flexible entry strategies for emerging telecom markets

NORTH- HOLLAND

Flexible Entry Strategies for Emerging Telecom Markets

D AVI D C. CROSON, JAMES F. FOX, and V L A D I M I R L. A S H U R K O V

ABSTRACT

The existing technical literature on the telecommunications industry addresses, on both operational and cost dimensions, the relative advantages of different telecommunications technologies. Significant complementary research also exists in the area of entry strategies for developing markets or those without a competitive history. We believe that these two literature bases can combine to form a theory of "flexible entry," in which a firm's telecom technology decisions support entry of potentially high-growth but also high-risk markets, such as those associated with rapidly developing economies. Specifically, we suggest the definition of a systematic framework to balance technological choice and market conditions--two choices to be undertaken concurrently, under conditions of future uncertainty, for a firm contemplating entry. We suggest the use of efficient frontier analysis, trading off flexibility and commitment, for this purpose. Flexibility in this sense represents the ability to redeploy assets to alternate purposes without loss. Commitment, rather than the opposite of flexibility, denotes the ability of a firm to resist being "forced out" of a favorable market. While flexibility preserves capital in the event of poor demand realizations, commitment is essential to continued profitability in the event of favorable demand realizations. Suggestions for future expansion of this framework are proposed. © 1998 Elsevier Science Inc.

Introduction The existing literature on the technological investments in the telecommunications

industry (e.g., [1]) addresses, on both operational and cost dimensions, the relative advantages of different telecommunications technologies. Significant complimentary research also exists in the area of formulating entry strategies for developing markets or those without a competitive history (e.g., [2-5]. We believe that these two literature bases can be fruitfully combined to form a theory of "flexible entry," in which a firm's telecom technology decisions support entry of potentially high-growth but also high- risk markets, such as those currently associated with many rapidly developing economies. Specifically, a systematic framework is currently lacking to balance technological choice

DAVID C. CROSON is Assistant Professor of Operations and Information Management at The Wharton School of the University of Pennsylvania in Philadelphia.

JAMES F. FOX is an Associate at McKinsey & Company, of Bedminster, New Jersey, focusing in the areas of telecommunications and medical devices.

VLADIMIR L. ASHURKOV is a Russian citizen who recently returned to Russia with a long-term goal of becoming a telecommunications entrepreneur.

Address reprint requests to David C. Croson, 1316 Steinberg Hall-Dietrich Hall, 3620 Locust Walk, Philadelphia, PA 19104-6366. E-maih <[email protected]>

Technological Forecasting and Social Change 57, 35-52 (1998) © 1998 Elsevier Science Inc. All rights reserved. 0040-1625/98/$19.00 655 Avenue of the Americas, New York, NY 10010 PII S0040-1625(97)00088-7

36 D.C. CROSON ET AL.

and market conditions--two choices that must be undertaken concurrently, under conditions of future uncertainty, for a firm contemplating entry into these markets.

The factors most relevant to the technology investment decision appear to be the composition of the technology's overall cost structure (i.e., the fraction of total costs accounted for by fixed or sunk investments and marginal operating costs), future expandability both in terms of added users and bandwidth, and ability to bootstrap its own network externalities through first planning to serve high-value and relatively price- insensitive customers (frequently business, urban, or high-volume users) and then gradu- ally to expand the network to encompass customers for whom universal service would initially be economically impractical (e.g., residential, rural, or low-volume users.) This targeted entry strategy depends on first attacking the most attractive segments of the market [4] rather than providing universal service, which would inevitably also include customers costly to serve. We will then demonstrate how to construct a (hypothetical) ideal technology that fully meets all market requirements for each of the types of attractive market environments, and suggest how to synthesize a technology mix, utilizing present technologies that best fit our ideal technology criteria. 1

Next we will explore different tactical entry strategies a firm could execute, with an eye towards limiting the risk of a large loss (should forecasts of demand, growth, political stability, or technological innovation prove too optimistic) while preserving the option to grow and expand (should present-day forecasts prove pessimistic). This analysis is built around tradeoffs between flexibility and commitment. By systematically varying the required flexibility and commitment for success, we can construct an "efficient frontier" along these two dimensions that specifies the appropriate technology choice. The resulting model will enable a firm to identify and distinguish appropriate strategies for different telecom market types by prescribing the correct combination between flexibility and commitment; identify the technology investments (both those currently available and yet to come) to implement a strategy on the efficient frontier; combine the ideal technology with an entry strategy whose success is not particularly sensitive to accurate forecasts of demand, political conditions, technological progress, or any other unknowables, but instead allows the firm to adapt dynamically as these conditions unfold. In this respect, such a flexible approach complements technological forecasting by providing an alternative method of dealing with uncertainty when further refinements in forecasting are not economical.

The third part of our project applies our model's findings to sample emerging markets using existing technology. A surprising result, for example, is that Vietnam and Russia, while having very different characteristics, share the same recommended entry approach.

Theoretical Background for Flexibility and Commitment Analysis In finance theory, investments are evaluated along the dimensions of risk and

return. For any given level of risk, there is a corresponding maximum level of return that can be achieved using the securities in the investment universe. The (return, risk) combinations corresponding to a given amount of resources to be invested make up the efficient frontier [6]. Borrowing from this concept, we claim that the two significant dimensions to determine efficient frontier for strategic technology investments in general are flexibility and commitment, as shown in Figure 1.

Such an analysis will, as a by-product, indicate where technologies not yet developed would have the highest impact on ease of entry.

