDGE category “Research: Statistical Data Sources”. On this website, the list of members top transnational corporations can be found under the “Largest TNCs” link, located on the left or at the top of the page. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “World Investment Report”
Resource Name: UNCTAD: Largest Transnational Corporations
Website: http://www.unctad.org/Templates/Page.asp?intItemID=2443&lang=1 globalEDGE™ Category: “News & Periodicals: Publications”
Exercise 2
The Country Brand Index website provides both business- and tourist-related information concerning the countries of the world. This resource can be accessed by searching “Country Brand Index” at http://globaledge.msu.edu/ResourceDesk/. The link to is found under the globalEDGE category “Reference: Travel/Living Abroad”. On this website, both categories described in the exercise can be found, located at the bottom of the page. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “Country Brand Index”
Resource Name: Country Brand Index
Website: http://www.countrybrandindex.com/ globalEDGE™ Category: “Reference: Travel/Living Abroad”
Entry Strategy and Strategic Alliances
Learning objectives
• Explain the three basic differences that firms contemplating foreign expansion must make: which markets to enter, when to enter those markets, and on what scale.
• Outline the advantages and disadvantages of the different modes that firms use to enter foreign markets.
• Identify the factors that influence a firm’s choice of entry strategy.
• Evaluate the pros and cons of acquisitions versus greenfield ventures as an entry strategy.
• Evaluate the pros and cons of entering into strategic alliances.
This chapter is concerned with three closely related topics: the decisions of which markets to enter, when to enter those markets, and on what scale.
When a firm that wishes to enter a foreign market, it has several options, including exporting, licensing or franchising to host country firms, setting up a joint venture with a host country firm, or setting up a wholly owned subsidiary in the host country to serve that market. Each of these options has its advantages and each has its disadvantages.
Strategic alliances have become more frequent. They may be seen as one way for firms to enter into cooperative agreements between actual or potential competitors. The term "strategic alliances" is often used rather loosely to include a wide range of arrangements between firms, including cross-share holding deals, licensing arrangements, formal joint ventures, and informal cooperative deals.
The magnitude of the advantages and disadvantages associated with each entry mode are determined by a number of different factors, including transport costs and trade barriers, political and economic risks, and firm strategy.
The opening case discusses General Electric’s changing perspective on the value of joint ventures as a market entry mode. In the past, General Electric has avoided joint ventures and the shared control they imply when entering foreign markets, but more recently, the company has embraced the entry mode as a means of acquiring knowledge of the local market. The closing case explores JCB’s market entry strategy in India.
OUTLINE OF CHAPTER 14: ENTRY STRATEGY AND STRATEGIC ALLIANCES
Opening Case: General Electric’s Joint Ventures
Introduction
Basic Entry Decisions Which Foreign Markets? Timing of Entry Scale of Entry and Strategic Commitments Summary
Management Focus: Tesco’s International Growth Strategy Management Focus: The Jollibee Phenomenon—A Philippine Multinational
Entry Modes Exporting Turnkey Projects Licensing Franchising Joint Ventures Wholly Owned Subsidiaries
Selecting an Entry Mode Core Competencies and Entry Mode Pressures for Cost Reductions and Entry Mode
Greenfield Venture or Acquisition? Pros and Cons of Acquisitions Pros and Cons of Greenfield Ventures Greenfield or Acquisition?
Strategic Alliances The Advantages of Strategic Alliances The Disadvantages of Strategic Alliances Making Alliances Work
Management Focus: Cisco and Fujitsu
Chapter Summary
Critical Thinking and Discussion Questions
Closing Case: JCB in India
CLASSROOM DISCUSSION POINT
Ask students to find several examples of companies expanding into new markets. Students can use publications like the Wall Street Journal or Business Week as sources. Then ask students to consider why the companies involved chose the form of market entry involved.
Try to get students to think about the trade-offs involved with the various forms of market entry. Jot their responses on the board using the framework presented in the text.
Finally, refer back to the discussion during the presentation of the material so students recognize the trade-offs companies make.
OPENING CASE: General Electric’s Joint Ventures
The opening case explores General Electric’s change in strategy. For years, General Electric entered new markets using wholly owned operations that it built from the ground up. Today however, the company has moved to a joint venture approach. Discussion of the case can revolve around the following questions:
1. General Electric has traditionally followed a strategy of expanding into new markets using wholly owned greenfield ventures. More recently however, the company has shifted to a strategy of forming joint ventures with local companies. Explain why General Electric has made this strategic shift.
2. What are the disadvantages of General Electric’s new strategy of using joint ventures to enter foreign markets?
Another Perspective: To explore General Electric’s international operations in more depth, go to {http://www.ge.com/}.
Another Perspective: To extend this case, consider {http://www.businessweek.com/innovate/content/may2008/id20080515_212057.htm?chan=search}.
LECTURE OUTLINE FOR CHAPTER
This lecture outline follows the Power Point Presentation (PPT) provided along with this instructor’s manual. The PPT slides include additional notes that can be viewed by clicking on “view”, then on “notes”. The following provides a brief overview of each Power Point slide along with teaching tips, and additional perspectives.
Slides 14-3 Basic Entry Decisions
Firms expanding internationally must decide which markets to enter, when to enter them and on what scale, and which entry mode to use. Entry modes include exporting, licensing or franchising to a company in the host nation, establishing a joint venture with a local company, establishing a new wholly owned subsidiary, or acquiring an established enterprise.
Slide -14-4 What Influences Entry Mode Choice
Several factors affect the choice of entry mode including transport costs, trade barriers, political and economic risks, costs, and firm strategy.
Slide 14-5 Which Foreign Markets?
The choice of foreign markets will depend on their long run profit potential.
Slides 14-6- 14-8 Timing of Entry
Once attractive markets are identified, the firm must consider the timing of entry. Entry is early when the firm enters a foreign market before other foreign firms, and late when the firm enters the market after firms have already established themselves in the market.
First mover advantages are the advantages associated with entering a market early. First mover disadvantages are disadvantages associated with entering a foreign market before other international businesses.
Slide 14-10 Scale of Entry and Strategic Commitments
After choosing which market to enter and the timing of entry, firms need to decide on the scale of market entry. Large-scale entry may keep rivals out and may stimulate indigenous competitive response. Small-scale entry allows time to learn about the market and reduces risk exposure.
Slide 14-11 Which is Best?
There are no “right” decisions when deciding which markets to enter, and the timing and scale of entry, just decisions that are associated with different levels of risk and reward.
Slide 14-12-14-13 Entry Modes
The six entry modes are exporting, turnkey projects, licensing, franchising, joint ventures, and wholly owned subsidiaries.
Slides 14-14 Exporting
Exporting avoid costs of investing in new location and may help achieve experience curve and location economies. Exporting faces challenges from tariff barriers, transportation costs, control over marketing, and local low-cost manufacturers.
Another Perspective: The Business Link {http://www.canadabusiness.ca/eng/} provides information companies should know before they begin exporting. Students can click on the various topics to learn more about export financing, export plans, dealing with risk, and so on.
Slides 14-15 Turnkey Projects
Turnkey projects allow a company to get a return on knowledge assets and are less risky than conventional FDI. The disadvantages are that there is not long-term interest in the location, the project may create a competitor, and process technology may be selling a competitive advantage.
Another Perspective: To learn more about how one company, Ashoka Technologies, organizes turnkey projects for clients go to {http://www.turnkey-projects.com/turnkey-plants.html}.
Slides 14-16 Licensing
Licensing does not bear the costs and risks of investment and avoids political/economic restrictions in a country.
Slides 14-17 Franchising
Franchising reduces costs and risks, avoids political and economic restrictions, and allows for quicker expansion. Disadvantages include loss of control over quality.
Slides 14-18 Joint Ventures
Joint ventures benefit from the local partner's knowledge, shared costs, and reduced risk.
Disadvantages include loss of control over technology and conflict between partners.
Another Perspective: 1000ventures, available at {http://www.1000ventures.com/business_guide/jv_main.html} is a web site that offers a wealth of information about joint ventures.
Slides 14-19 Wholly Owned Subsidiaries
Wholly owned subsidiaries offer the most control and the highest level of risk and cost.
Slides 14-22 Selecting an Entry Mode
The optimal choice of entry mode involves trade-offs.
Slide 14-23 Core Competencies and Entry Mode
The optimal choice of entry mode for firms pursuing a multinational strategy depends to some degree on the nature of their core competencies.
Slide 14-24 Pressures for Cost Reductions and Entry Mode
When pressure for cost reductions is high, firms are more likely to pursue some combination of exporting and wholly owned subsidiaries.
Slide 14-26 Greenfield Ventures or Acquisitions
Firms can establish a wholly owned subsidiary in a country through a greenfield strategy (building a subsidiary from the ground up) or through an acquisition strategy.
Slides 14-27 Pros and Cons of Acquisitions
Pros: quick, preemptive, possibly less risky. Cons: disappointing results, overpay, optimism/hubris, culture clash, failure of synergies
Slide 14-28 Pros and Cons of Greenfield Ventures
Greenfield ventures allow the firm to build the subsidiary it wants, but it is slow, risky, and may involve preemption by competitors.
Acquisition is quicker, so a consideration if there are competitors ready to enter.
Slide 14-30 Strategic Alliances
Strategic alliances refer to cooperative agreements between potential or actual competitors.
Slide 14-31 The Advantages of Strategic Alliances
Strategic alliances facilitate entry into a foreign market, allow firms to share the fixed costs (and associated risks) of developing new products or processes, bring together complementary skills and assets that neither partner could easily develop on its own, can help a firm establish technological standards for the industry that will benefit the firm.
Strategic alliances can give competitors low-cost routes to new technology and markets, but unless a firm is careful, it can give away more than it receives.
The firm must be certain that the partner is one that can help the firm achieve its goals and not act opportunistically to exploit the alliance purely for its own ends.
