3Market Entry Strategies

3.1About Strategy and Internationalization

The term strategy goes back to Chandler, who defined strategy ‘as the determination of the basic long-term goals and objectives of an enterprise and the adoption of courses of action and allocation of resources necessary for carrying out these goals’ (Chandler, 1962: 23). Consequently, strategic management is a set of managerial decisions and actions that determine the long-run performance of a firm. Therefore, strategic management emphasizes monitoring and evaluating of external opportunities and threats in light of an organization’s internal resource strengths and weaknesses. The strategy of a corporation involves a comprehensive master plan stating how the corporation will achieve its mission and objectives and maximize its competitive advantages (Wheelen & Hunger, 2010: 53, 67). The concept of strategic management is focused primarily on the development of long-term corporate success. Strategies, due to external or internal circumstances, sometimes cannot be realized as planned. In this case, the strategy needs to be modified. Emergent and deliberate strategies create the firm’s realized strategy (Mintzberg, Lampel, Quinn, & Ghoshal, 2003: 5). Strategy indicates a complex bundle of planned activities for the attainment of long-term business objectives that also should consider emergent decision and action patterns. Optimal allocation of the firm’s entrepreneurial and management capabilities is of vital importance for effective strategy implementation (Kutschker & Schmid, 2006: 798).

Larger firms, such as multinational enterprises, usually follow three types of strategies that are hierarchically linked to the firm’s corporate level, strategic business unit (SBU) level, and functional (department) level. On the top management level (corporate level), there are directional strategies that can be categorized as growth, stability, and retrenchment strategies. A growth strategy, as the term itself indicates, is launched in order to increase the firm’s turnover and profits through expansion. A stability strategy is implemented after the acquisition of another firm, so organizational integration of the acquired business activities is required. A retrenchment strategy is realized through the shutdown or outsourcing of businesses that continuously accumulate losses, and there is little hope that these poorly performing business units will recover in the future.

In more detail, growth strategies are realized by expanding business activities in the current industry through enlargement of the current product portfolio or manufacturing depth (horizontal, vertical, backward, or forward integration) in related industries (concentric diversification) or in unrelated industries (conglomerate diversification). Porter’s concept of competitive strategies, such as cost leadership, differentiation, and niche strategies, is found in the firm’s strategic business units (SBUs) (Porter, 1999: 32–38; Wheelen & Hunger, 2010: 67).

Strategies on the functional level are embedded in the firm’s operating departments, such as purchasing (e.g., parallel or multiple sourcing strategies), marketing strategies (e.g., penetration versus skimming strategy, push versus pull strategy, shower versus waterfall strategy), R&D (technological leadership versus followership strategy), and operations strategies (e.g., individual versus serial production or mass production). A functional strategy implements and realizes directional and business unit strategies by maximizing the firm’s department strengths and effectiveness. Functional strategies are concerned with developing a distinctive competence in order to provide the enterprise and its business units with a competitive advantage (Wheelen & Hunger, 2010: 68).

In light of globalized integrated valued added activities and trade and capital flow patterns, a firm’s growth strategy is often realized through enlargement of its business by means of geographic expansion into foreign markets. As a result, the firm is engaged in internationalization processes because its products and services are transferred across national boundaries. The firm’s management selects the country and relevant actors; where or with whom the transaction should be performed; and the corresponding international exchange transaction modality, which is called a firm’s market entry strategy or, synonymously, market entry mode (Andersen & Buvik, 2002: 347–348). An entry mode refers to the institutional or organizational arrangement chosen by the firm for its business activities in target foreign markets (Hollensen, Boyd, & Ulrich, 2011: 7). The international business activity can range from manufacturing of goods, to servicing customers, to sourcing various inputs (Holtbrügge & Baron, 2013: 239; Welch, Benito, & Petersen, 2007: 18). When entering new markets, the operating management is confronted with various challenges that usually come along with more or less known societal, ecological, economic, legal-political, expertise (S.E.E.L.E), environmental surroundings of the firm. Thus, there should be various advantages from international business activities that cause firms to consider taking the risk of entering foreign markets. What motivates a firm to internationalize? The following are the main reasons.