FLEXIBLE ENTRY STRATEGIES 37

o Optimal Techno :~ Optimal Tec y Choi

I E,ioient Frootier \ \ ~1 \ \ ~

] ,Cho/ice _~ Optimal Technolog "~o I f o r Firm 13- ~\ " ~ e

Less Committed Commitment Axis More Committed •

Fig. 1. The efficient frontier of flexibility and commitment.

Flexibility in this context refers to the option to expand, contract, or retarget operations within a national market, or the ability to remove capital assets from danger of nationalization or expropriation should the need arise. For capital costs, flexibility is roughly the opposite of sunkenness; if investments can be reversed at will, they are 100% flexible. Thinking of flexibility as an option, but not an obligation, either to expand or to contract gives the correct flavor. We will also comment on the value of flexibility as the ability to defer undertaking irreversible investments until after information about a market is revealed, in the spirit of Dixit and Pindyck [7].

While technological flexibility is generally useful, it carries with it an enduring difficulty of proving credibly that, once in, one is committed to defending a market. Commitment refers not to the opposite of flexibility but to the firm's ability to "put down roots" in a market and credibly threaten not to leave if entry occurs, but rather to defend its market share vigorously. Our definition of commitment thus parallels that of Dixit and Pindyck [7] and Ghemawat [8], who define commitment in terms of the undertaking of irreversible actions (such as sinking money into the building of a telecommunications infrastructure) that have limited alternative uses outside of the market. A firm is committed if it cannot be forced out of a market by making conditions in this market unbearable, even if it has the option to leave should a particularly lucrative opportunity arise elsewhere. While in this treatment we simplify the strategic value of commitment to encompass only the value of these irreversible actions in deterring entry, there are clearly benefits to such commitment (as a declaration of good faith, for example) for bargaining with national governments as well.

E V A L U A T I N G UNCERTAIN INVESTMENTS BY FLEXIBILITY AND COMMITMENT

Any investment under uncertainty poses a hazardous choice: the investing firm must dedicate scarce resources toward projects that yield benefits, the quantity and timing of which is unknown. Inherent in this decision is the firm's willingness to accept

38 D. C. CROSON ET AL.

~ro 4,s /n

Best Feasible Technology \ ~ \ .~ for Fi~m A "" \ ~ \ \ "Z2=

Original Idealized

Actual Feasible -.. \ \ a ' ~ Technology Combinations ~ ' ~ \ ~

...-- , ~ e Best FeasibleTech~nology' ~ ~---~o "~ for Firm B -- ~\ "~ ~ ',k. &'&

More Committe~l • Less Committed Commitment Axis

Fig. 2. Effects of lack of smoothness on technology choice.

tradeoffs between flexibility and commitment. In particular, for technology investments designed to yield competitive advantage, investing firms will make substantial investments understaflding that there will come a time when resources will be irrevocably committed beyond the point of reversal. Thus, although a cursory review may favor high levels of flexibility, a purely flexible entry strategy is not without consequences. Ghemawat [3, 8] stated that it is the firm's level of commitment that provides much of its sustainable competitive advantage. Thus, a purely flexible strategy may preserve the investment "principal" at the expense of sacrificing the "return" from the more committed strategy.

F U R T H E R EXPLANATION OF THE EFFICIENT FRONTIER

In portfolio theory, the efficient frontier is usually assumed to be smooth, continuous, and convex. These assumptions result from an investor's ability to specify an arbitrarily fine percentage mixture of qualitatively different securities (e.g., a portfolio of 54.2517% stocks and 45.7483% bonds) that can deliver any desired combination of risk and return. In applying the lessons of portfolio theory to "real" (in the sense of "physical," as opposed to "financial") applications, we recognize that technology investments may not be combinable in a smooth way (as in the above portfolio example) and thus that a firm may not be able to position itself at simply any desired point on the efficient frontier but instead must compromise by locating at a feasible point close to the desired strategy (e.g., see Figure 2).

Since there are only a finite number of combinations pairing technology options and entry strategies, the efficient frontier is not smooth, continuous, or convex. The firm's only defensible options reside at the vertices of the efficient frontier. A nice property of this analysis is that when a firm commits to such an investment decision,


(~

LL

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LL

\ \

\ \

Entrant's Choices of Technology which dominate Incumbent's position

Incumbent's Choice

•


Fig. 3. Choosing a technology that dominates the incumbent.

it must place itself on the efficient frontier at all costs or risk encroachment by a new entrant who positions itself closer to the frontier.

Since the incumbent is vulnerable to any entrant that positions itself in the region bounded by lines parallel to the flexibility and commitment axes and the efficient frontier (see the shaded area in Figure 3), it is vital for the firm considering initial entry into such a market (a potential incumbent) to understand the bounds of the efficient frontier for each of its markets so that it does not choose an untenable position.

DETERMINANTS OF THE INVESTMENT PREFERENCE LINE FOR A TELECOM COMPANY

While all potential firms in a particular geographic market face the same efficient frontier (determined by technology), we can introduce strategic heterogeneity by en- dowing each with its own investment preferences, similar to individual consumers' risk-reward tradeoffs determined by their utility functions. Some factors determining the slope of the line that defines each firm's willingness to trade off the two desirable attributes of flexibility and commitment are the nature of the existing portfolio of investments and exposures, relationships with local governments and telecom players, breadth of technological experience, opportunity cost of capital, access to capital, and so on. Given that some of the factors that make up the company's preference line are specific to a particular country and market, the slope of the preference line may differ substantially in each market the company considers.

