Modes of Internationalization

Entry Mode Selection

• Choice of entry mode for business depends to a large extent on the degree of involvement, a firm wants to have.

• International entry strategies concern with Location selection, timing of entry, and entry mode selection and investment pattern.

• These entry strategies are important because they determine an MNE’s investment environment, operations treatment, resource commitment and evolutionary path.

Entry Mode ChoicesMODES OF FOREIGN ENTRY

TRADE RELATED MODE CONTRACTUAL MODE INVESTMENT MODE

EXPORT AND IMPORT LEASING FOREIGN DIRECT INVESTMENT

COUNTER TRADE LICENSING FOREIGN PORTFOLIO INVESTMENT

•BARTER•COUNTER PURCHASE•OFFSET•BUYBACK

FRANCHISING

TURNKEY PROJECTS

Entry Mode Choices

• Entry modes are specific forms or ways of entering a target country to achieve strategic goals in that country.

• Entry mode choices fall into three categories :1. Trade related2. Transfer related3. Investment related

• Along this sequence, the level of resource commitment, organizational control, involved risks and expected returns all increase.

Trade Related Entry Modes

• It includes • exporting,• countertrade

Export and Import

• It is the first step towards international exposure a firm takes.

• Under it the firm maintains the production facilities at home and sells its products abroad.

• Exporting is a type of international entry open to virtually all kinds and size of firms, unlike other types of entry modes which require greater resources and involve more risks.

• Goods can be exported directly to foreign customers or buyers or through export intermediaries.

• These are the third parties that specialize in facilitating imports and exports.

• The scope of their functions can be limited only to transportation, handling of documents and custom claims ,

• or they may perform more extensive services, including taking ownership of foreign bound goods or assuming total responsibility of marketing and financing exports.

• Managers involved in exporting must know the terms of sale.

• Terms of sale are conditions stipulating rights/responsibilities and costs/risks borne by the exporter and importer.

• These terms are defined by International Chamber of Commerce as standards, and are widely used in export transactions. Some of these are :

• FOB (Free on Board) : A term of price in which the seller covers all costs and risks up to the point whereby the goods are delivered on board the ship in a designated shipment, and the buyer bears all the cost and risks from that point on.

• FAS (Free Alongside Ship) : A term of price in which the seller covers all costs and risks up to the side of the ship in a designated shipment port.

• The buyer bears the risk there after.• CIF (Cost, Insurance, and Freight): A term of price

in which the seller covers cost of the goods, insurance and all transportation and miscellaneous charges to the named foreign port in the country of final destination

• C & F ( Cost and Freight) : Similar to CIF except that the buyer purchases and bears the insurance.

Counter Trade

• Countertrade is a form of trade in which a seller and a buyer from different countries exchange merchandise with little or no cash equivalents, changing hands.

• Countertrade can be categorized as four distinct types of trading arrangements

• Barter• Counter Purchase• Offset• Buyback

• Barter is the direct and simultaneous exchange of goods between two parties without a cash transaction.

• Barter trade occurs between individuals, between governments, between firms or between a government and a firm, all from different countries.

Counter Purchase

• A counter purchase is a reciprocal buying agreement whereby one firm sells its products to another at one point in time and is compensated in the form of the other’s products at some future time .

• Eg. Russia purchased construction machinery from Japan’s Komatsu in return for Komatsu’s agreement to buy Siberian timber).

Offset

• An offset is an agreement whereby one party agrees to purchase goods and services with a specified percentage of it proceeds from an original sale.

• Unlike counter purchase whereby exchanged products are normally unrelated , products taken back in an Offset are often the outputs processed by this party in the original contract.

• For eg., the Shanghai aircraft Manufacturing Corp. China may buy jets from Boeing using the proceeds from manufacturing the tail sections of the jets for Boeing.

• Offsets is particularly popular in sales of expensive military equipment or high cost civilian infrastructure.

Buyback

• Occurs when a firm provides a local company with inputs (mostly capital inputs) for manufacturing products to be sold in international markets, and agrees to take a certain percentage of the output produced by the local firm as partial payment.

• Helpful for developing economy producers in upgrading technologies and machinery .

Contractual Entry Modes

• Associated with transfer of ownership or utilization of specified property from one party to the other in exchange for royalty fees.

• These modes are extensively employed in technology-related or intellectual/industrial property rights related transactions.

• This category includes the following entry modes : • International Leasing• International Licensing• International Franchising• Turnkey Projects

International Leasing

• A foreign firm (lessor) leases out its new or used machines or equipment to the local company (often in a developing country).