1. Demand-oriented factors: Foreign market entry because of its attractiveness in terms of market volume and growth rates, which provide additional sales volumes, in addition to (often) saturated home markets.
2. Supply-oriented factors: Access to rare and valuable resources found in foreign markets, such as qualified and motivated employees, raw materials, knowledge, technological expertise, infrastructure, and others.
3. Follow-the-customer necessity: To avoid the risk of being dropped from the procurement list of an important customer, the supplier needs to follow its customer, which is engaged in a foreign target market.
4. Follow-the-competitor necessity: To avoid leaving the competitors either with all the sales opportunities or all the investment benefits provided in a regional industry cluster in foreign markets, the firm must join the competitors in the foreign markets.
5. Financial reasons: To realize the advantages of foreign markets because of investment incentives (tax reductions, subsidies), large multinationals can make use of cross-stock listing, less costly debt financing because of lower interest rates, and the higher liquidity of the foreign markets.

As is clear from the reasons presented above, a firm does not always make its decision about whether, where, and how to internalize independently but often makes the decision as a result of its bilateral relationships with other actors in its relevant industry network.

The strategic decision process in the course of entering foreign markets is relatively complex, and the outcomes of foreign business normally have a vital impact on a firm’s destiny. In other words, the decision regarding the foreign entry mode strategy is one of the most critical for the management. Among others, it is usually costly to change the mode of entry once it is established due to its long-term consequences for the firm (Brouthers & Hennart, 2007: 396; Pedersen, Petersen, & Benito, 2002: 340).

The choice of which foreign country to enter commits a firm to operating in a certain geographical and sociocultural terrain and signals its future strategic intention to customers, suppliers, competitors, and other stakeholder (Ellis, 2000: 443). The portfolio of international market entry strategies can basically be distinguished among contractual forms (e.g., exports, franchising, original equipment manufacturing); cooperative partnerships, such as international joint ventures; and foreign direct investments (e.g., wholly owned subsidiaries). These strategies will be explained in detail in the following sections of the chapter.

3.2Case Study: The Global Strategy Concept of Samsung

Lee Kun-hee, chairman of Samsung Group, and his family own less than 5 percent of the shares of Samsung Electronics directly. Nevertheless, they are able to control Samsung Electronics because of the circular equity structure within Samsung Group, such as Samsung Everland, Samsung C&T, and Samsung Insurance. The total shares in these companies held by Lee and his family are worth about Euro 10 billion (status 2012). Lee and his family exercise absolute management authority (Han, Liem, & Lee, 2013: 4).

Samsung realizes various advantages accruing from these diversified product lines. One obvious benefit is the resulting diversified business risk. Because the company’s products spread out into many fields, it is more effectively able to cope with the ups and downs in particular product markets; and this helps the company to develop its sales performance, which reflects the company’s growth strategy in the global markets. Another advantage is the cross-product component sharing, which is important when different products are converging onto the same platforms (Chen & Li, 2007: 77). Large manufacturing facilitates help spread the costs of research and development and allow realization of overall economies of scale effects.

Successful growth provides the chance to take advantage of the experience curve in order to reduce the per-unit costs of products sold. The sales development of Samsung Group has shown an outstanding sales performance over the last years relative to its competitors. However – for example, compared to the industry benchmark in terms of profit margins, which is currently Apple Inc. (USA) – Samsung’s management has not been able to expand net income with the same growth rates. What might be the reason for this shortfall? First, Samsung is embedded in various and diversified business fields and owns facilities that have enormous fixed costs. Thus, taking the risk of running overcapacities, the firm becomes vulnerable in the case of economic downturns in the worldwide markets. In this situation, Samsung sells its products at relatively marginal price levels in order ‘to feed the production lines’ (bfai, 2007). Second, the electronics industry, which is the core business of Samsung Group, is highly price competitive. Permanent product innovations are necessary to secure the firm’s business destiny for the future. The corresponding investment volume in research and development as well as large-scale manufacturing capacities has been increased in recent years.