Slides 14-32 Making Alliances Work
The success of an alliance is a function of partner selection, alliance structure, and manner in which the alliance is managed.
Another Perspective: The Association of Strategic Alliance Professionals {http://www.strategic-alliances.org/} is an organization devoted to the formation of successful strategic alliances. The organization is supported by a number of well-known global companies, and provides information on the involvement of the companies in strategic alliances.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: Reread the Management Focus on Tesco. Then answer the following questions:
a) Why did Tesco’s initial international expansion strategy focus on developing nations?
b) How does Tesco create value in its international operations?
c) In Asia, Tesco has a long history of entering into joint venture agreements with local partners. What are the benefits of doing this for Tesco? What are the risks? How are those risks mitigated?
d) In March 2006, Tesco announced that it would enter the United States. This represents a departure from its historic strategy of focusing on developing nations. Why do you think Tesco made this decision? How is the U.S. market different from others Tesco has entered? What are the risks here? How do you think Tesco will do?
ANSWER 1:
a) Tesco’s global expansion strategy has been rather unique in the grocery industry. Rather than competing head-to-head with established retailers in developed markets like the United States and Western Europe, Tesco chose to pursue markets with strong growth potential, but little current competition. The strategy allows the company to use its expertise to grow international market share, without incurring the costs of establishing itself in already crowded markets.
b) The keys to Tesco’s success in its international operations is its ability to spot markets with strong underlying growth trends, identify existing companies in those locations that have a deep understanding of the local market, form a joint venture with those companies and transfer its expertise in the industry to the venture, and later buy the partner out. The strategy is highly successful, supplementing the company’s UK earnings with an additional ₤7.6 billion in revenues in 2007. Tesco is now the number four company in the global grocery industry.
c) Tesco’s strategy of entering foreign markets via joint ventures has proven to be highly successful. The company is able to bring its expertise in retailing as well as its financial strength to the venture where it is paired with the partner’s knowledge of the local market. Local managers are hired to run the operations, with only support coming from expatriate managers. This format allows Tesco to use its core strengths to get into the market, and then later, after the ventures have become established, buy out its partner.
d) Most students will probably agree that while Tesco’s entry into the crowded market in the United States represents a departure from its traditional strategy of focusing on developing nations with little existing competition, the strategy still reflects the company’s traditional strategy in that the format the company has chosen to use, Tesco Express, still avoids the head-to-head competition that the company has steered clear of in developing markets. In that sense, the strategy could prove to be highly successful. The company can enter the market using its Tesco Express format, avoid major competition while it gains brand recognition and experience in the market, and then later, expand into the traditional grocery business.
Another Perspective: Students can go to Tesco’s corporate home page {http://www.tescocorporate.com/} for up-to-date information about the company’s global expansion plans.
Another Perspective: To extend this feature, consider {http://www.businessweek.com/globalbiz/content/apr2009/gb20090421_205044.htm}.
QUESTION 2: Licensing propriety technology to foreign competitors is the best way to give up a firm's competitive advantage. Discuss.
ANSWER 2: The statement is basically correct - licensing proprietary technology to foreign competitors does significantly increase the risk of losing the technology. Therefore licensing should generally be avoided in these situations. Yet licensing still may be a good choice in some instances. When a licensing arrangement can be structured in such a way as to reduce the risks of a firm's technological know-how being expropriated by licensees, then licensing may be appropriate. A further example is when a firm perceives its technological advantage as being only transitory, and it considers rapid imitation of its core technology by competitors to be likely. In such a case, the firm might want to license its technology as rapidly as possible to foreign firms in order to gain global acceptance for its technology before imitation occurs. Such a strategy has some advantages. By licensing its technology to competitors, the firm may deter them from developing their own, possibly superior, technology. And by licensing its technology the firm may be able to establish its technology as the dominant design in the industry. In turn, this may ensure a steady stream of royalty payments. Such situations apart, however, the attractions of licensing are probably outweighed by the risks of losing control over technology, and licensing should be avoided
QUESTION 3: Discuss how the need for control over foreign operations varies with firms’ strategies and core competencies. What are the implications of the choice of entry mode?
ANSWER 3: If a firm’s competitive advantage (its core competence) is based on control over proprietary technological know-how, licensing and joint venture arrangements should be avoided if possible so that the risk of losing control over that technology is minimized. For firms with a competitive advantage based on management know-how, the risk of losing control over the management skills to franchisees or joint venture partners is not that great. Consequently, many service firms favor a combination of franchising and subsidiaries to control the franchises within particular countries or regions. The subsidiaries may be wholly owned or joint ventures, but most service firms have found that joint ventures with local partners work best for controlling subsidiaries.
QUESTION 4: A small Canadian firm that has developed some valuable new medical products using its unique biotechnology know-how is trying to decide how best to serve the European Union. Its choices are given below. The cost of investment in manufacturing facilities will be a major one for the Canadian firm, but it is not outside its reach. If these are the firm’s only options, which one would you advise it to choose? Why?
a. Manufacture the product at home and let foreign sales agents handle marketing.
b. Manufacture the products at home and set up a wholly owned subsidiary in Europe to handle marketing.
c. Enter into a strategic alliance with a large European pharmaceutical firm. The product would be manufactured in Europe by the 50/50 joint venture and marketed by the European firm.
ANSWER 4: If there were no significant barriers to exporting, then option (c) would seem unnecessarily risky and expensive. After all, the transportation costs required to ship drugs are small relative to the value of the product. Both options (a) and (b) would expose the firm to less risk of technological loss, and would allow the firm to maintain much tighter control over the quality and costs of the drug. The only other reason to consider option (c) would be if an existing pharmaceutical firm could also give it much better access to the market and potentially access to its products and technology, and that this same firm would insist on the 50/50 manufacturing joint venture rather than agreeing to be a foreign sales agent. The choice between (a) and (b) boils down to a question of which way will be the most effective in attacking the market. If a foreign sales agent can be found that is already quite familiar with the market and who will agree to aggressively market the product, the agent may be able to increase market share more quickly than a wholly owned marketing subsidiary that will take some time to get going. On the other hand, in the long run the firm will learn a great deal more about the market and will likely earn greater profits if sets up its own sales force.
CLOSING CASE: JCB in India
The closing case explores the joint venture between Britain’s JCB, a manufacturer of construction equipment, and Indian engineering conglomerate, Escorts. The two companies linked up to make back hoe loaders for the Indian market. The joint venture was a first for JCB, and proved to be hugely successful, gaining 80 percent of the market. However, JCB felt the arrangement limited its expansion opportunities, and recently bought out its partner. Today, JCB is a major player in the construction equipment market in both India and China. The following questions can be helpful in directing the discussion.
QUESTION 1: What was the strategic rationale underlying JCB’s entry into India in 1979, and China in 2005? Given that capital to fund expansion is limited, does it make more sense for JCB to expand its presence in these markets, as opposed to more developed markets, such as those of Western Europe?
ANSWER 1: When JCB entered the Indian market in 1979, the company felt the market was primed for growth, and that the potential in the market was too large to ignore. By entering the market early, JCB hoped to establish a foothold in the market and an advantage over competitors.
QUESTION 2: Why do you think JCB chose to enter India via a joint venture, as opposed to some other entry mode?
ANSWER 2: JCB entered the Indian market in 1979 via a joint venture with Escorts. The decision to enter via a joint venture arrangement was prompted by high tariff barriers that made JCB’s traditional strategy of exporting its product to foreign locations difficult. Given that JCB was primarily an exporter and had little experience operating in foreign locations, the joint venture arrangement offered the company a means of serving the Indian market without incurring all the risk involved in setting up a wholly owned operation.
QUESTION 3: Why did JCB not simply license its technology to Escorts?
ANSWER 3: JCB’s technology provided the company with a key competitive advantage. JCB avoided licensing arrangements because it felt that such arrangements did not give it the control over its technology that was needed. JCB feared that licensing its technology to Escorts could eventually make Escorts a direct competitor.
QUESTION 4: What were the potential disadvantages of JCB’s joint venture with Escorts?
ANSWER 4: JCB was concerned that the joint venture limited its ability to expand. The company did not want to share its proprietary technologies that were at the core of its competitive advantage with Escorts, and feared that without complete control over the venture, it could not properly serve the rapidly growing Indian market.
QUESTION 5: What were the benefits of gaining full control of the Indian joint venture in 2002? Can you think of any drawbacks?
ANSWER: While the joint venture between JCB and Escorts was successful, JCB chose to buy out its partner. JCB took advantage of new government regulations to initially buy a majority position in the venture in 1999, and later in 2002, buy it outright. Most students will probably agree that the main benefit of gaining full control of the venture was that JCB could now transfer its leading edge technologies to the venture without fearing that it could be creating a future competitor. Furthermore, since JCB had full control over the venture, it could continue its expansion in India. Some students may wonder though whether the company has taken on too much risk in the Indian market.
Another Perspective: Students can go to {http://www.jcb.com/} for additional information on the company.
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:
Title: As U.S. Automakers Struggle, Fiat Seizes Expansion Opportunities
Run Time: 7:05
Abstract: This video explores the attempt by Italian automaker Fiat, to become a bigger global player through the purchase of General Motors’ Opel division, and the acquisition of 35 percent of ailing U.S. automaker, Chrysler.
Key Concepts: globalization, international trade, international strategy, corporate culture, global expansion, market entry
Notes: The global auto industry may soon see some major changes. Italian automaker Fiat is hoping to become a bigger player in the industry, and unlike its U.S. counterparts which are struggling to survive, Fiat is ready to expand. The company is currently in the process of acquiring up to a third of ailing Chrysler, and is in talks about a potential purchase of General Motors’ Opel division. If both acquisitions proceed Fiat, which is presently the world’s ninth-largest auto company, will become the fifth-largest automaker in the world.
