Chapter 14 Outline

Selecting an Entry Mode

As the preceding discussion demonstrated, there are advantages and disadvantages associated with all the entry modes; they are summarized in Table 14.1. Due to these advantages and disadvantages, trade-offs are inevitable when selecting an entry mode. For example, when considering entry into an unfamiliar country with a track record for nationalizing foreign-owned enterprises, a firm might favor a joint venture with a local enterprise. Its rationale might be that the local partner will help it establish operations in an unfamiliar environment and will speak out against nationalization should the possibility arise. However, if the firm's core competence is based on proprietary technology, entering a joint venture might risk losing control of that technology to the joint venture partner, in which case the strategy may seem unattractive. Despite the existence of such trade-offs, it is possible to make some generalizations about the optimal choice of entry mode. That is what we do in this section.²⁰

Core Competencies and Entry Mode

We saw in Chapter 12 that firms often expand internationally to earn greater returns from their core competencies, transferring the skills and products derived from their core competencies to foreign markets where indigenous competitors lack those skills. We say that such firms are pursuing an international strategy. The optimal entry mode

Table 14.1

Advantages and Disadvantages of Entry Modes

Entry Mode		Advantage		Disadvantage
Exporting		Ability to realize location and experience curve economies		High transport costs Trade barriers Problems with local marketing agents
Turnkey contracts		Ability to earn returns from process technology skills in countries where FDI is restricted		Creating efficient competitors Lack of long-term market presence
Licensing		Low development costs and risks		Lack of control over technology Inability to realize location and experience curve economies Inability to engage in global strategic coordination
Franchising		Low development costs and risks		Lack of control over quality Inability to engage in global strategic coordination
Joint ventures		Access to local partner's knowledge Sharing development costs and risks Politically acceptable		Lack of control over technology Inability to engage in global strategic coordination Inability to realize location and experience economies
Wholly owned subsidiaries		Protection of technology Ability to engage in global strategic coordination Ability to realize location and experience economies		High costs and risks

for these firms depends to some degree on the nature of their core competencies. A distinction can be drawn between firms whose core competency is in technological know-how and those whose core competency is in management know-how.

Technological Know-How

As was observed in Chapter 6, 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. Thus, if a high-tech firm sets up operations in a foreign country to profit from a core competency in technological know-how, it will probably do so through a wholly owned subsidiary.

This rule should not be viewed as hard and fast, however. One exception is when a licensing or joint venture arrangement can be structured so as to reduce the risks of a firm's technological know-how being expropriated by licensees or joint venture partners. We will see how this might be achieved later in the chapter when we examine the structuring of strategic alliances. Another exception exists when a firm perceives its technological advantage to be only transitory, when it expects rapid imitation of its core technology by competitors. In such cases, the firm might want to license its technology as rapidly as possible to foreign firms to gain global acceptance for its technology before the imitation occurs.²¹ Such a strategy has some advantages. By licensing its technology to competitors, the firm may deter them from developing their own, possibly superior, technology. Further, by licensing its technology, the firm may establish its technology as the dominant design in the industry (as Matsushita did with its VHS format for VCRs). This may ensure a steady stream of royalty payments. However, the attractions of licensing are probably outweighed by the risks of losing control over technology, and thus licensing should be avoided.

Management Know-How

The competitive advantage of many service firms is based on management know-how (e.g., McDonald's). For such firms, the risk of losing control over their management skills to franchisees or joint venture partners is not that great. These firms' valuable asset is their brand name, and brand names are generally well protected by international laws pertaining to trademarks. Given this, many of the issues arising in the case of technological know-how are of less concern here. As a result, 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 the controlling subsidiaries. A joint venture is often politically more acceptable and brings a degree of local knowledge to the subsidiary.

Pressures for Cost Reductions and Entry Mode

The greater the pressures for cost reductions are, the more likely a firm will want to pursue some combination of exporting and wholly owned subsidiaries. By manufacturing in those locations where factor conditions are optimal and then exporting to the rest of the world, a firm may be able to realize substantial location and experience curve economies. The firm might then want to export the finished product to marketing subsidiaries based in various countries. These subsidiaries will typically be wholly owned and have the responsibility for overseeing distribution in their particular countries. Setting up wholly owned marketing subsidiaries is preferable to joint venture arrangements and to using foreign marketing agents because it gives the firm the tight control over marketing that might be required for coordinating a globally dispersed value chain. It also gives the firm the ability to use the profits generated in one market to improve its competitive position in another market. In other words, firms pursuing global or transnational strategies tend to prefer establishing wholly owned subsidiaries.