The only markets likely to be even considered for entry are those with acceptable levels of market access, political stability, and regulatory controls. Such markets can then be grouped upon the dimensions of present level of infrastructure and expected levels of growth. Table 1 illustrates these dimensions for several attractive markets.

After the firm has chosen its target market types, it must then develop an understanding of its technology options from the viewpoint of an entrant. Of the factors that

40 D. C. CROSON ET AL.

TABLE 1 Present Infrastructure/Level of Rivalry in Attractive Markets

Present infrastructure High Low

Expected growth High Israel Vietnam

Russia India Taiwan

Medium Spain Philippines Portugal Mexico Argentina

Source: [13].

affect the level of flexibility and commitment, only two are under the direct control of the telecom investor: the technology chosen and the mode of entry to be applied in the market.

We propose that a telecom firm facing such an entry decision can map out its efficient frontier, and deduce its correct combination of technology choice and entry mode, through executing a decision process consisting of the following stages, corresponding to the process of selecting an optimal portfolio: (a) developing criteria for identifying attractive telecommunication markets; (b) generating an ordinal ranking of pure and hybrid technology options along the dimensions of commitment and flexibility, (c) generating an ordinal ranking of market entry mode strategies along those dimensions, (d) ranking all (or at least a representative sampling of) possible technology/ entry-strategy pairings, incorporating interactions between the technology and entry mode strategies; (e) mapping the paired options on the flexibility-commitment plane, (f) eliminating technology-entry combinations that are dominated by others in the consideration set (i.e., which offer less flexibility for a given level of commitment, or which offer less commitment for a given level of flexibility, than some other feasible point); (g) mapping the efficient frontier and the investment preference line onto the flexibility-commitment plane; and (h) choosing and implementing the technology-entry option that is the point at which the company's flexbility-commitment preference profile is tangent to the implementable efficient frontier (delivering the best achievable combination of flexibility and commitment).

In the remainder of this article, we will assume that an attractive market has been identified and address the process of creating an ordinal ranking of the technologies and entry strategies, combining these rankings to define the efficient frontier and selecting a technology/entry-strategy pair from the frontier for that particular attractive market.

E n t r y - O r i e n t e d O v e r v i e w o f T c l c c o m T e c h n o l o g y C h o i c e s

MATCHING TECHNOLOGY WITH MARKET CHARACTERISTICS Cost Structure of the Technology

Each potential technology investment will be comprised of both sunk cost investments (which must be committed before customers are acquired) and marginal operating costs (committed on a "pay-as-you-go" basis). As factors such as expected growth and political stability become more uncertain and consequently difficult to predict for the technology decision, the firm will become increasingly averse to making investments with a heavy sunk-cost component in that particular market. Thus, the firm facing


uncertain circumstances will, on the margin, be willing to accept a larger marginal operating cost in order to limit the necessity for sunk and irretrievable investments.

It should be clarified at this point that, when considering technology choice for flexible entry, it is prospective sunk costs (investments that, once made, are irreversible and have little or no alternative value) and not prospective fixed costs (investments that are required to serve the first customer but may have such alternative uses) that are important. An investment with high fixed costs, such as a satellite communication system, may have very low market-specific sunk costs. The question to distinguish between sunk and fixed costs in this context is, "Would this cost be recoverable (i.e., could the asset serve an alternative use) if we served zero customers in this country market?" For a satellite, the answer is clearly "Yes," despite the capital intensity of this technology, because the satellite itself can be easily redeployed to serve another market (possibly even without any physical redirection).

Future Expandability of the Technology For developing markets that have already been deemed potentially attractive for

entry, the inherent uncertainty of payback of sunk assets must, by definition, at least be balanced by potential opportunities for profitable growth. The potential entrant will be highly interested in maintaining the flexibility to expand its number of clients, range of services, and geographic area of coverage should the market turn out to be favorable. Although the firm may be forced to pay a significant sum either to invest in the technology with such an option imbedded in it, or to exercise the option once the market has revealed itself favorably, the value of this option may be relatively easily evaluated using standard decision-tree methodologies.

Minimum Efficient Scale of Technology Versus Segmentation in the Market The choice between universal and selective coverage is triggered by the level of

infrastructure and expected demand. A country starting from low teledensity cannot be expected to achieve 100% universal coverage in a sufficiently limited amount of time to satisfy investors' desire for an attractively short payback period. Thus, the technology best suited for the entry strategy from the investor's point of view will necessarily provide selective coverage at first, initially serving only the high-value customers who are willing to pay relatively high margins for telecom services. This combination of initial entry at a small scale and a target market willing to pay for instantaneous access suggests the use of wireless technologies such as cellular and satellite. On the one hand, the flexibility advantage of these technologies in markets characterized by low infrastructure and uncertain demand is that they can be installed quickly and will thus be able to provide communication services instantly to a limited, less price-sensitive clientele. On the other hand, such a cream-skimming strategy offers a limited dollar amount of absolute profit, even though its return on invested equity may be spectacular, due to its low capital intensity. Furthermore, such a niche strategy may actually alert incumbents to a new method of competition, which knowledge could allow them to make higher scale entry into high-value markets more difficult.

Universal coverage as a strategy (in the sense that an attempt is made to make services available to a much broader customer group, although not necessarily at a uniform price) is more suited for a market with moderately developed infrastructure and stable demand for communications. In moderately developed markets, a significant segment of customers is observed to be willing to pay premium rates for high bandwidth data and entertainment services; the ability to deliver these services using the same


infrastructure utilized for traditional voice communications is a clear advantage, both for telecom provision (shared infrastructure costs) and for providers of these value- added services (immediate access to customers).