Until now, Fiat, a highly diversified company with divisions in everything from ski resorts to agricultural equipment, has been only a minor player in the United States. However, CEO Sergio Marchionne believes that in order to survive, that situation must change. Marchionne feels that Fiat’s long-term competitiveness depends on its ability to expand its reach in the United States and indeed, in Europe. It seems that Marchionne, who feels the company’s current sales of 1.5 million vehicles is too small to enable Fiat to be a viable global player, wants to become a force to be reckoned with. Acquiring 35 percent of Chrysler in addition to Opel would give the company sales of 5.5 million vehicles, well above the 3.5 million level that Marchionne feels is necessary to be a strong global player. Some analysts wonder though, whether Fiat is getting in over its head.
David Kiley of Businessweek, worries that Fiat is trying to do too much at once. Fiat’s strategy involves the acquisition of highly distressed companies – a strategy that may prove to be difficult in the current economy. Kiley finds it telling for example, that other key players in the industry like Toyota and BMW have shied away from the opportunities that Fiat is currently pursuing. Kiley points out that acquiring a new company means that Fiat not only gains new assets and market position, but it also means that Fiat inherits a new corporate culture – one that may be vastly different from its own. BMW actually has first hand experience in the challenges of trying to mesh another company with existing operations. The company unsuccessfully tried to integrate Rover with its own operations in the 1990s only to later sell it off. Now, BMW and Toyota are looking to grow organically rather than via acquisition. Kiley also wonders whether Fiat will be able to overcome the negative perceptions many consumers currently have of Chrysler and its products. The most recent Consumer Reports, a key source of buying information for many American consumers, does not recommend that consumers purchase any Chrysler-made products.
Discussion Questions:
1. Fiat is currently trying to buy both a piece of Chrysler and General Motors’ Opel division. Why does Fiat want to make these acquisitions? What advantages would they bring to Fiat?
2. Some experts worry that Italian automaker Fiat may be moving too quickly with its global expansion strategy. Reflect on the risks involved with Fiat’s acquisition strategy. How might a deal with Opel affect Fiat’s ability to proceed with its effort to successfully integrate part of Chrysler?
3. Fiat is currently a minor player in the U.S. auto market. Discuss how the deal with Chrysler could change that position. What role, if any, might the U.S. government play in promoting Fiat has the industry’s lifesaver?
4. What are the challenges associated with growing via acquisition versus growing organically? In your opinion, does the fact that Fiat is a highly diversified company give it any advantage with its current plans to acquire General Motors’ Opel division and 35 percent of Chrysler?
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following from International Business DVD Volume 5:
Title 12: Tesco in the U.S.A.
Abstract: This video explores British retailer Tesco’s attempt to break into the very difficult grocery store business in the United States
Key Concepts: international strategy, international marketing, standardization versus adaptation, globalization, foreign market entry, competitive advantage
Notes: British retailer Tesco is attempting to do what no other foreign retailer has managed to yet – break into the U.S. grocery business. Tesco is opening six stores in California under the Fresh & Easy name. The effort is the company’s first venture into the U.S. market, and the company is hoping to revolutionize the grocery business in the United States.
Tesco is hoping that by offering fresh and healthy food at affordable prices it will be able to attract U.S. customers. Fresh and Easy stores are small - only about a quarter of the size of a typical U.S. grocery store, but they are designed to allow customers to get as many items as possible in a single shopping trip. Tesco knows the stakes are big. Other retailers like Marks and Spencer and Sainsbury have failed in the United States. Even France’s Carrefour, the second largest retailer in the world after Wal-Mart, found it impossible to crack the U.S. market. Tesco is hoping that its extensive homework will help it succeed.
Before opening its stores in California, Tesco set up a dummy shop to study buyer behavior and even hired a team of anthropologists to live with families and learn about their shopping habits. Tesco wants to be able to set up its stores in such a way that it is as easy and convenient as possible for shoppers to get what they want. Consequently, the layout of the Fresh and Easy stores is quite different from how a Tesco store is typically laid out, and the stores stock more ready-to-go meals designed to attract busy American buyers. Still, Tesco has it work cut out for it. Analysts claim that American shoppers have very high expectations for grocery stores. Merchandising needs to be perfect, the store needs to be laid out in a convenient way, and customer service needs to be good.
Time will tell whether Tesco has finally found the secret to success in the U.S. grocery industry. For now though, the company is focusing on offering the customer everyday low prices – a strategy that seems to have been successful for at least one U.S. retailer.
Discussion Questions:
1. Which entry method did Tesco use to enter the U.S. market? Why was this method chosen over others?
2. Tesco’s new stores in the United States are called Fresh & Easy markets. Why did Tesco adopt the new name for its stores?
3. Consider Tesco’s timing on entering the U.S. market. Why has Tesco waited to enter the market until now? How might the decision to wait to enter the market help Tesco succeed in the United States?
4. What are strategic commitments? What do Tesco’s strategic commitments and scale of entry signal about the company’s plans for the future?
5. Tesco has conducted extensive research on the habits of American shoppers. Why was the research important to Tesco? How will it help the company succeed in the United States?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following exercises:
Exercise 1
A vital element in a successful international market entry strategy is an appropriate fit of skills and capabilities between partners. As such, the Entrepreneur magazine annually publishes a ranking of the top 200 global franchisors seeking international franchisees. Provide a list of the top 10 companies that pursue franchising as a mode of international expansion. Study one of these companies in detail and provide a description of its business model, its international expansion pattern, desirable qualifications in possible franchisees, and the support and training typically provided by the franchisor.
Exercise 2
The U.S. Commercial Service prepares reports known as the “Country Commercial Guide” for countries of interest to U.S. investors. Utilize the Country Commercial Guide for Brazil to gather information on this country’s energy and mining industry. Considering that your company is plans to enter Brazil in the foreseeable future, select the most appropriate entry method. Be sure to support your decision with the information collected.
Answers to the Exercises
Exercise 1
The annual ranking of the top 200 global franchisers can be found by searching the term “entrepreneur” at http://globaledge.msu.edu/ResourceDesk/. This resource is named Entrepreneur Magazine: Top Global Franchises and is found under the globalEDGE category “Research: Rankings”. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “Entrepreneur”
Resource Name: Entrepreneur Magazine: Top Global Franchises
Website: http://www.entrepreneur.com/franchises/topglobal/index.html globalEDGE™ Category: “Research: Rankings”
Exercise 2
The Country Commercial Guides can be accessed by searching for the term “commercial guide” at http://globaledge.msu.edu/ResourceDesk/. The link is located under the globalEDGE category “Research: Multi-Country”. Detailed information regarding marketing U.S. products and services in Brazil can be found by selecting the report for this country and reading the chapter titled “Selling US Products and Services”. A direct link to the Country Commercial Guide for Brazil is also located on the Country Insights page for Brazil at http://globaledge.msu.edu/countryInsights/country.asp?CountryID=107
Search Phrase: “Country Commercial Guide”
Resource Name: Country Commercial Guides for U.S. Investors
Website: http://www.buyusainfo.net/adsearch.cfm?search_type=int&loadnav=no globalEDGE™ Category: “Research: Multi-Country”
OR
globalEDGE™ Location: “Country Insights / Region: Latin America / Brazil”
Resource Name: Brazil
Website: http://globaledge.msu.edu/countryInsights/country.asp?CountryID=107 (site location frequently changes, therefore link through the globalEDGE Country Insights page might be more reliable)
Exporting, Importing and Countertrade
Learning objectives
• Explain the promises and risks associated with exporting.
• Outline the steps managers can take to improve their firm’s export performance.
• Identify the information sources and government programs that exist to help exporters.
• Grasp the basic steps involved in export financing.
• Articulate how countertrade can be used to facilitate exporting.
Previous chapters have presented exporting as just one of a range of strategic options for profiting from international markets. This chapter looks more at the nuts and bolts of how to export.
Exporting is not just for large enterprises; many small firms have benefited significantly from the moneymaking opportunities of exporting.
The volume of export activity in the world economy is increasing as exporting has become easier. The gradual decline in trade barriers under the umbrella of GATT and now the WTO (see Chapter 5) along with regional economic agreements such as the European Union and the North American Free Trade Agreement (see Chapter 8) have significantly increased export opportunities. At the same time, communication and transportation technologies have alleviated the logistical problems associated with exporting.
Firms are increasingly using fax, the World Wide Web, toll-free 800 numbers, and international air express services to reduce the costs of exporting. Consequently, it is no longer unusual to find small companies that are thriving as exporters.
The opening case explores the growth of MD International, a medical equipment export intermediary. The closing case examines why several small companies choose exports as a mean of growth.
OUTLINE OF CHAPTER 15: EXPORTING, IMPORTING AND COUNTERTRADE
Opening Case: MD International
Introduction
The Promise and Pitfalls of Exporting
Management Focus: FCX Systems
Improving Export Performance An International Comparison Information Sources Utilizing Export Management Companies Export Strategy
Management Focus: Exporting with a Little Government Help Management Focus: Export Strategy at 3M Management Focus: Red Spot Paint & Varnish
Export and Import Financing Lack of Trust Letter of Credit Draft Bill of Lading A Typical International Trade Transaction
Export Assistance Export–Import Bank Export Credit Insurance
Countertrade The Incidence of Countertrade Types of Countertrade The Pros and Cons of Countertrade
Chapter Summary
Critical Discussion Questions
Closing Case: Exporting and Growth for Small Business
CLASSROOM DISCUSSION POINT
Ask students if they have ever imported a product. Many students may have done so without realizing it simply by purchasing something from a foreign buyer via eBay. Similarly, many students may have engaged in direct exports when they have sold something to a foreign buyer via eBay.
Ask students to formalize the process by picking a product they would like to export. Then ask students which markets they will target and why. Next, ask students how they could get their product to consumers in that market. What additional information will they need to proceed with their plan?
Organize the responses from students on the board in an export plan format. Then, ask students to visit some of the Department of Commerce web sites to fill in the gaps. Discuss why it is important to get the various pieces of information, and which elements are easier to obtain and why. Refer back to the export plan as the material in the chapter is presented.