There is no doubt – relative to its Japanese rivals, such as Sony, Sharp, and Panasonic – that Samsung has reached a more stable and prospective business performance during the last years. Samsung has concentrated on its core competence, the electronics business. The firm invested early in LCD/ LED displays and smart phone production capacities at a time when the market potential had been neglected by others. In addition, Samsung Electronics has been expanded in several vertically integrated business segments. The complete manufacturing capacities of television sets, semi-conductors, and mobile phones belong to the most important strategic business segments of Samsung (BBC, 2008; Samsung_Electronics, 2008). Samsung’s vertical integration is described in more detail in the following section.

3.2.4The strategy of vertical integration of Samsung Electronics

Samsung Electronics is the flagship company of Samsung Group, which is composed of 516 companies worldwide. Out of 516, 195 are full fledged Samsung Electronics subsidiaries, meaning they are incorporated entities of which Samsung Electronics owns more than a 50 percent share. In addition, Samsung Electronics controls an additional 63 companies that make components for its subsidiaries, although it does not own a majority share in them. Smart phones, television sets, and more than 260 additional products under the Samsung Electronics brand are produced and sold through Samsung Group’s network (Han et al., 2013: 3).

The strength of Samsung Electronics is the company’s efficient use of its worldwide vertically integrated research and development, procurement, manufacturing, and sales network. Vertical integration means a firm utilizes an internal transfer within the organization of intermediate parts that a firm produces for its own use, such as materials, components, semi- or completely assembled products, and services. A firm may integrate backward and start generating value added activities it previously procured from outside suppliers. Alternatively, a firm may integrate forward and start integrating products and services, such as a sales and distribution or after-sales service, in order to be closer to the firm’s customers and their ‘voices’. Both of these processes represent methods of a firm’s growth strategy (Penrose, 1995: 145).

After the Korean Civil War, during the second half of the 1950s, the Korean government started to route Chaebols into particular industries without building the infrastructure of component suppliers or supporting services. Since the Chaebols found it difficult to purchase or otherwise secure the necessary materials and components and the Korean government pushed domestic firms to industrialize, there were clear and seemingly inevitable reasons to integrate vertically. Differences in the Chaebols’ use of vertical integration stem from the distinct characteristics of the industries the conglomerates are involved with (Chang, 2003: 113–118). For example, in the case of smart phones and television sets, Samsung Electronics controls almost all stages from research and development, to manufacture, up to worldwide sales and distribution. In comparison to Western enterprises, such as Philips or Apple, the Korean firm indicates a much deeper grade of vertical integration. Figure 37 illustrates the vertically integrated value added activities of Samsung Electronics regarding a state-of-the art LED television set.

As illustrated above, Samsung Electronics is closely interlinked with Samsung Display, a manufacturer and key supplier of displays for television sets. Samsung Display can rely on Samsung Corning, which produces the screen glass for the displays. Samsung Electro Mechanics delivers components for the display assembly. An LCD/ LED television set is based on a combination of display and semiconductor technology. Firms like Samsung, with a strong background in both display and semiconductor technologies, are in a comfortable position to manufacture state-of-the art television sets (Kim, 1997: 144). Vertical integration helps Samsung maintain better quality control and delivery punctuality than the company could achieve through outsourcing. Furthermore, vertical integration means that the fruits of research and development in one stage of production are more likely to be shared with other stages, thereby increasing the overall competitiveness of both upstream and downstream operations. Nowadays, the main part of Samsung Electronics’ sales is conducted directly with the customers who serve as the firm’s major information source in terms of the design and desired product features. Through its vertical integration, Samsung Electronics is able to launch its products more rapidly on the global markets than most of its competitors (Chang, 2003: 120–121; Kim, 1997: 144; Worstall, 2013).