• In this mode, the foreign lessor retains the ownership of the property throughout the lease period during which the local user pays a leasing fee.

International Licensing

• International Licensing is an entry mode in which a firm transfers it intangible property such as expertise, know-how, blueprints, technology and manufacturing design to its own unit or to another firm for a specified period of time in exchange for a royalty fee.

• Licensing allows the licensee to produce and market a product similar to the one the licensor has already been producing in its home country without requiring the licensor to create a new operation abroad.

• Licensing may be of the following types :1. Exclusive – an exclusive license is the right to

produce or market a product using specific technology in a given geographical region only.

2. Non Exclusive – a non exclusive license does give single firm exclusive rights to a technology. It may have to be shared with other firms in the same region.

3. Cross Licensing – is a reciprocal agreement in which intangible property is transferred between two parties making them licensor and licensee simultaneously.

International Franchising

• Foreign franchisor grants specified intangible property rights (e.g., trademark or brand name) to the local franchisee, who must follow strict and detailed rules as to how it does business.

• Production Equipment, managerial systems, operating procedures, access to advertising and promotional materials, loans and financing may all be part of a franchise.

Turnkey Projects

• Also called Build-operate-transfer (BOT) is an investment in which a foreign investor assumes responsibility for the design and construction of an entire operation, and upon completion of the project, turns the project over to the purchaser and hands over management to local personnel whom it has trained.

Investment Related Entry Modes

• Involves ownership of property, assets, projects and business invested in a host country.

• Takes two forms : foreign direct investment (FDI) and Foreign portfolio investment (FPI)

Foreign Direct Investment

• Refers to the investment in the assets of a company for purpose of control.

• Firms undertaking FDI will control overseas operations and economic activities.

• FDI- related entry modes are sophisticated, involves higher risk and longer term contribution than both trade and transfer-related modes choices.

• Underlines the firm’s long-term strategic goals of international presence and require a continuous contribution and commitment to investments and operations abroad .

• The country making the FDI investment is called the home country and the country receiving FDI is called the host country.

Foreign Portfolio Investment

• Investment in financial instruments such as stocks and bonds through the stock exchange and other financial markets only to earn return on investment.

• To understand foreign portfolio investment, one needs to know portfolio theory.

• Portfolio theory describes the behavior of individuals or firms which invests in large amount of financial assets in search of the high returns.

Differences between FDI and FPI

• FDI investment is done to gain controlling interest or ownership in a foreign company. Whereas FPI is only targeted at earning returns from the investment.

• FDI is considered to be more stable form of investment, FPI is more volatile and easy exits are possible.

• FDI brings with it the spill over effects of technology and managerial expertise leading to a competitive environment and increased consumer welfare. FPI helps to increase both the width and depth of host country financial markets and thereby contributes to financial development.

Portfolio Investments in India

• Indian Stock Market was opened up to FII investment in 1992-93 and since then there has been a significant increase in the portfolo investment by FIIs.

• The decision to open the economy portfolio investment rested on the following 2 considerations :

1. Flow of foreign equity would help in developing the domestic equity market, by bringing in the world’s best practices and stimulating competition.

2. Foreign equity would act as a window to the world and disseminate and spread knowledge about investment opportunities available in India.

Euro/ADR issues

• Since 1992-1993, Indian companies satisfying certain conditions, have been allowed to access foreign capital markets through Euro-issues of Global Depository Receipt (GDRs) and Foreign Currency Convertible Bonds (FCCBs).

• A Depository Receipt (DR) is basically a negotiable certificate , denominated in US dollars, that represents a non-US company’s publicly-traded local currency (INR) equity shares.

• DRs are created when the local currency shares of an Indian company (for e.g.) are delivered to the depository’s local custodian bank, against which the Depository Bank issues DRs in US dollars.

• The DRs may trade freely in the overseas markets.

• The prefix global implies that the ADRs are marketed globally rather than in a specific country or market.

Factors Determining Entry Mode

Country-Specific Factors• Government FDI Policy• Infrastructure Conditions• Legal framework and property right

framework in host country.• Political risks• Cultural Distance

Industry-Specific Factors• Entry Barriers into the target industry• Industrial uncertainty and complexibility• Availability and favorability of supply and distribution

in the industry.Firm-Specific Factors• Resource possession (technological, organizational,

operational and financial) influences the firm’s ability to explore market potential.

• Risk of piracy and leakage of technologies• Firms strategic goals for international expansion• International or host country experience

Project-Specific Factors• Project Size• Project Orientation• Availability of Local Partners