Another Perspective: Export.gov has a great web site covering the basics of exporting. Within the site {http://www.export.gov/index.asp} you can click on various topics related to getting ready to export, developing an export plan, finding leads and so on. The site is well worth a visit, and could be used as the basis for an in-class export project.
OPENING CASE: MD International
The opening case explores the success of MD International in Latin America. MD International is an export intermediary for U.S. medical equipment manufacturers. The company has been able to capitalize on falling trade barriers, as well as expanding health care programs in the Latin American region. MD International currently represents more than 30 companies and sells to some 600 regional distributors. Discussion of the case can revolve around the following questions:
1. How has MD International used export assistance programs to support its efforts in Latin America? In your opinion, would MD International have been successful without programs like EXIM’s export financing?
2. What makes MD International attractive to medical equipment manufacturers? How does MD International succeed in the region when many of its clients might not?
3. Why did MD International choose to focus on the Latin American market? How does its strategy of representing multiple manufacturers help insulate the company from economic downturns?
Another Perspective: MD International was recently acquired by Welch Allyn. To learn more about the acquisition and MD International, go to {http://www.welchallyn.com/regions/Latin-America/wamd/en-la/default.htm}.
LECTURE OUTLINE FOR CHAPTER
This lecture outline follows the Power Point Presentation (PPT) provided along with this instructor’s manual. The PPT slides include additional notes that can be viewed by clicking on “view”, then on “notes”. The following provides a brief overview of each Power Point slide along with teaching tips, and additional perspectives.
Slide 15-3 Why Export?
Exporting firms need to ❖ identify market opportunities ❖ deal with foreign exchange risk ❖ navigate import and export financing ❖ understand the challenges of doing business in a foreign market
Slides 15-4 The Problems and Pitfalls of Exporting
Exporting offers the opportunity to take advantage of a bigger market, and the economies of scale that come with producing for a bigger market. However, it is also a more complex market.
Common pitfalls include poor market analysis, poor understanding of competitive conditions, a lack of customization for local markets, a poor distribution program, poorly executed promotional campaigns, problems securing financing, a general underestimation of the differences and expertise required for foreign market penetration, and an underestimation of the amount of paperwork and formalities involved.
Slide 15-6 Improving Export Performance
There are various ways to gain information about foreign market opportunities and avoid the pitfalls associated with exporting.
Another Perspective: The UK Trade and Investment office is devoted to helping companies develop their export business. The web site is available at {https://www.uktradeinvest.gov.uk/ukti/appmanager/ukti/home?_nfls=false&_nfpb=true} Click on “Business Opportunities” to see a sample of a trade lead, or click on “Country Report” to see the types of information available in a typical report on a specific country.
Slide 15-7 Getting Information
A big impediment to exporting is the simple lack of knowledge of the opportunities available. To overcome ignorance firms need to collect information.
Another Perspective: Your students may wonder how firms U.S. firms find buyers in foreign countries. To find foreign customers, exporters often use '"trade leads" that are provided by organizations dedicated towards the activity of matching "buyers" and "sellers" in an international context. An example of a site that provides trade leads is the Export.gov at {http://www.export.gov/index.asp}.
The U.S. Department of Commerce is the most comprehensive source of export information for U.S. firms.
Another Perspective: Students may want to explore the U.S. Department of Commerce’s web site {http://www.commerce.gov/}and click on “Trade Opportunities for U.S. Businesses.”
Another Perspective: The Small Business Administration (SBA) also has an extensive web site {http://www.sba.gov/} with information about exporting to different countries, contacts and leads, and so on.
Slides 15-8 Utilizing Export Management Companies
Export management companies (EMCs) are export specialists that act as the export marketing department or international department for client firms.
Another Perspective: The FITA Directory of Export Management Companies web site {http://fita.org/} provides information on export management companies, and also trade leads and international market research.
Slide 15-9 Reducing the Risk of Exporting
Firms can reduce risk by carefully choosing their export strategy, and following some basic guidelines. Firms should hire an EMC or export consultant, to help identify opportunities and navigate through the tangled web of paperwork and regulations so often involved in exporting, focus on one, or a few markets at first, enter a foreign market on a fairly small scale in order to reduce the costs of any subsequent failures, recognize the time and managerial commitment involved, develop a good relationship with local distributors and customers, hire locals to help establish a presence in the market, be proactive, and consider local production.
Another Perspective: A great web site to visit to determine whether a company is ready to export is the International Trade Centre, run by UNCTAD/WTO. If you go to the site {http://www.intracen.org/ec/welcome.htm }you can use the interactive quiz to gauge export readiness. Click on “Export Fitness Checker”, then on “Use the Export Fitness Checker online” to see the quiz.
Slide 15-10-15-11 Export and Import Financing
Firms engaged in international trade face a problem - they have to trust someone who may be difficult to track down if they default on an obligation.
Including a third party in a transaction adds an element of trust to the relationship.
Slide 15- 12 Letter of Credit
A letter of credit is issued by a bank at the request of an importer and states that the bank will pay a specified sum of money to a beneficiary, normally the exporter, on presentation of particular, specified documents.
Slide 15-13 Draft
A draft is simply an order written by an exporter instructing an importer, or an importer's agent, to pay a specified amount of money at a specified time.
Slide 15-14 Bill of Lading
The bill of lading is issued to the exporter by the common carrier transporting the merchandise.
Slides 15-16 A Typical International Trade Transaction
The typical international trade transaction involves 14 steps as outlined in Figure 15.4.
Slide 15-18 Export Assistance
There are two forms of government-backed assistance available to exporters:
1. Financing aid is available from the Export-Import Bank
2. Export credit insurance is available from the Foreign Credit Insurance Association
The Export-Import Bank (Eximbank) is an independent agency of the U.S. government that provides financing aid to facilitate exports, imports, and the exchange of commodities between the U.S. and other countries.
Export credit insurance protects exporters against the risk that the importer will default on payment. In the U.S., export credit insurance is provided by the Foreign Credit Insurance Association (FICA).
Slide 15-19 Countertrade
Countertrade refers to a range of barter-like agreements that facilitate the trade of goods and services for other goods and services when they cannot be traded for money.
Countertrade began in the 1960s primarily in the Soviet Union and Eastern bloc countries. Its popularity increased during the 1980s when many developing countries that were short of hard currencies used countertrade instead. More recently, its use increased after the 1997 Asian financial crisis.
Slides 15-20-15-21 Types of Countertrade
There are five distinct versions of countertrade:
1. barter
2. counterpurchase
3. offset
4. compensation or buyback
5. switch trading
Slides 15-23-15-24 Pros and Cons of Countertrade.
The main attraction of counter trade is that it gives a firm a way to finance an export deal when other means are not available. Countertrade is unattractive because it may involve the exchange of unusable or poor-quality goods that the firm cannot dispose of profitably.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: A firm based in Washington State wants to export a shipload of finished lumber to the Philippines. The would- be importer cannot get sufficient credit from domestic sources to pay for shipment, but insists that the finished lumber can quickly be resold in the Philippines for a profit. Outline the steps that the exporter should take to effect the export of this shipment to the Philippines?
ANSWER 1: The steps are as follows:
The Philippine importer places an order with the American exporter, and asks the American if he would be willing to ship under a letter of credit.
The American exporter agrees to ship under a letter of credit, and specifies relevant information such as prices, delivery terms, and the like.
The Philippine importer applies to the Bank of Manila (or some other international bank) for a letter of credit to be issued in favor of the American exporter for the merchandise the importer wishes to buy.
The Bank of Manila issues a letter of credit in the Philippine importer's favor and sends it to the American exporter's bank, the Bank of Seattle.
The Bank of Seattle advises the American exporter of the opening of a letter of credit in his favor.
The American exporter ships the goods to the Philippine importer on a common carrier.
The American exporter presents a 90 day time draft to the Bank of Seattle, drawn on the Bank of Manila in accordance with the Bank of Manila's letter of credit and accompanied by the bill of lading. The American exporter endorses the bill of lading such that the title to the goods goes with the holder of the document - which at this point in the transaction is the Bank of Seattle.
The Bank of Seattle presents the draft and documents to the Bank of Manila. The Bank of Manila accepts the draft, taking possession of the documents and promising to pay the now accepted draft in 90 days.
The Bank of Manila returns the accepted draft to the Bank of Seattle.
The Bank of Seattle tells the American exporter that they have the accepted bank draft, which is payable in 90 days.
The exporter sells the draft to the Bank of Seattle for a discount from the face value and receives the discounted cash value of the draft in return.
The Bank of Manila notifies the Philippine importer of the arrival of the documents. It agrees to pay the Bank of Manila in 90 days. The Bank of Manila releases the documents so that the Philippine importer can take possession of the shipment.
In 90 days the Bank of Manila receives the importer's payment so that it has funds to pay the maturing draft.
In 90 days the holder of the matured acceptance, in this case the Bank of Seattle, presents it to the Bank of Manila for payment. The Bank of Manila pays.
(If the exporter feels confident in and can completely trust the purchaser in the Philippines, then a much simpler procedure than this could be followed.)
Another Perspective: Trade Port provides a Global trade Tutorial on export financing. The tutorial is available at {http://www.tradeport.org/tutorial/financing}. The site provides excellent details on the process, and is well worth a visit.
QUESTION 2: You are the assistant to the CEO of a small textile firm that manufactures high-quality, premium priced, stylish clothing. The CEO has decided to see what the opportunities are for exporting and has asked you for advice as to the steps the company should take. What advice would you give to the CEO?
ANSWER 2: This question is designed to stimulate classroom discussion and/or to encourage your students to “think” about the export process in completing a written answer for this question. There are a number of approaches that can be pursued in answering this question. The first step might be to tap into some of the government information sources that are available, free of charge, to see if international markets are available for the company’s product. There are also a number of resources on the Internet, mentioned throughout the text that can assist companies in learning about the foreign market potential of their products. Another approach would be to contact an export management company for assistance. While this approach may involve some cost, it may be the fastest way to get “up and running” in regard to initiating an export program.