As illustrated in Figure 38, Samsung Electronics performs well in terms of net sales and net income and is much better positioned than most of its Japanese competitors. Nevertheless, vertical integration also comes along with potential challenges. One of the potential hazards to efficiency comes from vertically integrated suppliers who lack the incentive to be more efficient or innovative because they have captive in-house customers (Mahoney, 1992: 559). This lack of incentive can be severe in the case of Chaebol affiliates because large portions of their sales are transferred internally (Chang, 2003: 122). One’s own component production may be less efficient relative to its procurement from outside supply sources. Internal price discussions can lead to wasted time and effort (Roberto, 2009).

In the worst case, financially troubled affiliates can survive only with support from their parent company, which guarantees production volumes. The internal charges between the company units are higher prices than the market average. To create a homogeneous group culture and facilitate the inter-group transfer of personnel, Chaebols use the same level of benefits for all business units, which are often too generous for poorly performing businesses, and support unprofitable affiliates via various forms of internal transactions (Chang, 2003: 122–123). The permanent challenge for Chaebols like Samsung is favoritism, which leads to buying from within and hinders competition as well as the input of fresh, innovative business ideas from group outsiders. The top management of Samsung obviously recognized this danger and started to run each business unit as a separate profit center, which supports competition with outside suppliers for orders up to a certain budget. In some cases, up to one third or more of product demand is procured from Samsung’s outside sources, even if it could be supplied in-house.

The system of component production and supply for Samsung Electronics is made up of five layers. The first layer is composed of Samsung Group subsidiaries and accounts for around ten percent of the value of the components purchased by Samsung Electronics. The second layer is made up of transnational electronics component suppliers who have independent technical capability. The US-based Qualcomm, which has a CDMA patent, and 3Com, which has a wireless patent, are examples of companies in this layer. The third layer comprises suppliers to which Samsung Electronics outsources parts production that it could produce by itself but chooses not to for cost or production capacity reasons. These companies – such as Taiwanese AU Optronics for example – supply small-scale LCD panels. The fourth layer is composed of domestic subcontractors that supply parts that Samsung Electronics could not produce itself, such as mobile phone cases manufactured by Intops LED Company Ltd. The final layer in the supply chain is composed of smaller low-cost parts (Han et al., 2013: 6).

Samsung Electronics does not procure and manufacture components only for its in-house uses. It also serves as a vertically integrated, specialised, and large-scale supplier for its major competitors, such as Sony (DRAM, NAND flash, LCD panels), Apple Inc. (mobile processor, DRAM, NAND flash), Dell (DRAM, flat panels, lithium-ion batteries), and Hewlett-Packard (DRAM, flat panels, lithium-ion batteries). Having control over the NAND and controller has major implications both for performance and reliability. Samsung has knowledge of various nuances of these components and can tweak them along each step in the development process to ensure that they work together perfectly. Manufacturers of generic SSD controllers have to worry about supporting multiple NAND specifications (from varying manufacturers who each have different manufacturing processes), while Samsung’s proprietary SSD controller is engineered solely to work with its own NAND – which means engineers can focus all of their efforts towards one common specification. As the most integrated SSD manufacturer in the industry, Samsung controls all of the most crucial design elements of an SSD: NAND, Controller, DRAM, and Firmware. Working together, these components are responsible for a crucial task –storing, stable operating, and protecting precious data (Samsung, 2014d).