This is not to say that initial entry must be at full scale, however. The early project cash flow from the skimming strategy described above may lengthen the amount of time over which investors will be willing to recoup their investment's returns (as less capital will be at risk following the initial partial payback). Such a lengthened horizon will enable a transition towards universal service if the market develops appropriately and will permit a quick exit if the market collapses.

Population Density of the Market Population density has a significant influence on the telecom technology investment

decision in a nonintuitive way: the less populated the region, the higher the capital requirement per customer to provide infrastructure that depends on geographical place- ment of assets (such as copper wire or cable). When the population density goes below a certain threshold, it becomes more economical to use technologies that can span large geographical areas without a proportional increase in investment. If the firm found it necessary to serve such geographically disperse segments, opting for cellular, satellite, and fixed wireless technologies may result in a higher marginal operating cost but, paradoxically, a smaller investment per customer.

EVALUATION OF FIBER-OPTIC TECHNOLOGY Currently, fiber-optic technology seems to be the highest performance solution, on

an absolute basis. The bandwidth provided by optical fiber exceeds any requirements of today's communications. One of its most attractive features is its flexibility in use: it supports voice, data, or video transmissions. In comparison with copper or radio- frequency communications, fiber is not a hybrid solution, but, due to its broadband nature, it can accommodate most foreseeable needs of information transmission.

Fiber is not, however, a dominant technology, because bandwidth is not flee. The technology is characterized by relatively high sunk costs and low maintenance costs. The U.S. $1,750-$2,000 per subscriber to bring fiber-optic cable to the average home represents a truly daunting commitment for the average telecom provider. Whether these expenditures would be justified by increased usage of value-added services that the fiber optic bandwidth would afford is as yet unclear. Once the fiber is laid, though, the maintenance required is minimal, since the fiber characteristics do not deteriorate with time.

Because of high initial cost required to install fiber-optic connections, developed countries have adopted a gradual approach to introducing this technology. Many countries have invested in national fiber backbones and interexchange fiber links. Business customers are typically the first to employ fiber-optic connections. In Japan, the strategy was to connect large companies first, then small businesses, and, then, residential customers. This reflects the general progression of strategies of telecommunications companies who are committing to fiber in a gradual manner: FTTO (fiber-to-the-office) --* FTTC (fiber-to-the-curb) ---* FTTH (fiber-to-the-home). We observe that new market entrants (e.g., Sprint in the U.S.) have been quicker to install fiber because they do not have to either amortize immense investments in copper infrastructure (leading to a false impres- sion at the management level that these investments are not sunk) or to justify these previously sunk investments to their shareholders. This technology is inherently expand-


able, allowing more price-sensitive customers to piggyback on infrastructure built for less price-sensitive segments of the telecommunications market.

Flexibility Rating: 3 (medium) Commitment Rating: 1 (highest)

EVALUATION OF CABLE TV/TELEPHONY TECHNOLOGY While cable television has existed for years in many countries, the use of cable

infrastructure for voice and data is relatively recent. Cable TV infrastructure has a distinct advantage over conventional copper wires in that it uses coaxial (as opposed to twisted-pair) cable in transmitting information. This technological feature means that cable can deliver the higher bandwidth required for voice communications, data communications, and interactive services, such as video-on-demand. Until recently, in most countries (the U.K. excepted), the cable network lacked switching ability and thus could be used only for one-way communications (e.g., providing residential customers access to television).

Given that a cable fixed-link network is already in place, however, converting it to enable two-way communications requires only modest investment. Such conversion allows cable providers to gain revenue, leveraging the installed infrastructure to enter a larger and potentially profitable market for a small incremental entry cost. Recent acquisitions, such as the merger of USWest & Continental Cable, place an implied value of about U.S. $1,000-$2,000 per subscriber on a cable network. This range can be used as an upper bound on the fixed investment required to provide coaxial cable infrastructure.

The technology structure of coaxial cable suggests a pricing strategy for a new entrant into telecommunications who uses it. Traditionally, telephone companies have charged a monthly base fee and a further unit-based fee determined by usage of phone services, whereas cable companies have traditionally charged a fiat monthly fee. The high-fixed, low-variable cost structure of high-bandwidth networks favors the fiat-fee method, and if cable companies use fiat-fee charges, they may be able to gain a significant competitive edge over conventional phone companies through drawing away the highest- usage customers and, presumably, charging differential fiat fees based on customer segmentation.

Anecdotal evidence argues that entertainment services are very important in emerging markets. Users have shown their willingness to pay for subscription television, even though charges may be several times higher than for basic TV service or basic telephone connections. Therefore, coaxial cable infrastructure, which combines ability to transmit TV and voice signals, might be an attractive candidate for a greenfield strategy, committing to one-way content provision with an embedded option to expand into two-way communications and telephony at a later date.

Flexibility Rating: 4 (low) Commitment Rating: 2 (high)

EVALUATION OF CELLULAR AND WIRELESS TECHNOLOGY Mobile communications is one of the most rapidly growing areas of telecommunica-

tions. In 1994, for example, 20 million subscribers to cellular services were added. In Nordic countries, more cellular connections are being added than main phone lines.