QUESTION 3: An alternative to using a letter of credit is export credit insurance. What are the advantages and disadvantages of using export credit insurance as opposed to a letter of credit for (a) exporting a luxury yacht from California to Canada, and (b) exporting machine tools from New York to Ukraine?
ANSWER 3: Exporters prefer to get letters of credit from importers. However, when the importer is in a strong bargaining position and able to play competing suppliers off against each other, an exporter may have to forgo a letter of credit. The lack of a letter of credit exposes the exporter to the risk that the foreign importer will default on payment. The exporter can insure against this possibility by buying export credit insurance. Students may suggest that in the case of the luxury yacht, should the importer fail to make payment, the clearly defined laws of Canada would make it easier to go after the importer than would be the case with the machine tools in the Ukraine, and that therefore a letter of credit is less important for the yacht exporter. On the other hand, students may note that there is probably more competition in machine tools as compared to luxury yachts and that the exporter of machine tools may lose the sale if the exporter insists on a letter of credit.
QUESTION 4: How do you explain the continued existence of counter trade? Under what scenarios might its popularity increase still further by the year 2015? Under what scenarios might its popularity decline?
ANSWER 4: Countertrade becomes popular when foreign exchange markets are limited or importers do not have access to the foreign exchange (low reserves) they need to fund their purchases. Currency crises and monetary instability are two conditions that lead to countertrade. As long as countries lack hard currencies and foreign exchange reserves, yet have an interest in trade, countertrade is likely. If countries erect trade barriers that decrease world trade, or if the monetary systems of many countries strengthen significantly, then countertrade may decrease.
QUESTION 5: How might a company make strategic use of countertrade schemes to generate export revenues? What are the risks associated with pursuing such a strategy?
ANSWER 5: Countertrade is an alternative means of structuring an international sale when conventional means of payment are difficult, costly, or nonexistent. The governments of developing countries sometimes insist on a certain amount of countertrade. Thus, if a firm is unwilling to enter a countertrade agreement, it may lose an export opportunity to a competitor that is willing to make a countertrade agreement. Companies willing to entertain countertrade as a means of financing, will have an advantage over those firms that prefer traditional forms of financing. Firms engaging in countertrade must be willing to invest in an in-house trading department dedicated to arranging and managing countertrade deals, and must be aware of the quality of the products received in countertrade deals.
CLOSING CASE: Exporting and Growth for Small Businesses
The closing case explores how three small companies, Morgan Motors, Wadia, and Malden Mills, have successfully increased their sales and profits through exports. Morgan Motors, a British sports car manufacturer ships 70 percent of its production overseas. Wadia, a Michigan-based producer of high end compact disc players relies on exports for 70 to 80 percent of its sales. Malden Mills, an American manufacturer of high technology textiles earned over half of its 2006 sales from exports. The following questions can be helpful in directing the discussion.
QUESTION 1: What are the main benefits of exporting for companies like Morgan and Wadia?
ANSWER 1: Both Morgan Motors and Wadia made the decision to export for similar reasons. Morgan Motors makes sports cars for a very small market niche. The size of the niche in Britain is too small for the company to survive, so Morgan had to expand into other markets to remain in business. Wadia shares a similar predicament. Wadia produces premium priced compact disc players for audiophiles. Its product is so specialized that just 20 percent of its sales come from the local marketplace. Students will probably recognize that for both of these companies survival meant foreign expansion, and that by targeting similar niches in foreign markets, they could grow their sales.
QUESTION 2: What would be the outlook for a company like Morgan Motors if it neither exported nor imported?
ANSWER 2: Most students will probably conclude that without the ability to import and export, companies like Morgan Motors are unlikely to succeed. Morgan Motors sells just 30 percent of its production in its domestic market. Without the revenues from foreign markets, the company’s profits would drop significantly. Moreover, since Morgan Motors imports major components for its cars from foreign companies like Bosch and BMW, not being able to import would also hamper the company’s ability to build its vehicles.
QUESTION 3: What are the impediments to exporting success faced by companies such as Morgan and Wadia? What steps can these companies take to improve their probability of succeeding in export markets?
ANSWER 3: Exporting can present numerous challenges for small companies like Morgan and Wadia. Like their larger counterparts, small companies need to conduct the same types of market research, organize financing, absorb foreign exchange risk, and so on. Both Morgan and Wadia have taken advantage of export assistance provided by various organizations like export agencies and export financing companies. One small company, Malden Mills, took advantage of market research offered by the South Carolina Export Consortium, and a working capital loan guarantee from the U.S. Export-Import Bank.
QUESTION 4: Is it legitimate for local and national government agencies to use taxpayer money to help small companies export?
ANSWER 4: Small companies employ an increasing number of people in today’s market. Therefore, most students will probably agree that it is important for government to support the operations of small companies. However, not all students are likely to agree that taxpayer funds should be used to support export programs. Some students will probably suggest that by supporting the export programs of small companies, the government is in effect helping to create domestic jobs, and boost the local economy – a clear benefit to a country’s citizens. Other students however, may argue that taxpayer money should be used to create programs that will reach a wider population – especially if the success of export programs cannot be guaranteed.
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:
Title: Brazil Seeks to Break New Ground in Global Marketplace
Brazil Looks to World Market
Run Time: 11:21
Abstract: This video explores Brazil’s booming economy and its efforts to become the world’s largest producer of ethanol, and a leading exporter of agricultural products.
Key Concepts: globalization, economic differences, political differences, comparative advantage, global competition, outsourcing production, World Trade Organization, subsidies
Notes: Evidence of Brazil’s recent economic success is everywhere – from manufacturing to agriculture. Today, Brazil is home to the world’s third largest aviation manufacturer, Embraer, a company that nearly went under in the early 1990s. Brazil is also the world’s largest producer of soy. Much of the crop is exported to China where it is converted to tofu. In addition, Brazil is the world’s leading exporter of coffee, sugar, beef, orange juice, poultry, and tobacco. Brazil also leads the world in ethanol production. Brazil’s ethanol, unlike the corn-based ethanol produced in the United States, is a byproduct of its sugar crop. Brazil is so far ahead of other countries like the United States in its ethanol production that 90 percent of new cars in Brazil run entirely on ethanol, and its production has spawned the development of an entire industry to support its production.
Brazil’s rise to the top is a result of privatization efforts, determination, and talent. Optimism and confidence about the future is widespread. Horacio Forjaz, Executive Vice President for Emraer notes for example, that prior to its privatization, Embraer lacked credibility and a competitive product line. It was not until 1994, after it was privatized, that the company recognized there was an opportunity to produce jets designed to fly between 50 and 130 passengers on regional routes. Today, the company, which counts JetBlue, Delta, and Virgin Australia among its customers, has orders that will keep it at full production for the next six years. Executive say that it represents a new Brazil that is globally confident and prominent. Brazil’s farmers have recognized the importance of global markets for growth. Rodrigo Varsato, Agricultural Engineer, claims that technology is critical to the nation’s success in agriculture. He points out that unlike the United States or China, Brazil is uniquely positioned for further growth in agriculture because the country has land for expansion.
Brazil is using its new found success to bargain with other nations. The country is taking on the United States and Europe at the Doha Round of trade talks where it is pushing for the elimination of agricultural subsidies paid to developed country farmers and other protectionist policies that effectively limit the development of agriculture in developing countries. Celso Amorim, Foreign Minister, is confident that Brazil can change the way negotiations take place in the World Trade Organization, to one where the perspectives of the developing world are taken more seriously. Already, Brazil may have a trump card of sorts. The country is the world’s largest producer of ethanol, which sells at about half the price of gasoline. Ethanol is available at over 30,000 stations across the country, and is produced from the country’s abundant sugar crop. To date, tariffs have kept the product out of the United Sates, but Jose Luis Olivero, vice president of Dedini, a supplier of equipment to the industry, believes that the situation will change. He notes that the United States cannot continue its dependence on imported oil, and that Brazil, as the world’s most competitive producer of ethanol, is perfectly situated to take advantage of the market. Despite the country’s success, some critics have suggested that Brazil needs to pay closer attention to the home market, and less attention to the global market. Brazil’s government though, discounts the criticism noting that the country now has a vibrant middle class, and a dramatic decline in the number of people at the lower end of the socioeconomic spectrum.
Discussion Questions:
1. Explain the importance of agriculture to Brazil’s current success. What role will agriculture play in Brazil’s future? What are the implications of this for other countries? How might countries like the United States react if Brazil is successful in its quest for the elimination of agricultural subsidies paid to developed country farmers?
2. How has Brazil’s position as the world’s largest exporter of soy and other agricultural products helped U.S. companies?
3. Reflect on Brazil’s efforts to take on a bigger role in the global economy. In your opinion, are critics who argue that country should be more inwardly focused right? Why or why not? How might Michael Porter consider this situation?
4. Brazil is a frontrunner in the use of biofuel. Explain, using the theory of comparative advantage, how Brazil has achieved this position, and what it means for the country.
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following from International Business DVD Volume 5:
Title 11: Work Trade with Great Britain and Brazil
Abstract: This video explores the trading relationship between Great Britain and Brazil, and how the British Consul is helping to improve the relationship through trade delegations.
Key Concepts: globalization, trade, small business
Notes: Great Britain and Brazil have been trading partners for some 200 years. At one point Great Britain was one of Brazil’s top five trading partners. Today though, Great Britain has dropped to number thirty-six. In fact, Great Britain has gone from being an influential important trading partner to accounting for just two percent of Brazil’s trade. The British Consul would like to change this situation, and so is putting together a trade delegation comprised of people from Northeast Britain who would like the opportunity to form lasting relationships with Brazilian companies.