As a vertically integrated supplier, Samsung is able to achieve economies of scale and protect its position as a consumer electronics giant by leveraging its ability to produce component parts and assemble its products in a large-scale and cost-efficient process. Samsung Electronics relies on other companies mainly in terms of software applications – for example, Google, which supplies the operating system for smart phones and delivers related applications (Apps). In contrast to Samsung, Apple Inc. is a vertically integrated specialized buyer. Apple Inc. represents four companies in one – a hardware company, a software company, a service company, and a retail company. It controls all the critical parts of its value chain, but leaves the manufacturing process of its electronics components to other companies, such as Samsung. Consequently, Apple Inc. is rather a design company, not a manufacturing company like Samsung Electronics (Vergara, 2012). Samsung’s supplier positioning also poses another risk. The firm finds itself competing with its customers – which are, in parallel, competitors. About a third of Samsung’s revenue comes from companies that compete with it in producing television sets, smart phones, computers, printers, and other items (Ramstad, 2009).

3.2.5International business expansion

As South Korean electronics firms gradually strengthened their presence and expanded their market shares overseas, import restrictions regarding goods from Korea increased in key markets such as the United States and the European Union. By the end of the 1980s, there were restrictions in the form of antidumping duties, quotas, and quality standard restraints on Korea’s major export producers of color television sets, including Samsung. (Cherry, 2001: 65). As a result, Korean Chaebols strengthened their foreign direct investment activities, and overseas expansion through foreign direct investment has been impressive in the case of Samsung Electronics.

During the 1970s, the firm concentrated its manufacturing capacities on its home market, South Korea. The first foreign direct investment outside Korea was done in Mexico and Thailand (1988). In Europe, Samsung built its first television set manufacturing plant in Hungary in 1989. Meanwhile, China, as a manufacturing platform, has played an outstanding role for Samsung. Particularly at the beginning of the 1990s, Samsung Electronics established several manufacturing locations for a wide range of products (e.g., television sets, audio, telecommunication, etc.) in China. The manufacturing capacity expansion, including the foreign direct investment activities of Samsung Electronics, as well as additional details, such as the year of establishment and the manufactured products, are illustrated in Figure 39 for the period 1969 to 2013.

In recent times, such as in 2002, taking advantage of a favorable investment environment (e.g., relatively low costs combined with subsidies from the government), Slovakia was selected as a new investment location for building television set manufacturing capacities in Europe. In 2008 and 2009, Samsung invested in Russia, Vietnam, and Poland, while ‘coming back to Asia’ when it established LCD (2012) and semiconductor (2013) manufacturing capacities in China. Straight from its foundation, the Samsung management obviously has invested in locations where it has forecast promising business opportunities instead of paying too much attention to geographical distance or perceived cultural differences.

Traditional internationalization theories like the Uppsala approach assume that firms follow a linear, incremental internationalization chain pattern (Johanson & Vahlne, 1977: 23–26; Luostarinen, 1980, 200 –201). Interestingly, Samsung has developed its international business, from its beginning, in contrast to the traditional internationalization theories. As can be seen, in the business expansion route of Samsung Electronics, the firm did not follow an incremental, linear investment path from nearby countries located in Asia to more distant countries such as those overseas. Instead, through various joint venture and strategic alliances, Samsung Electronics has gained knowledge from its relationship partners, which rather reflects major characteristics of the network theory of internationalization.

3.2.6Product design, research, and development

Samsung Electronics has continuously increased its efforts to seek a reputation as a premium brand manufacturer. In this regard, Samsung’s advertising campaigns have increased considerably. In Europe, Samsung is rather known for its electronics products but plays a minor role in other businesses, such as heavy industry, insurance, credit cards, and others. Samsung Electronics’ annual budget for worldwide promotion expenditures amounts to around one billion Euro. Such a large advertising budget allows for market-specific and professional campaigns. Additionally, the company does extensive sports sponsoring. In Europe, Samsung’s brand awareness has particularly increased during the last decade. One of the reasons for this is the company’s strategy of single brand marketing, which includes a diversified electronics product range of smart phones, television sets, and other items.

A company that provides a full product range obtains attention and, consequently, easier access to the end consumer. This is an advantage in mass markets such as consumer electronics with relatively standardized products and intense price competition. As a high-technology company that produces various types of products in different segments (e.g., mobile media, semiconductors, home applications), Samsung has to consider that the designing process is one of the fundamental activities in creating value. Since high-tech products are changing rapidly, the corresponding creation of designs is needed in order to compete in the global market (Korea_Associates, 2012: 14). For its product designs, Samsung is running product design centers located in the following countries (compare illustration).