Cellular connections can be added incrementally, so a potential provider does not necessarily have to commit large financial resources even if the demand in the area is small. Although the average cost per subscriber to establish cellular service is substan-


tially higher than for plain old telephone service over copper lines, cellular networks seem to be the default entry strategy in rapidly developing emerging economies, as they allow firms to skim less price-sensitive market segments who demand performance (e.g., businesses and entrepreneurs) without requiring large investments and still main- tain the option of expansion should the market prove prosperous. Cellular service also provides a quick solution without any waiting in areas where availability of traditional telephone service may be limited. This immediate accessibility proves very attractive to entrepreneurs and rapidly growing firms--who frequently develop into the most desired and hotly contested customer segment.

The field of cellular and wireless telephony is developing very rapidly. New develop- ments include fixed wireless technology for local loop and multichannel multipoint distribution systems (MMDS or "wireless cable"). The most intriguing possibility, as yet untested, is to use MMDS in developing countries for both fixed-cellular and multichannel television.

Hexibility Rating: 2 (high) Commitment Rating: 5 (lowest)

EVALUATION OF WIRED (COPPER) TECHNOLOGY Twisted-pair copper wires are mostly used for local service. The plain copper wire

can provide only a narrowband connection: it is difficult to exceed 56,000 bits per second during data transmission. Nonetheless, growth in wired connections throughout the world in 1994 was the highest rate noted in the past 20 years, boosted by new demand from the Asia-Pacific region. Although developed countries are contemplating competing technologies such as fiber-optic cable, wireless and satellite technology for local loop, most developing countries without local telephony infrastructure continue to lay copper wire, which has sharp limits on its expandability.

Despite its inherent technological limitations, several extensions to copper wire can serve as gap fillers, before high bandwidth comes to homes. ISDN, for example, is a standard that can send a combination of voice and data simultaneously at speeds up to 128,000 bits per second. This standard is now actively promoted by telecom providers in developed countries, at least partially because it makes use of already available infrastructure. Another option is the Asynchronous Digital Subscriber Line, currently in the test stage, which can send up to four television signals, along with voice communications, over the same line. At this point it is hard to predict the eventual competitive position of these technologies versus other means of communication; it seems clear, however, that new copper wire makes sense only as part of a larger infrastructure- building strategy and, despite its popularity as a first step for governments, should not be chosen by default as the first part of a flexible entry strategy for a profit-maximizing firm. In our evaluation of twisted-pair, we assume a firm utilizing an existing twisted- pair network, rather than laying new copper wire. This assumption represents the first example of pairing technology with an entry mode: here, joint venture or acquisition, rather than greenfield entry.

Flexibility Rating: 5 (lowest) Commitment Rating: 3 (medium)

EVALUATION OF SATELLITE COMMUNICATIONS TECHNOLOGY Satellites can provide both TV and telecommunication services. Satellite technology

for communications is characterized by high terminal costs and transmission delays; the maintenance costs for satellite networks are also relatively high. Two planned for-profit


infrastructure projects (Teledesic and Iridium) promise to provide universal telecom coverage through a network of satellites, but the extent to which these projects will be successfully implemented is yet unclear.

Flexibility Rating: 1 (highest) Commitment Rating: 4 (low)

Selecting an Entry Strategy The technology decision is only part of the puzzle a firm must identify if it is

successfully to enter emerging telecom markets. The firm must also identify the most effective entry strategy for a particular market environment, to be coupled with the technology choice. We will examine three entry strategies (joint venture, acquisition, or greenfield entry) in order of decreasing flexibility, identifying each strategy's advantages and disadvantages. Greenfield entry involves building an infrastructure from scratch. The major difference betwen joint venture and acquisition is a matter of degree: in acquisition, the entrant bears 100% of the risks, costs, and rewards, whereas in the joint venture these are shared in some proportion among the partners. The fact that the new entrant is partnering with or buying an existing telecom provider can lead to a significantly increased speed to market over insisting on building from scratch. The buyer can also use the available financial and other information of the existing company to get a better estimate of the costs and revenues of the project. Buying or cooperating with a potential competitor does not increase the number of players, so the entrant will look forward to competing with one fewer company.

JOINT VENTURE The joint venture, a partnership between an existing incumbent and the potential

entrant, is an entry strategy with a dual personality. The joint venture attempts to provide significant access to markets while at the same time limiting the cooperating firms' exposure to the risk of the venture.

The joint venture can be very useful for the potential entrant who lacks experience or resources that would be required for greenfield or acquisition to succeed. For instance, one of the firms may have extensive country expertise or access to proprietary technologies that are vital to the success of the enterprise the other lacks. A joint venture will allow firms to combine their separate strengths to offset corresponding weaknesses. (Another reason why a joint venture might become the most attractive entry mode is if regulation precluded direct foreign ownership of telecommunications facilities; for example, if local governments were to require partial domestic ownership of telecom firms.) Firms can also utilize a joint venture in order to limit the amount of their investment at risk; such investment may be of some use to the domestic partner even if the market does not develop favorably, thus limiting the sunkenness of the capital required. Finally, the joint venture is useful when a firm wishes a shorter term investment due to its other opportunities; the domestic partner can agree to acquire the operations after a specifically designated period of time, provided that this exit strategy has been spelled out before the uncertainty is resolved.

Of course, the joint venture has some drawbacks as well--first among which is regret, as profits and losses are shared between the partners. Either the partnership will be successful (in which case the entrant will regret not having pursued a greenfield or acquisition strategy) or unsuccessful (in which case the entrant will regret having entered at all.) In addition, the partners' interests may diverge, leading to alliance risks of shirking (deliberate underperformance on unobservable dimensions, such as quality),


poaching (unauthorized use of assets and information belonging to the other partner), and opportunistic renegotiation (using unexpected circumstances to renegotiate or dis- solve the partnership agreement). These alliance risks can destabilize even a profitable joint venture. 2

Due to the sharing of profits with a joint venture partner, the joint venture is most useful when the level of investment must be limited or when the local government will not allow a more aggressive entry strategy. Thus the joint venture can be particularly useful in markets that are clearly profitable but that present only moderate or low growth prospects.

