Modes of International Business

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International Business Session - 6 Date: 18.08.2011:

International Business Session - 6 Date: 18.08.2011 Modes of International Business By Prof. Rakhi R. Shrivastava

Session Objectives:

Session Objectives After this session you will be able to comprehend: The factors influencing the choice of a particular mode of international Business The features, merits and demerits of direct and indirect trade as well as counter trade. Various forms of contractual entry mode Distinction between foreign direct investment and foreign portfolio investment Nature and forms of mergers and acquisitions and the motivation behind such moves A comparative picture of trade vs FDI Comparison between FDI and contractual entry mode Comparative analysis of green field investment and mergers and acquisitions.

Determinants of Entry Mode:

Determinants of Entry Mode A firm adopts various modes for its entry into business transaction across borders. Which mode a firm should adopt depends at least upon four factors. The are Subservience of corporate objectives Corporate capability Host country environment Perceived Risk ( Firm would prefer to expand internationally only if the benefits surpass the anticipated risks

Types of Entry Mode:

Types of Entry Mode

Trade Mode:

Trade Mode

1. Exports:

1. Exports

1. Exports: Classification of Exporters:

1. Exports: Classification of Exporters

2. Counter Trade::

2. Counter Trade:

2. Counter Trade: (1. Pure Barter):

2. Counter Trade: (1. Pure Barter) Eg: Russia supplied news print and crude oil to India for decades and in turn India supplied tea, garments, medicines and tobacco products to Russia at a comparatively low price, so both the countries enjoyed advantage .

Counter Trade: (2. Buy back Agreements):

Counter Trade: (2. Buy back Agreements) It is a form of industrial counter trade. A buy back is an arrangement by which the home country representative sets up a project in the host country, which has sufficient foreign exchange reserves to fully pay the supplier for the project. Normally the counter period is for long term varying form 10 to 20 years. The project amount is paid partially in foreign exchange and the remaining amount is paid in kind. Usually the home country purchases the end product of the same project at a comparatively low price. This can be sold in the home country or could be diverted to a third country in order to maximize the profit margin.

Slide 11:

Eg. Bharat heavy Electricals (BHEL) sets up projects in other countries. It gets partial payments in foreign exchange and for the balance amount it takes back tankers from the host country and market them in any other country as well as sell in India at higher prices. Counter Trade: (2. Buy back Agreements) … cont…

Counter Trade: 2. Buy back Agreements:

Counter Trade: 2. Buy back Agreements Another example is from UNECE: In 1970s, Austria used to sell pipeline equipment related material to the then soviet union so that latter could develop certain gas fields and could pipe a part of the output back to austria. In case of developing countries, such contracts arrangements are common as they suffer from technology gap on large scale.

Counter Trade: 3. Counter Purchase Agreement:

Counter Trade: 3. Counter Purchase Agreement This is a method wherein company A from Country A supplies product X to Country B. Country B which has a surplus of product Y, compensates by supplying it to company A, which finds a market for product Y in country C. Country C sells the product z to country D which has sufficient foreign exchange to pay for it. Country D can then pay country C, and finally, country A collects payment routed through companies B & C. Thus purchasing takes place against supply until a country with foreign exchange reserves is found for transactions. Many multinational companies use this system to make large amount of money at every stage of the transaction.

Counter Trade: 4. Develop-for-import Arrangement:

Counter Trade: 4. Develop-for-import Arrangement Develop for import arrangements are also a type of buyback arrangements where the exporter of plant and machinery participate in the capital of the importing firm and takes the share in the profit. The role of exporter is much more here than in general buyback agreements.

Counter Trade: 5. Frame-Work agreement:

Counter Trade: 5. Frame-Work agreement Frame work Agreements are the long term protocol or bilateral clearing agreement normally concluded between government. Trade is balanced after a long period of time as mentioned in the agreement. If the trade is not equal in value, the debtor sells the agreed upon commodity in the international market and the creditor is paid off. For example- Mexico sold cocoa to the United States of America to pay off its excess import from Malaysia (Far Eastern Economic Review, 1983)

Merits of Counter Trade: :

Merits of Counter Trade: Bilateral or counter trade has various advantages: A good option for meeting import requirements Helps stabilize the export earnings because it predetermines the size of export and import. Helps stabilize the terms of trade Due above two it encourages stability in the development process. Helps in trade diversification It augments the flow of technology to the developing countries It is long term in nature so provides other facility also. It reduces the net currency outflow and recovers the foreign exchange problems Helps in correcting distortion in exchange rate policies.