Members of the trade delegation meet to learn more about the opportunities in Brazil, and to learn about doing business in the country. Brazil is considered to be an attractive market mainly because of its size and scale. Delegates want to capitalize on the market’s 185 million people. The consul also helps delegates clearly define and identify how they can do business in Brazil. Each delegate has a different goal. One delegate for example wants to find work placement positions for students, while another is looking for retailers to stock his product. One delegate is looking for a joint venture partner. Most delegates agree that being part of the trade delegation is beneficial because they can work with people who have contacts in Brazil and know the market. Getting an introduction can be important in Brazil where building relationships can be an essential part of a business deal.
Four weeks later, the trade delegation appears to have been a success. One delegate found the jobs placements she was looking for, and another was working with a distributor for his product. The delegate who had been seeking a joint venture was in talks with a potential partner. In general, the delegates were able to close some knowledge gaps, and improve their chances for success in Brazil.
Discussion Questions:
1. How has the relationship between Great Britain and Brazil changed over the last 200 years? What makes Brazil an attractive market for British firms today?
2. Why are opportunities like the trade delegation set up by the British Consul so important to small companies that want to expand internationally? What type of assistance do they provide?
3. Discuss the typical behavior of small firms when they export. Do small firms typically take a proactive or a reactive approach to exporting? What does participation in the trade delegation suggest about the participants?
4. How can small firms improve their export performance? What role does the British Consul play in helping firms succeed in foreign markets?
5. As part of its program, the British Consul is setting up a mentor program for trade delegates. As a business person who is new to the Brazilian market place, what does the mentor program mean to you?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following exercises:
Exercise 1
Exporting is an important way for small and large companies to introduce products and develop new markets. In fact, the Internet is rich with resources that offer guidance to companies wishing to expand their markets through exporting. The trade tutorials at the globalEDGE website provide links to these resources. Identify five sources and provide a description of the services available for new exporters through each source.
Exercise 2
Understanding the specific terminology used in the export process is necessary prior to your company’s first export venture. Utilize the globalEDGE Glossary of International Business Terms to identify the definitions of the following exporting terms: advance payment, air waybill, bill of lading, certificate of product origin, deferred payment credit, harmonized tariff schedule, voluntary export restraint, and wharfage charge.
Answers to the Exercises
Exercise 1
There are a variety of sources that provide guidance to companies that consider starting exporting. A rich list of those resources can be found by searching the term “exporting” at http://globaledge.msu.edu/ResourceDesk/, or by directly entering the “Trade Tutorials” category under the Global Resources section of the Resource Desk. Each approach will render different results. Some of the websites that provide information for U.S. exporters are: the U.S. Department of Commerce’s “Basic Guide To Exporting”, the U.S. Small Business Administration's “Small Business Guide to Exporting”, and Ralph Jagodka’s “Skills Needed For Effective International Marketing”. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “exporting” globalEDGE™ Category: “Trade: Trade Tutorials”
Resource Name: Multiple Names
Website: Multiple Websites
Exercise 2
An alphabetic list of the terms commonly used in international business can be found under the glossary section of the resource desk, at http://globaledge.msu.edu/resourceDesk/glossary.asp . The definitions of the terms mentioned in the exercise are as follows:
advance payment: Trading method in which the buyer pays for the goods before they are sent out , method is used when buyer is of unknown credit worthiness. air waybill: A nonnegotiable instrument of domestic and international air transport that functions as a bill of lading. bill of lading: A document that establishes the terms and conditions of a contract between a shipper and a shipping company under which freight is to be moved between specified points for a specified charge. certificate of product origin: A document required by certain foreign countries for tariff purpose, certifying the country of origin of specified goods. deferred payment credit: A type of letter of credit which provides for payment some time after presentation of the shipping documents by the exporter. harmonized tariff schedule: A method of classification used by many countries to determine tariffs on imports. voluntary export restraint: One country promises another country to limit its imports; this is often done when the promising country fears increased tariffs or quotas if it does not self-regulate. wharfage charge: A charge assessed by a pier or dock owner for handling incoming or outgoing cargo.
Location: Resource Desk / Glossary
Resource Name: globalEDGE: Glossary of International Business Terms
Website: http://globaledge.msu.edu/resourceDesk/glossary.asp globalEDGE™ Category: “Trade: Trade Tutorials”
Global Production, Outsourcing, and Logistics
Learning objectives
• Explain why production and logistics decisions are of central importance to many multinational businesses.
• Explain how country differences, production technology, and product features all affect the choice of where to locate production activities.
• Discuss how the role of foreign subsidiaries in production can be enhanced over time as they accumulate knowledge.
• Identify the factors that influence a firm’s decision of whether to source supplies from within the company or from foreign suppliers.
• Articulate what is required to efficiently coordinate a globally dispersed production system.
This chapter focuses on two major activities—production and materials management, and attempts to clarify how when they are performed internationally, the cost of value creation can be lowered, and how value can be added by better serving customer needs.
The choice of an optimal manufacturing location must consider country factors, technological factors, and product factors.
Foreign factories can improve their capabilities over time, and this can be of immense strategic benefit to the firm. Managers need to view foreign factories as potential centers of excellence and encourage and foster attempts by local managers to upgrade factory capabilities.
An essential issue in many international businesses is determining which component parts should be manufactured in-house and which should be outsourced to independent suppliers.
The chapter also discusses the contributions of information technology to these activities. This is especially important in the era of the Internet.
The Opening Case examines why India has become a hot production location for automakers, while the Closing Case explores Boeing’s decision to outsource much of the production of its new 787 aircraft.
OUTLINE OF CHAPTER 16: GLOBAL PRODUCTION, OUTSOURCING, AND LOGISTICS
Opening Case: The Rise of the Indian Automobile Industry
Introduction
Strategy, Production, and Logistics
Where to Produce Country Factors Technological Factors Product Factors Locating Production Facilities
Management Focus: Phillips in China
The Strategic Role of Foreign Factories
Management Focus: Hewlett-Packard in Singapore
Outsourcing Production: Make-or-Buy Decisions The Advantages of Make The Advantages of Buy Trade-offs Strategic Alliances with Suppliers
Managing a Global Supply Chain The Role of Just-in-Time Inventory The Role of Information Technology and the Internet
Chapter Summary
Critical Discussion Questions
Closing Case: Building the Boeing 787
CLASSROOM DISCUSSION POINT
Using the auto industry, ask students to reflect on the production decisions of several companies. Why does BMW produce cars in Alabama? Why does General Motors have a plant in China? Why does Nissan have design studios in Southern California? Try to get students to address all of the basic production issues outlined below.
The five basic questions that deal with production are:
1. Where should production be located and should it be concentrated or dispersed?
2. What should be the long-term strategic role of foreign production sites? Should the firm abandon a foreign site if factor costs change, or is there value to maintaining an operation at a given location even if economic conditions change?
3. Should the firm own foreign production or should production be outsourced?
4. How should a globally-dispersed supply chain be managed?
5. Should the firm manage the logistics or outsource their management?
OPENING CASE: The Rise of the Indian Automobile Industry
Summary
The opening case describes India’s evolution as a small car manufacturing hub for several global automakers. By 2012, India is expected to export half a million vehicles a year. South Korea’s Hyundai is leading the charge, exporting over one third of its Indian production. Suzuki and Nissan have both entered the Indian market more recently. Both companies see the Indian market as an important component in their future production and marketing strategies. Discussion of the case can revolve around the following questions:
1. Why did Hyundai initially commit to the Indian market? What benefits does Hyundai currently enjoy as a result of being first to market? What are the drawbacks of being an early market entrant?
2. What makes India an attractive location for auto production? What disadvantages do you see? How do Indian production capabilities fit into the strategies of companies like Hyundai and Nissan?
3. Nissan is planning to hire Indian engineers to develop a new car to compete with Tata’s “People Car.” Why does Nissan want to involve local engineers in the product development process rather than simply transferring an existing design to India?
Another Perspective: Students can explore Tata Motors and Hyundai’s Indian operations in more depth at {http://www.tatamotors.com/} and {http://www.hyundai.co.in/}. To extend this case, consider {http://www.businessweek.com/globalbiz/content/jan2009/gb20090130_425063.htm}, {http://www.businessweek.com/innovate/content/mar2009/id20090318_012120.htm}, and {http://www.businessweek.com/globalbiz/content/dec2008/gb20081222_336390.htm}.
LECTURE OUTLINE FOR CHAPTER
This lecture outline follows the Power Point Presentation (PPT) provided along with this instructor’s manual. The PPT slides include additional notes that can be viewed by clicking on “view”, then on “notes”. The following provides a brief overview of each Power Point slide along with teaching tips, and additional perspectives.
Slide 16-3 Production Issues For Firms
Where should foreign production be located? How should a globally dispersed supply chain be managed?
Slides 16-4 Strategy, Production and Logistics
Firms need to identify how production and logistics can be conducted internationally to: • lower the costs of value creation • add value by better serving customer needs
Slide 16-5-16-6 Improving Quality
To increase product quality, most firms today use the Six Sigma program which aims to reduce defects, boost productivity, eliminate waste, and cut costs throughout a company.
Another Perspective: To extend the discussion on TQM and Six Sigma go to {http://www.motorola.com/content.jsp?globalObjectId=3088}and click on the “Free Six Sigma Lessons” icon.
Slide 16-7 Where to Produce?
Three factors are important when making location decisions:
1. country factors
2. technological factors
3. product factors
Slide 16-8 Country Factors
Country factors that can affect location decisions include: • the availability of skilled labor and supporting industries • formal and informal trade barriers • expectations about future exchange rate changes • transportation costs • regulations affecting FDI
Another Perspective: The United States Central Intelligence Agency maintains a “country profile” on each country in the world. The country profiles provide useful information to companies contemplating doing business in a particular country. The country profiles {https://www.cia.gov/cia/publications/factbook/index.html} are available to the public. Students can use the reports as a basis for comparing different production locations.