ACQUISITION When the alliance risks of shirking, poaching, and opportunistic renegotiation are

too great to allow a joint venture to function, or when the prospects are sufficiently optimistic to justify 100% ownership, acquisition may improve on the joint venture strategy. On the negative side, it may be difficult to understand exactly what is being sold in a rapidly growing but still underdeveloped infrastructure. The financial and reporting requirements in such emerging countries (or lack thereof) frequently hamper an assessment of the acquisition's financial attractiveness. In addition, while general uncertainty about future prospects may depress the asking price for the business to be acquired, the fact that the seller has a better idea of these prospects than the buyer does place the less informed buyer at risk of the "winner's curse" [9] of succeeding in acquiring the business, only to realize in retrospect that the price was too high.

The ideal market for entry via acquisition would be one in which the existing players are established with well-documented operating histories, sophisticated enough to be valuable acquisition targets and yet not targets of a bidding war. These criteria indicate that markets with high infrastructure and high expected growth (which justifies the large initial equity capital investment to finance the acquisition) would be well served by this strategy. If the operating history and capital structure of the acquired firm are such that debt is available to finance the acquisition, lower growth can also be accommodated.

GREENFIELD The decision to start from scratch to build an infrastructure depends on several

conditions beyond the unavailability of strategic venture partners or potential acquisition targets. A spoiling factor occasionally overlooked is the presence of excess capacity in the existing infrastructure (if any): even if existing telecom providers are resistant to the idea of joint ventures or being acquired, excess capacity in the existing telecom infrastructure gives incumbent providers both the ability and the motive significantly to reduce their prices and make other efforts to defend their competitive position. Of course, greenfield projects, due to the inherent uncertainty involved in doing something new and capital intensive, are prone to various cost and deadline overruns--a condition known as project risk [10]--and thus greater confidence in cost and revenue estimates is required than for other entry modes.

The greenfield has the obvious advantage of the new entrant having control over all aspects of technology and market strategy, and also of retaining full ownership should the market blossom. The disadvantages of the greenfield entry strategy are the relatively higher financial and economic risks and an uncertain exit strategy. A plant that was never completed, or was completed but never operated at full capacity, would

2 Thanks to Eric Clemons for multiple discussions on these types of alliance risks.


likely be sold at a significant discount when the owner decides that the market entry was not a particularly good idea--the prospective buyer, realizing the limited nature of the market, adjusts the buyout offer accordingly.

Given the factors discussed above, the greenfield entry strategy can be recommended only for markets with high expected growth and low infrastructure. The high growth would justify the high level of financial commitment and exposure, where the low infrastructure will limit the number of possible competitors. Presumably, government attitude towards foreign investment might also be warmer if domestic firms have not been able to create a robust telecommunications infrastructure.

Specific Market Applications: Russia and Vietnam In this section, we suggest how to apply our framework to two specific market

environments--Russia [11, 12] and Vietnam [12, 13]. In the above sections, we have offered our rankings of technologies and entry strategies in accordance with their flexibility and commitment. We now attempt to complete the picture for two specific market environments by first providing an overview of the markets' present state and then suggesting possible flexible entry strategies for these markets. Surprisingly, despite the differences in these two countrys' situations, the recommendation for the (technology, entry strategy) pair for flexible entry is the same for both.

APPLICATION OF ENTRY STRATEGY FRAMEWORK TO RUSSIA AND VIETNAM Russia and Vietnam, despite their differences, both exhibit underserved telecom

markets. Both countries also have a desperate need for outside financial resources, especially in high-risk/high-return ventures. As few domestic firms have access to significant capital, this presents opportunities for informed foreign investors.

We have examined elsewhere [5] aspects of the Russian and Vietnamese telecommunications markets that indicate that some segments of these markets may be attractive to outside investment using a flexible technology and the appropriate entry strategy. As stated in our methodology, we suggest the firm prioritize technologies and entry strategies along the dimensions of flexibility (to preserve the economic value of the capital investments that must be sunk in the entry process) and commitment (to preserve the value of the ongoing enterprise and prevent imitation or excessive entry, should the country conditions evolve favorably). While we believe that the ordinal ranking of technologies and entry strategies along the dimensions of flexibility and commitment is valid regardless of the specific market environment, the efficient frontier of (technology, entry strategy) pairs will vary dramatically by country.

One aspect that simplifies the analysis, as with most emerging markets, in neither Russia nor Vietnam is a foreign firm allowed to own and operate a private full-scale telecommunication concern--making joint venture the only generally feasible entry strategy (although the terms of the joint venture can be negotiated to approximate anything between a consulting relationship or full ownership by the entrant). We suspect that this constraint will not substantially harm the expected profitability of such entry opportunities, as the national firms provide local market expertise and an established client base and have access to certain infrastructure elements (such as existing copper- based networks) that could prove useful for certain technology choices--particularly those hybrids that depend on supplementing a fully flexible technology with a low-cost "workhorse" infrastructure. The exception that did not place the joint venture as the dominant entry mode was niche markets such as satellite communications. In this area, it is technically possible for a firm to initiate a greenfield entry strategy coupled with the


satellite technology, by virtue of a satellite not residing within national boundaries-- thus avoiding the letter of the ownership restriction. Yet, even in this scenario, we would expect to see the satellite provider partnering with a firm with an established local presence in order to provide marketing, billing, collection, and currency repatriation services. Although this partner need not be an existing national telecom provider (a bank, for instance, might serve admirably), we would not rule out their participation in this role.