Demerits of Counter Trade: :

Demerits of Counter Trade: Bilateral or counter trade has various disadvantages: It is against multilateral trade Can no control distortion completely Difficult to sell products are sometimes traded. Balancing of trade poses serious problems.

Contractual Entry Modes:

Contractual Entry Modes

Contractual Entry Modes 1.INTERNATIONAL LICENSING :

Contractual Entry Modes 1.INTERNATIONAL LICENSING International licensing is an agreement between the (licensor- generally a well developed company) and the licensee (can be its own unit located as subsidiary or a firm located abroad) over a period of time for the use of its intangible property like brand name, marketing, know-how, blue print, copyright, work method, technology and manufacturing designs and trademark by paying a license fee. For example the British American Tobacco Company (BATS) has given licenses in many countries for the manufacture of their brand of cigarettes “555”. In India ITC is licensed producer of “555”. Pepsi Cola provided a license to Heineken of the Netherlands, giving them exclusive right to produce and sell Pepsi Cola in Netherlands.

Contractual Entry Modes 1.INTERNATIONAL LICENSING :

Contractual Entry Modes 1.INTERNATIONAL LICENSING Involvement of licensor is very less in day to day functions so returns are comparatively low. Licensing works on specific conditions like specific territory and specific time period of license. The licensor is entitled for such permission after the establishment of commanding position globally and has a brand command.

Contractual Entry Modes 1.INTERNATIONAL LICENSING Types of License:

Contractual Entry Modes 1.INTERNATIONAL LICENSING Types of License

Contractual Entry Modes: 2. FRANCHISING:

Contractual Entry Modes: 2. FRANCHISING It is a type of licensing. In this form of technical collaboration, the franchiser is the entrant and the franchisee is the host country entity. Here the franchiser exercises more control over franchisee. The franchisor supplies the main part of the product, and provides the following services to franchisee: Trade marks Operating Systems Product Brand name, managerial assistance, geographic exclusivity or specific set of procedures of the franchisor for creating the product in question.

Contractual Entry Modes 2. FRANCHISING:

Contractual Entry Modes 2. FRANCHISING

Contractual Entry Modes: 2. FRANCHISING:

Contractual Entry Modes: 2. FRANCHISING Company support systems such as advertising, training employees and quality assurance are also involved in franchising. McDonalds, Dairy Queen, Domino’s Pizza and KFC are well known franchisee brands. NIIT and APTECH have also appointed franchisee in Africa, Southeast Asia, Gulf countries and China. Hotel Hilton and Marriott are well known in operators in the hotel sector. Jatia in India are the national franchisee of McDonalds. All the investments on premises, HR, operations and promotions are totally borne by the franchisee. The objective of franchisor is to maintain an standard through out the world in terms of quality, brand logo and symbol, but the product is adaptable depending on the socio-cultural background of the country.

Contractual Entry Modes: 3. MANAGEMENT CONTRACTS:

Contractual Entry Modes: 3. MANAGEMENT CONTRACTS Companies with low level of technology and managerial expertise may seek the assistance of foreign countries. A management contract is an agreement between two companies whereby one company provides managerial and technical assistance for which proper monetary compensation is given either as a flat, lump-sum fee, a percentage of sales or a share in profits. For example Delta Airline, Air France and KLM offer such services in developing countries. Exxon is a major operator in the gulf region in the field of oil exploration.