For advanced and research-intensive products, Samsung Electronics still concentrates on its home base in South Korea. In addition to the Samsung Advanced Institute of Technology (SAIT) located in South Korea, the network is completed by local research and development centers in various locations around the world (Lynskey & Yonekura, 2002: 283). The technological results are transferred to the headquarters in Seoul, which collects data from similar research units around the world and prepares fine-tuned economies of scale production scenarios for various Samsung factories around the globe. More specifically, the Samsung Electronics research and development activities are organized in three layers. (The first two layers are core to technology development and product planning.)

(1)The Samsung Advanced Institute of Technology (SAIT) ensures Samsung’s technological competitiveness in core business areas, identifies growth engines for the future, and oversees the securing and management of technology including patents.

(2)The research and development centers of each business focus on technology that is expected to deliver the most promising long-term results. Each division of Samsung Electronics has its own research department, but all of these can outsource projects both to SAIT and to third-party institutions.

(3)Divisional product development teams, working with design centers, are responsible for commercializing products scheduled to launch in the market within one or two years.

Samsung Electronics spends about Euro 6 to 10 billion per annum on research and development, which equals about 7 percent of gross earnings. In smart phones, research and design is taking place in multiple centers, with the ‘solution divisions’ in Korea preparing products for external customers like Apple and for its internal customers in Samsung (Korea_Associates, 2012).

There is no doubt that Samsung has successfully changed its reputation from a cheap original equipment manufacturer (OEM) to a technology- and marketing-driven company. Samsung’s strength is based on its expertise forecasting future market potentials, which comes along with its major strength: very fast market response times. Despite its diversified business portfolio, further strengths of Samsung lay in its vertical manufacturing depth and in the firm’s fast knowledge absorbing capabilities of strategically valuable information from customers, suppliers, and competitors’ products. The acquired knowledge immediately results in newly developed products and the establishment of vertically integrated economies of scale manufacturing techniques, using regional cost advantages in its own factories – such as those in China and, more recently, in Vietnam. The products are launched through Samsung’s global sales network, usually faster than competitors, which allows further experience curve and learning effects.

Additionally, through faster market entry than its competitors, an impression of an innovative technological pioneer (first inventor) is spread, which is in most of Samsung products still not the case (e.g., LCD/LED TV was mainly developed by Sharp, smart phones introduced by Apple, laptops by Toshiba, Blu-ray by Sony, and so on). Samsung rather holds the position of the ‘second first’, targeting to learn from the mistakes of the others; but this is done very effectively by the largest Korean Chaebol. This absorptive capability, together with its efficient forecasting and market timing, establishes Samsung as a true industry benchmark in high-technology industries.

Chapter review questions

1. Describe the major characteristics of the management philosophy of the South Korean Chaebol Samsung and the culturally based strengths and weaknesses in terms of developing the business.
2. Explain the historical reasons for, the current business fields of, and the advantages and disadvantages of the diversification strategy of Samsung Group.
3. Explain the vertical integration strategy of Samsung Electronics and the corresponding opportunities and challenges for the management.
4. Taking today’s perspective, do you think Samsung Electronics holds the position of a technological leader or technological follower in the consumer electronics industries?
5. Assuming you are in the shoes of the management, where do you see the future of Samsung Electronics? Explain the reasons for your answer, and provide reasonable arguments.