Among technologies, we see a limited set of technologies that will dominate others along the dimensions of flexibility and commitment. Some firms, due to the extensive risks associated with these market environments, will opt for an extremely flexible technology at any cost of expenditure or commitment if they are to invest at all. In this situation, wireless technology would prove to be dominant.

We might think that firms willing to take more risk (and seeking commitment benefits that may deter future entry) would normally choose fiber due to its cost and bandwidth advantage over new cable and copper installations. Yet, due to the extreme risks associated with these markets, the appropriate discount rate for evaluating an investment in a new fiber network would be inordinately high. Thus, a firm wishing a more commit ted presence would be pointed toward acquiring and possibly updating an existing copper network. As the basic infrastructure of establishing the copper network is a sunk cost (and thus need not be financed or, necessarily, reimbursed on a full-cost basis to its owner) and would be accessible via partnering with the holder of these assets, investment in improving an existing copper network may be more attractive than making new fiber investments. Such "update investing" has two strategic benefits: it enables the firm to control a scarce asset, not only "locking out" future entrants; it also strengthens the firm's commitment to remain in the market and defend its market share, even if entry were to occur, by virtue of having sunk investments into a nonredirectable resource and, in effect, being committed to stay the course. By eliminating its own alternatives, a firm can credibly commit to a continued presence.

We have identified three possible pairings we feel would lie upon the efficient frontier for market entry. These pairings represent an extremely flexible strategy, a moderate strategy, and a fully committed strategy. As we stated earlier, the firm's choice among these three entry strategies will be dependent upon the slope of its own risk preference line. A firm valuing flexibility highly but relatively indifferent to commitment will jump at the opportunity for a joint venture using wireless technology; a firm valuing commitment above all else will seek a partnership to upgrade the existing copper infrastructure, and a firm valuing both flexibility and commitment will combine satellite communications with the existing copper infrastructure to create a hybrid technology, as shown in Figure 4.

The most flexible option (Figure 4, Point A) involves wireless technologies coupled with a joint venture entry mode. The joint venture will provide all of the benefits mentioned (and be subject to the alliance risks described) and limit the level of resources an entering firm would need to commit before the uncertainty of market attractiveness resolves itself. The entering firm would presumably provide technological expertise and investment in infrastructure establishment or improvement--while capital intensive, this plan also provides flexibility for salvaging the investment if things do not go well. The national partner would most likely provide access to scarce licenses, billing and collections support, and local market knowledge. The choice of the wireless technology limits sunk cost infrastructure investments when compared to other technologies, as most of the capital can be easily removed and redeployed to another country if necessary.


I i

(Dominated points: less commitment and same flexibility)

Point (A): JV with Wireless

Point (B): JV with Satellite \ and Existing Copper Infrastructure \

\ \ \ \

Point (C): JV with Satellite \ an d UnPg raatdreotfu rCe° ppe r - - . , ~

(Dominated points: Z I less flexibility and same commitment) " ~ 1


Fig. 4. Undominated technology-strategy combinations.

The flexibility of the wireless technology allows firms to expand service to a larger pool with only marginal investments. Of course, the firm utilizing this ultimately flexible strategy has pursued flexibility and security of capital investment at all costs, which will result in higher marginal operating costs and exclusion (without further extensive investment) from possible growth in forms of communication that require high bandwidth such as data and video communications. Furthermore, such a firm is demonstrably uncommitted to a continued presence in the market and will thus be expected to face more extensive challenges to their markets from new entrants.

The moderate entry strategy (Figure 4, Point B) involves a joint venture with a partner who has access to or control of extensive existing copper networks. The foreign firm would sharply limit its investments in directly improving this network, instead using either wireless or satellite technologies to bridge gaps in service or provide service to previously unserved geographic regions. Although this hybrid technology would have higher marginal operating costs than copper wire alone, the level of irrevocably sunk investments required would drop dramatically. Furthermore, the firm would always have the option of upgrading the existing copper network with better technology in the future, should the market prove robust and many of the initial risks negated. This moderate strategy signals a significant level of commitment by securing scarce copper network resources (which, once these resources' owners have been partnered with, are presumably not available for other entrants) and provides a cost-effective option for favorable future investment while limiting initial sunkenness. This option, however, may come at a high price: it is doubtful that the national partners would grant exclusive control or partnering rights on their copper networks, provided that they have an alternative, without a guarantee of extensive investment and future upgrading of the network.

In the last and most committed strategy (Figure 4, Point C), the entering firm makes a strong commitment with its national partner to invest in the existing copper


Should Choose (C): Wants Mostly Commitment

/

Should Choose (B): J~ In between ~

Should Choose (A): ~ U \ I Wants Mostly F lex ib i l i ty -~ A

Fig. 5. Decision rule for Russia and Vietnam, based on the slope of the flexibility-commitment preference line.

network as demand necessitates, with the understanding that the foreign firm will have exclusive rights for partnering on this network. This agreement results in joint ownership of the network, providing the foreign firm with access to a low-operating-cost network that would be able to meet many of the communication demands in the near future, as well as an unlimited option for future expansion. The national firm in return would have access to capital, as well as technological expertise, to improve the network and expand service. Given that the average Russian cellular user places more than 400 minutes a month of cellular phone calls due to the unreliability of the copper network [14], one would expect some of the cellular traffic to move to the lower cost upgraded copper network once efficiency and reliability increase. Of course the super-committed strategy also exposes the entrant to greater risk, as it assumes that the market will turn out favorably and seeks to deter entry at all costs. While the entering firm will capture 100% of the market, this will be of small comfort if total demand turns out to be miniscule. Accurate forecasts of unserved demand are paramount in this scenario (as opposed to the other scenarios, which allowed the firm to learn as they went, while present in the country). The committed strategy also requires extensive sunk investments that are subject to renegotiation or nationalization.