Contractual Entry: 4. CONTRACT MANUFACTURING:

Contractual Entry: 4. CONTRACT MANUFACTURING Many companies outsource their products and concentrate mainly on marketing operations . It is the strategy to identify a manufacturing unit to produce items at a competitive price in any part of the world. For example Nike id procuring its athletic footwear in number of factories in South Asia. Contract manufacturing with dimension in service sector offers ample opportunities for Indian Companies in the form of Business process Outsourcing ( BPO) and Knoledge Process Outsourcing ( KPO)

Contractual Entry Modes; 4. CONTRACT MARKETING:

Contractual Entry Modes; 4. CONTRACT MARKETING Company strong in manufacturing may not be strong in marketing its products. These companies deal with marketing and retail outlets around the world such as TESCO, MACY’s K Mart, Wal Mart etc. Such manufacturing units enter into a marketing agreement and concentrate more on the production at low manufacturing costs. Thermal and ION exchange Many India companies are contract marketer for German based medical equipments.

Contractual Entry: Modes: 5. TURNKEY PROJECTS:

Contractual Entry: Modes: 5. TURNKEY PROJECTS A turnkey project is an agreement where a company agrees to construct the entire project from concept to completion. It covers everything from the supply of manpower and capital the erection of a plant as well as the installation and commissioning to the trial operation of a project. The turn key project contractors either get a fixed fee or the cost plus profits are collected over a period of time. Today, infrastructure projects such as power plants, airports, refineries, railway stations, highways and dams are constructed on turnkey basis. For example: Bechtel, Brown Bovary, Hyundai, Mitsubishi, L&T and Daewoo are turnkey contractors for international projects. Them used by these companies are ( BOT - build, Operate and Transfer) and BOOT - Build, Own, Operate and Transfer).

Contractual Entry Modes 5. TURNKEY PROJECTS:

Contractual Entry Modes 5. TURNKEY PROJECTS Advantages: Turn key projects allows firms to specialize in their core competencies which they could not have done in the absence of such contracts. Such contracts allow the host govt to obtain world class designs for its infrastructure projects.

Foreign Investments:

Foreign Investments

Foreign Direct Investments:

Foreign Direct Investments The flow of funds from one destination to another is called investment. Companies that are constantly involved in international business invest their money in manufacturing and marketing bases through ownership. Currently every developing country is formulating strategies by offering ample amounts of incentives to attract investments. FDI contributes to optimization of resources in the host countries, generating employment opportunities and enhancing the standard of living in the host country. The major development in the host countries is due to increased FDI. FDI can take place in the following forms:

Foreign Direct Investments:

Foreign Direct Investments

Foreign Investments: 1. JOINT VENTURE:

Foreign Investments: 1 . JOINT VENTURE Two or more firms join together to create a new business entity that is legally separate and distinct from its parent company. JV are established as corporations and owned by funding partners in the predetermined proportions. A joint venture is a binding contract between two venture partners to set up a project either in the home country, a host country or a third country. In this case both parties are committing to joint risk taking and joint profit sharing. For example the Taj group of Hotels had joined ventures in Russia for setting up five star hotels during 1980s.

Slide 34:

Maruti Suzuki, Mahindra Renault etc. Kinetic Honda, Hero Honda are other example of Joint Venture. One more example is American Motor Corporation entered into a joint venture with Beijing Automotive Works called Beijing Jeep to enter Chinese Market by producing jeeps and other vehicles. Foreign Investments: 1 . JOINT VENTURE… cont…

Foreign Investments 1. JOINT VENTURE- Advantages:

Foreign Investments 1 . JOINT VENTURE- Advantages JV provides large capital funds. JV are suitable for major projects. JV involve shred ownership so risk also spreads between and among partners. A place for different kinds of skills JV makes large projects and turnkey projects feasible and possible. JV provides synergy due to combined efforts of varied parties.

Foreign Investments 1. JOINT VENTURE- Disadvantages:

Foreign Investments 1 . JOINT VENTURE- Disadvantages JV are potential for conflicts Delay in Decision making due to varied interest and disputes. This leads to inefficient operations. Possibility of collapse of JV is more due to entry of competitors, changes in the business environment in the two countries and change in the partners’ strength.

Foreign Investments 2. COLLABORATION:

Foreign Investments 2. COLLABORATION While a joint venture deals with the complete project in financial terms and with proportionate partnership commitments, A collaboration deals only with some functions. For example Bajaj Auto has a collaboration with Kawasaki of Japan who offers technology for two wheelers.