Another Perspective: For additional information about a particular country, Yahoo provides an easy-to-search bank of linked sources that provide information about almost every country in the world. The site, {http://www.yahoo.com/Government/Countries/}, is useful to make quick comparisons between countries to gauge their relative attractiveness as production locations.
Slides 16-9-16-10 Technological Factors
The type of technology a firm uses in its manufacturing can affect location decisions.
Three characteristics of a manufacturing technology are of interest:
1. The level of fixed costs
2. The minimum efficient scale
3. The flexibility of the technology
Slide 16-11 What Should a Firm Do?
When fixed costs are substantial, the minimum efficient scale of production is high, and/or flexible manufacturing technologies are available, the arguments for concentrating production at a few choice locations are strong.
Slide 16-14-16-16 Product Factors
Two product factors impact location decisions:
1. The product's value-to-weight ratio
2. Whether the product serves universal needs
Slides 16-20-16-21 Locating Production Facilities
There are two basic strategies for locating manufacturing facilities:
1. concentrating them in the optimal location and serving the world market from there
2. decentralizing them in various regional or national locations that are close to major markets
Slides 16-19-16-20 The Strategic Role of Foreign Factories
The strategic role of foreign factories and the strategic advantage of a particular location can change over time.
Improvement in a facility comes from two sources:
1. Pressure to lower costs or respond to local markets
2. An increase in the availability of advanced factors of production
Slide 16-21 Outsourcing Production: Make-or-Buy Decisions
Should an international business make or buy the component parts to go into their final product? Make-or-buy decisions are important factors in many firms' manufacturing strategies.
Slides 16-22 The Advantages of Make
1. lower costs
2. facilitates investments in highly specialized assets
3. protects proprietary technology
4. facilitate the scheduling of adjacent processes
The benefits of manufacturing components in-house are greatest when: • highly specialized assets are involved • vertical integration is necessary for protecting proprietary technology • the firm is more efficient than external suppliers at performing a particular activity
Slides 16-23 The Advantages of Buy
Buying component parts from independent suppliers:
1. gives the firm greater flexibility
2. helps drive down the firm's cost structure
3. helps the firm capture orders from international customers
Slide 16-25 Strategic Alliances with Suppliers
Firms can capture the benefits of vertical integration without the associated organizational problems by forming long-term strategic alliances with key suppliers. However, these commitments may actually limit strategic flexibility.
Slide 16-26 Managing the Global Supply Chain
Logistics encompasses the activities necessary to get materials to a manufacturing facility, through the manufacturing process, and out through a distribution system to the end user
Another Perspective: Stanford University maintains a web site that is a forum for the dissemination of research and practical advice in the area of global supply chain management. The site supplies current information that can help extend a lecture on global materials management. The site is available at {http://www.stanford.edu/group/scforum/Welcome/index.html}.
Another Perspective: One company that specializes in global supply chain management is EPIQ. To get a better idea of the issues in global supply chain management, students may want to go to the company’s web site {http://www.epiqtech.com/} and explore some of the services the company provides.
Slide 16-27 The Role of Just-in-Time Inventory
The basic philosophy behind just-in-time (JIT) systems is to economize on inventory holding costs by having materials arrive at a manufacturing plant just in time to enter the production process, and not before
Slide 16-28 The Role of Information Technology and the Internet
Web-based information systems play a crucial role in materials management. They allow firms to optimize production scheduling according to when components are expected to arrive.
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: An electronics firm is considering how best to supply the world market for microprocessors used in consumer and industrial electronic products. A manufacturing plant costs approximately $500 million to construct and requires a highly skilled work force. The total value of the world market over the next ten years for this product is estimated to be between $10 billion and $15 billion. The tariffs prevailing in this industry are currently low. Should the firm favor concentrated manufacturing or decentralized manufacturing? What kind of location(s) should the firm favor for its plant(s)?
ANSWER 1: The firm should pursue a concentrated manufacturing strategy because (1) the tariffs prevailing in the industry are low, (2) the cost of building a plant to produce the microprocessors is high, and (3) the product's value-to-weight ratio is high. All of these factors favor a concentrated manufacturing strategy. In terms of location, the company should consider three factors: country factors, technology factors, and product factors. First, in terms of country factors, the firm should locate its plant in a country that has a highly skilled pool of workers available. That criterion probably limits the firm to developed nations. Second, in terms of technology factors, the firm is compelled to limit the number of its manufacturing facilities because of the high cost of constructing a plant. Third, in terms of product factors, the firm can manufacturer its product in a central location due to the relatively high value-weight ratio and the universal appeal of the product.
QUESTION 2: A chemical firm is considering how best to supply the world market for sulfuric acid. A manufacturing plant costs approximately $20million to construct and requires a moderately skilled workforce. The total value of the world market for this product over the next 10 years is estimated to be between $20billion and $30 billion range. The tariffs prevailing in this industry are moderate. Should the firm favor concentrated manufacturing or decentralized manufacturing? What kind of location(s) should the firm seek for its plant(s)?
ANSWER 2: This question is a tougher call than the scenario depicted in Question #1. The firm should probably pursue a limited decentralized manufacturing strategy (meaning that the firm should not set up a plant in every country that it sells to, but should set up plants in several "regions" of the world). This strategy makes sense because (1) The tariffs prevailing in the industry are moderate (rather than low), (2) the cost of constructing a facility is relatively modest ($20 million), and (3) only a moderately skilled work force is needed (which is probably available in many low-cost regions of the world). The firm should select its location based on country factors, technology factors and product factors. In terms of country factors, the firm should find locations where semi-skilled labor is inexpensive. In terms of technology factors, the firm is not constrained by high fixed costs, so technology is not a pervasive issue. Finally, product factors favor the firm locating in several locations throughout the world. The company's product has a low value-weight ratio, making it unattractive to produce the product in a central location and export it across the world.
QUESTION 3: A firm must decide whether to make a component part in-house, or to contract it out to an independent supplier. Manufacturing the part requires a non-recoverable investment in specialized assets. The most efficient suppliers are located in countries with currencies that many foreign exchange analysts expect to appreciate substantially over the next decade. What are the pros and cons of (a) manufacturing the component in-house, and (b) outsourcing manufacture to an independent supplier? Which option would you recommend? Why?
ANSWER 3: Manufacturing in-house would reduce the risk of currency appreciation and rising costs from independent suppliers. Specialized asset investment would make the firm dependent on specific suppliers, however, technological know-how would be protected, and improved scheduling would be available. Out-sourcing would be beneficial if the product using the component fails in the market because the supplier will bear the cost of the non-recoverable investment, and flexibility in case a better component can be designed or bought would be preserved. Outsourcing would also lower organizational and coordination costs. Based on what we know, manufacturing in house may be slightly preferred, but other information could tip the decision the other way.
QUESTION 4: Reread the Management Focus on Philips in China then answer the following questions:
a) What are the major benefits to Philips of shifting so much of its global production to China?
b) What are the risks associated with a heavy concentration of manufacturing assets in China?
c) What strategies might Philips adopt to maximize the benefits and mitigate the risks associated with moving so much product development and production activity to developing nations like China?
ANSWER 4:
a) China is an attractive production location for Phillips for several reasons. Perhaps the most important factor is the country’s cheap wages. In addition, the Chinese workforce is well educated, the economy is strong, and many of the company’s suppliers are doing business there. Students should recognize that using China as a global supply base from which to serve the world offers several advantages to Phillips. By having a single production location, the company can capitalize on costs savings that come from economies of scale as well as the low wages in China.
b) Most students will recognize that Philips is taking a risk by concentrating its manufacturing in China. If economic, political, or other types of problems arise in the country, Phillips could be in serious trouble since it will not have alternate locations to fill production gaps.
c) Some students might recommend that Philips consider forming joint ventures with local firms to gain some protection against the threat of nationalization or other adverse moves from a foreign government. Other students may suggest that Philips maintain production facilities in more than one country to offset potential problems in another.
QUESTION 5: Explain how an efficient materials management function can help an international business to compete more effectively in the global market place.
ANSWER 5: Given the complexity involved in coordination of material and product flows in a multinational enterprise (purchases, currency exchange, inbound and outbound transportation, production, inventory, communication, expediting, tariffs and duties), a materials management function can help to assure that these flows take place in the most efficient manner possible. A related advantage is that by having a materials management function, a firm may obtain improved information about the costs of different transport alternatives, and choose to reconfigure some of its flows to better take advantage of these costs. By being better able to utilize just in time techniques, the cost of production can be lowered while the quality is increased. The materials management function can also help an international business to develop information technology systems that allow it to better track the flow of goods throughout the firm.
CLOSING CASE: Building the Boeing 787
Summary
The closing case explores Boeing’s strategy for its new 787 aircraft. Boeing made the decision to outsource much of the production of the 787 in the hopes of significantly reducing the time to get the product to market. Boeing also anticipated that its outsourcing strategy would allow it to generate additional sales from the countries that were partners in the process, and reduce its costs and risks. While Boeing’s strategy worked for some components, for other parts, the strategy was a disaster. Suppliers were late and some produced poor quality parts forcing Boeing to commit additional resources to the project. Discussion of the case can revolve around the following questions.
QUESTION 1: What are the benefits to Boeing of outsourcing so much work on the 7878 to foreign suppliers? What are the potential risks? Do the benefits outweigh the risk?
ANSWER 1: Boeing made the decision to outsource much of the production of the 787 because of the potential gains this strategy could realize. By outsourcing, Boeing hoped to achieve significant costs savings, generate additional sales in the countries where outsourcing partners were located, and decrease the development time by as much as two years. Many students will agree that the potential benefits of this type of strategy are important, but may note that in Boeing’s case, the benefits may not have outweighed the risks. As Boeing found out, benefits are only realized if partners perform as expected. Because many of Boeing’s partners are behind schedule, production of the 787 is as much as a year behind, and Boeing is facing large penalties on delivery contracts to customers.