A company with a very steep (nearly vertical) preference line will be willing to give up flexibility to gain commitment and end up choosing Point C. Rotating the vertical preference line counterclockwise will eventually cause firms who prefer Point B to choose Point C; continuing this rotation will identify firms that prefer Point A. It is the arc in which the preference line through which the origin lies that determines the optimal choice of technology, as shown in Figure 5.

Moreover, much of the preference for flexibility in a particular market was caused by a company's exposure to expropriation or nationalization. Reducing the exposure of capital, however, reduced commitment to a particular market. How can a firm desiring a more committed strategy protect itself from this exposure? It is by definition impossible to do so in any particular market without giving up commitment, provided that the technology chosen is on the efficient frontier. However, if a well-capitalized firm utilizes a portfolio approach toward these investments undertaken simultaneously in multiple


2 ,<

ft.

Point (A): "" "- % o JV with Wireless "-- -.. o~

\ ~o

and Upgrade of Copper~ _ \ Infrastructure ' ' " ~ l


Fig. 6. Blockaded entry.

countries, it can achieve a level of diversification that mitigates the harm that these exposures pose to its overall capital base. In either the highly flexible/low-commitment or the high-commitment/low-flexibility strategies, the firm can synthesize a portfolio that provides an overall higher level of commitment and flexibility than could be achieved by any singular telecom investment.

Finally, it should be noted that some markets are simply not attractive to enter, even using the best technology on the efficient frontier, by virtue of having extraordinarily low potential or a robust incumbent who adequately serves the market (a condition known as "blockaded entry," in which the market can support one provider but not two). In these markets, all strategy-technology combinations will fail to yield a point that is dominant over the status quo, as shown in Figure 5. It may even be the case that entry is blockaded despite the fact that the incumbent 's technology had entailed significant sunk costs uncompensated by flexibility (i.e., the incumbent 's technology is not even on the efficient frontier). While the market is large enough for one inefficient firm, it is not large enough for one inefficient firm and a new entrant, and it is impossible to drive the inefficient incumbent out. In these cases, it is best for the firm to forego any entry into this market for now; instead, a potential entrant must wait until advances in technology expand the efficient frontier to a degree that some entry strategies will be profitable. As can be seen in Figure 6, Point B is almost profitable now but not profitable enough to make entry attractive.

Conclusions and Topics for Further Analysis In this article, we have proposed a decision-making framework for combining

technology with entry strategies, aimed at balancing flexibility and commitment, when considering entry into emerging telecom markets. We believe that the proposed method-


ology could be extended to include a more rigorous ordinal ranking of technologies in terms of flexibility and commitment and a more complete ranking of entry strategies that are not purely greenfield, joint venture, or acquisition. Specifically, supplementing our ordinal rankings with some form of cardinal methodology (e.g., "percentage of capital commitment that is salvageable" as a proxy for flexibility; "cost to an entrant to duplicate our capabilities" as a proxy for commitment) would make specific applications more robust.

Furthermore, a more complete treatment of the pairings of technology options and entry modes, including interaction between technology and entry mode strategies based on a portfolio of projects rather than considering a single project in isolation, would be useful. Lastly, an exploration of the process a firm utilizes to form the slope of its risk preference line when considering a particular entry project as part of a portfolio would be rewarding. It is conceivable, for example, that a well-diversified investor could choose many independent low-flexibility/high-commitment projects to create a high- flexibility/high-commitment portfolio, provided that the initial amount that was to be invested was large enough to overcome the inevitable project failures without exhausting all available capital. In any event, the framework of an efficient frontier of flexibility and commitment ought to suggest that 100% flexible technologies may not be ones to choose if sustainable profitability is sought, simply because of their inherent lack of commitment value.

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UK, 1984. 3. Ghemawat, P.: Sustainable Advantage, Harvard Business Review Sep. Oct., 53-58 (1986). 4. Clemons, E. K., Croson, D. C., and Weber, B. W.: Market Dominance as a Precursor of a Firm's Failure,

Journal c~f Management Information Systems 13(2), 59-75 (1996). 5. Fox, J. F.. and Ashurkov. V. L.: Flexibility and Commitment in Emerging Telecommunications Markets,

Working Paper, Emerging Technologies Management Research Program. The Wharton School of the University of Pennsylvania, 1996.

6. Brealey, R. M., and Myers, S. C.: Principles of Corporate Finance. 5th ed., McGraw-Hill, New York, 1996. 7. Dixit, A. K., and Pindyck, R. S.: Investment under Uncertainty, Princeton University Press, Princeton,

N J, 1994. 8. Ghemawat, P.: Commitment: The Dynamic of Strategy. Maxwell Macmillan International, New York, 1991. 9. Thaler, R. H.: The Winner's Curse: Paradoxes and Anomalies o( Economic Life. Princeton University

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Received 22 October 1996; accepted 25 June, 1997

flexible entry strategies for emerging telecom markets

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