Foreign Investments 4. MERGERS AND ACQUISITIONS:

Foreign Investments 4. MERGERS AND ACQUISITIONS In this case a company in the host country (domestic company) selects a foreign company and merges itself with the foreign company in order to enter international business. May purchase the foreign company and acquires its ownership and control. The examples are Arcelor – Mittal steel, Cementos Mexicanos, Acquisition of Petron Corporation – the largest petrolium refinery in Philippines and Ssangyong Oil Refining Company of South Korea by Saudi Arabia’s Government.

Foreign Investments 4. MERGERS AND ACQUISITIONS:

Foreign Investments 4. MERGERS AND ACQUISITIONS Why IB through M&A activities? It provides immediate access to international manufacturing facilities and marketing network. For example Proctor and Gamble entered Mexican Tissue products in 1997 by purchasing Loreto Y. Pena Prober's manufacturing and marketing systems. The company immediately gets ownership and control over the acquired firm’s factories, employees, technology, brand names and distribution networks. The company can formulates international strategy and generate more revenues. If the company has already reached at the stage of the optimum or over capacity level in the host country, this strategy helps the economy of host country.

Foreign Investments Major MERGERS AND ACQUISITIONS in india:

Foreign Investments Major MERGERS AND ACQUISITIONS in india Acquirer Target Company Country targeted Deal value ($ mn ) Industry Tata Steel Corus Group p1c UK 12,000 Steel Hindalco Novelis Canada 5,982 Steel Videocon Daeboo Electronics Corp. Korea 729 Electronics Dr. reddy’s Labs Betapharm Germany 597 Pharmaceutical Suzlon Enercy Hansen Group Belgium 565 Energy HPCL Kenya petroleum Refinery Ltd. Kenya 500 Oil and gas Ranvexy labs Tarapia SA Romania 324 Pharmaceutical Tata Steel Natsteel Singapore 293 Steel Videocon Thomson SA France 290 Electronics VSNL Teleglobe Canada 239 Telecom

Foreign (FDI) Entry Decision:

Foreign (FDI) Entry Decision

Comparison of Different Modes of Entry:

Comparison of Different Modes of Entry Mode Primary Advantages Primary Disadvantages 1. Exporting Relatively low financial exposure Permit gradual market entry Acquire knowledge about local market Avoid restrictions on foreign investment Vulnerable to tariffs and NTBs Logistical complexities Potential conflicts with distributors. 2. Licensing Low financial risks Low cost way to assess market potential Avoid tariffs, NTBs, restrictions o foreign investments Licensee provides knowledge of local markets Limits market opportunities / profits Dependence on License Potential conflict with licensee May be creating future competitor

Comparison of Different Modes of Entry:

Comparison of Different Modes of Entry Mode Primary Advantages Primary Disadvantages 3. Franchising Low financial risks Low cost way to assess market potential Avoid tariffs, NTBs, restrictions o foreign investments Maintain more control than licensing Licensee provides knowledge of local markets Limits market opportunities / profits Dependence on License Potential conflict with Franchisee May be creating future competitor 4. Contract manufacturing Low financial risks Minimize resources devoted to manufacturing Focus firm’s resources on other elements of the value chain Reduce control (may affect quality, delivery schedules etc.) Reduced learning potentials Potential public relations problems may need to monitor working conditions etc.

Comparison of Different Modes of Entry:

Comparison of Different Modes of Entry Mode Primary Advantages Primary Disadvantages 3. Management Contract Focus firm’s resources on its area of expertise Minimum financial exposure Potential returns limited by contracts May unintentionally transfer proprietary knowledge and techniques to contract. 4. Turnkey projects Focus firm’s resources on its area of expertise Avoid all long term operational risks Bear financial risk ( cost overrun etc) Bear construction risk ( delay, problems with suppliers) 5. Foreign Direct Investment High profit potential Maintain Control over Operations Acquire Knowledge of local market Avoid tariffs and NIBs High financial and managerial investments High exposure to political risk. Vulnerable to restrictions on foreign investment Greater managerial complexity

Functional Alliances:

Functional Alliances