QUESTION 2: In 2007 and 2008 Boeing ran into several publicized issues with regard to its management of globally dispersed supply chain. What are the causes of these problems? What can a company like Boeing do to make sure that such problems do not occur in the future?
ANSWER 2: In 2007-2008, Boeing announced that delivery of the 787 would be delayed by as much as 12 months. The delay was the result of problems with Boeing’s partners. Companies that had been hired to produce various parts were behind schedule, producing inferior parts, and even outsourcing themselves. Many students will probably suggest that Boeing might have been able to avoid some of its problems with greater oversight and communication with partners. For example, it appears that Boeing was unaware that some partners had actually outsourced work they had been hired to complete. Many students will probably agree with Boeing that there is tremendous potential value in outsourcing production to those firms that are the most efficient producers, but students will probably also point out that for such an effort to be successful, especially on the scale that Boeing is working on, communication and close partnering is essential.
QUESTION 3: Some critics have claimed that by outsourcing so much work, Boeing has been exporting American jobs overseas. Is this criticism fair? How should the company respond to such criticism?
ANSWER 3: The question of whether jobs are being shipped abroad is likely to generate significant debate among students. Some students will probably suggest that through its outsourcing program, Boeing is indeed taking jobs away from U.S. citizens. Other students however, may note that cost savings were a critical issue for Boeing in its decision to outsource work on the 787 project. Without the cost savings, production of the 787 may not have been a viable option. Students may therefore conclude that Boeing’s decision to outsource is actually creating jobs.
Another Perspective: To see where Boeing is with its 787 and its strategy in general, go the {http://www.boeing.com/}. To extend this case, consider {http://www.businessweek.com/bwdaily/dnflash/content/dec2009/db20091222_986652.htm} and {http://www.businessweek.com/bwdaily/dnflash/content/jun2009/db2009064_854140.htm}.
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following:
Title: Hanesbrands Relocates Manufacturing to Asia
Run Time: 9:08
Abstract: This video explores the effects of apparel maker Hanesbrands’ strategy to relocate production from North and South America to several Asian countries including Vietnam, Thailand, and China.
Key Concepts: globalization, pressures for cost reductions, global economy, global strategy, global production and sourcing, foreign direct investment, levels of economic development, social responsibility
Notes: At Hanesbrands’ new factory in central Vietnam, workers are busy manufacturing apparel that will be exported to the United States. Hanesbrands opened the factory as part of its strategic plan to shift production to lower cost locations. In addition to this factory, the company has opened four other facilities in Asia that together with the Vietnam factory, employ 6,000 people. Vietnam was a particularly attractive location for investment because of its low cost labor, good infrastructure, low taxes, and proximity to the company’s fabric operations in China.
Workers at the Vietnam plant earn about $80 per month which is about $30 more per month than the country’s legal minimum wage. Hanesbrands also provides its workers with free lunches. In exchange, employees put in six day, 48 hour work weeks and agree not to join a union that is not approved by the Communist party. Hanesbrands is not the only Western company to shift production to Vietnam. In fact, some 10,000 foreign businesses have made investments totaling $40 billion. Vietnam government official Boi Kuk Ching believes that if the current pace of inward investment continues, Vietnam will become an industrial nation by 2020. The effects of the foreign investment can be seen everywhere. Many people are moving out of rural areas where they had survived on subsistence wages to take advantage of the better job opportunities in the urban areas. Consumption is up, and so is the selection of products to buy. However, while the economy may seem more prosperous, there are several disadvantages associated with the influx of investment. Air pollution has increased and housing costs have risen in urban areas. To keep housing expenses down, some people are choosing to squeeze multiple people into a single room. To avoid some of these problems, Doug Leegon, a sociology professor, suggests that Vietnam should make a bigger effort to encourage investment in rural areas as well as in urban areas.
In the United States, Hanesbrands has been criticized for shipping jobs offshore. As part of its cost saving strategy, the company has closed 30 plants in the United States, Canada, and Latin America, leaving some 19,000 people without jobs. Scott Nova of the Workers Rights Consortium believes that Hanesbrands and other companies should be more committed to the local communities and workers where they operate. Hanesbrands though, disagrees. In fact, the company claims that it is indeed making a long term commitment to its Asian operations, and that its investments should remain for 20 to 30 years. The company also points out that it had been in North Carolina for a century before making the decision to close its operations there. CEO Richard Noll says that the company’s current actions are simply part of its ongoing strategy to operate where costs are low, invest in innovation, and follow a low price policy. Noll notes that by investing in Vietnam and the other Asian countries, Hanesbrands is bring jobs to the region, and promoting economic growth. Noll’s comments do little to appease former employees in the United States where some have agreed to boycott the company’s products. These disgruntled workers may soon have more company thanks to a recent decision by
Hanesbrands to accelerate its plant closures in the United States in an effort to minimize the effects of the weakened economy.
Discussion Questions:
1. Vietnam has attracted some $40 billion of investments in recent years. Discuss why the country is attracting companies like Hanesbrands. What factors are driving this type of investment? What does the investment mean to Vietnam?
2. Using the framework in your text, discuss Hanesbrands’ global strategy. Is the company’s recent decision to close plants in North and South America driven by pressures for local responsiveness or pressures to lower costs? What type of strategy is Hanesbrands following? In your opinion, will Hanesbrands be successful? Why or why not?
3. Hanesbrands has been criticized for its decision to close plants in North and South America. Discuss the impact of these closures. How should the company respond to the criticism? What, if any, responsibility does Hanesbrands have to Vietnam and the other Asian countries?
4. Compare the compensation of workers in Vietnam to that of workers in the United States. In your opinion, are the workers in Vietnam being fairly compensated by Hanesbrands? Consider the relationship between management and labor. What bargaining power do the workers in Vietnam have?
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material presented in this chapter. In particular, you might consider the following from International Business DVD Volume 5:
Title 16: The Great British Jobs Takeaway – Indian Call Center
Abstract: This video explores the operations of a call center in India, and the benefits of operating the center in India as compared to Britain.
Key Concepts: outsourcing, offshoring, global economy, trade, globalization, levels of economic development, theory of comparative advantage, theory of factor proportions
Notes: At eleven o’clock at night the work day is just beginning for workers at GTL Limited in Mumbai in India. GTL Limited sells life insurance over the telephone. So, while their countrymen may be sleeping these workers are making calls to Britain where it is early evening – a peak time for telephone sales. Workers making sales calls greet call recipients using the local time reference.
Workers at the call center follow a carefully scripted sales pitch and view sample dialogue on their computer screens. Many call centers like GTL Limited require workers to use an English name like James. The workers claim that doing so makes them seem more familiar to their target market. One worker thinks that using his English name makes it easier for British people to relate to him, but does not believe that his employer is trying to fool customers. Some call centers though, also require workers to disguise their location, and indicate to customers that they work in nearby towns.
Call centers like GTL Limited can be found across the city and in other parts of India. Foreign companies have shifted their telephone sales and other activities to India to take advantage of the country’s well-educated, cheap labor force. Workers in India earn just 30 percent of what a British worker might earn. Making the process easier is the fact that jobs at call centers in India are popular. Many of the 1,500,000 graduates each year will seek employment in a call center. In fact, many call centers like GTL Limited actually require their workers to have a degree. British companies know they cannot compete with the inexpensive Indian call centers and so are actively seeking qualified Indian workers instead.
Discussion Questions:
1. Define the term ‘production’. How does the term apply to companies involved in services like life insurance sales?
2. Many firms today are dispersing production to offshore locations. Explain how call centers like the ones in India lower the cost of production for firms. What might lead a firm to buy services like those offered in an offshore call center?
3. In recent years, India has become recognized as a leader in providing customer care services. What makes India such an attractive location for companies looking to outsource their customer care activities?
4. How can the term ‘production’ be used when describing services? How do firms in the services industry use the term? How does it apply to the make-or-buy decision?
5. Adopting an English name is common for many Indians working in call centers. Why is this an important part of their job? What does it imply about the need for local responsiveness in the services industry?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following exercises:
Exercise 1
The globalization of production makes many people more aware of the differences in manufacturing costs worldwide. The U.S. Department of Labor’s Bureau of International Labor Affairs publishes a Chartbook of International Labor Comparisons. Locate the latest edition of this report and identify the hourly compensation costs for manufacturing workers in the U.S., Italy, Mexico, New Zealand, Norway, and Singapore.
Exercise 2
The internationalization of manufacturing has become much more predominant in recent years. In fact, the Industry Week magazine ranks the world’s largest manufacturing companies by sales revenue. Identify the largest Indian and Japanese manufacturing companies as provided in the most recent ranking by paying special attention to the industries in which these companies operate.
Answers to the Exercises
Exercise 1
The Chartbook of International Labor Comparisons can be located by searching for the term “Chartbook of International Labor Comparisons” at http://globaledge.msu.edu/ResourceDesk/. The resource is titled “A Chartbook of International Labor Comparisons” and is located under the globalEDGE Category “Research: Statistical Data Sources”. Hourly compensation costs are listed under the “Competitiveness Indicators for Manufacturing” section of this report. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “Chartbook of International Labor Comparisons”
Resource Name: A Chartbook of International Labor Comparisons
Website: http://www.bls.gov/fls/chartbook.htm globalEDGE™ Category: “Research: Statistical Data Sources”
Exercise 2
The Industry Week magazine ranking can be located by searching for the term “Industry Week” at http://globaledge.msu.edu/ResourceDesk/. The resource is titled “IndustryWeek: IW 1000 - World's Largest Manufacturing Companies” and is located under the globalEDGE Category “Research: Rankings”. Be sure to click on the Resource Desk link to search this area of the globalEDGE website.
Search Phrase: “Industry Week”
Resource Name: IndustryWeek: IW 1000 - World's Largest Manufacturing Companies
Website: http://www.industryweek.com/iwinprint/iw1000/ globalEDGE™ Category: “Research: Rankings”
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