3.3Foreign Market Entry Strategies

3.3.1Contractual modes of market entry

3.3.1.1Indirect and direct export

Export describes business activities where goods and/ or services are sold outside the country in which the major value-added activities took place. Export allows a fast and relatively less risky foreign market entry. The exporter‘s major risk is a financial risk (importer does not pay for the cargo) that can be reduced by asking for pre-payment before delivery or by using a letter of credit or export credit insurance. By developing the service or manufacturing the products at home and exporting them abroad, the organization is able to realize substantial economies of scale effects from its expanded sales volumes in the foreign markets in addition to its sales in the local market (Hitt, Ireland, & Hoskisson, 2015: 243). Exports help to develop the firm’s international business competence and innovative capabilities due to the firm’s access to information located in foreign markets. According to Love and Ganotakis (2013: 14), knowledge-intensive service-sector firms are able to gain earlier benefits from their expansion to export markets than manufacturing firms.

Basically, we distinguish between direct and indirect exports. Indirect exports and direct exports describe transactions in which the firm delivers products and/ or services to an importing company based on a contractual agreement. Having no, or very little, experience in the business of foreign trade, it is desirable for the firm to initiate its first foreign engagement through so-called indirect exports. This market entry mode is called indirect export because an intermediator, with a commission, searches for potential customers (importers) in the target foreign country. The commission is subject to negotiation between the exporter and the intermediator and usually ranges from two to fifteen percent of the contract value. The commission is due after a contract is signed by the exporter and importer. Because the intermediator searches for pre-negotiated agreements with potential importing customers, the exporting firm is not confronted with challenging socio-cultural conditions, such as unfamiliar negotiation behaviors or language barriers. However, intermediators who run their business based on a commission often carry the products of competing firms and, therefore, tend to have divided loyalties (Hill, 2012: 491).

In the case of direct exports, the firm undertakes personal relationships with the importing customer abroad. Direct export requires more resources relative to indirect business because of traveling as well as actively managing the negotiations and contracts. The advantages from direct market access and the benefits from gaining valuable first-hand customer information may easily exceed the costs of active export management. Carriers and banks are important participants in the exporter’s business-to-business network. The carrier’s willingness and degree of resource commitment influence the performance of on-time delivery of the cargo from the exporter to the importer. The bank, through its transfer of timely payments and its fee and loan policy (which is also a result of the bank’s resource commitment), has further significant impacts on the importer’s and exporter’s degree of satisfaction. The mutual resource commitments of the exporting firm, the importer, the bank, and the carrier for a direct export contract are illustrated in Figure 42. A particular form of export without the involvement of a bank is called barter. With barters, products and services are mutually exchanged between exporter and importer without financial payments. The volume of the products exchanged may differ depending on the unit value of each product. Barter businesses come about with firms located in rather fragile regions in terms of the economy, infrastructure, and finance.

The major challenges for a firm doing export business are cross-border trade barriers. Because of liberalized trade patterns as a result of the General Agreement on Tariffs and Trade (GATT), which became effective in 1948 and was replaced in 1995 by the World Trade Organization (WTO), the average customs import tariffs are lower or disappeared compared to the past. However, nontariff barriers (bureaucratic import documentation), which are more difficult to gain evidence about, may remain a threat for the exporting firm, especially in volatile export target markets where the government of the host country tends to make use of barriers in order to accommodate the domestic industry lobby.

Export easily becomes uneconomical for bulky products and/or long-distance markets, which entail relatively high transportation costs. Furthermore, in light of globalization, firms face the challenges of supply flexibility and efficient management of demand changes in order to gain competitive advantage (Vollmann, Berry, Whybark, & Jacobs, 2005: 588). Exports from geographically distant markets result in a longer transportation lead time and limited response time in case the order is changed by the customer. The after-sales service becomes more difficult and expensive when the manufacturing location is far away from the export sales market. Domestic production and export may not be appropriate if lower cost locations or highly skilled staff for manufacturing and selling the product or service is available abroad or if local manufacturing is supported by infrastructure incentives granted by the local government (Hill, 2012: 491–492).

In the past, products with a relatively high degree of tangibility and a low demand for interaction between producer and final customer were usually exported. In recent years, we have witnessed export activities for products with a high degree of intangibility, such as software development or accounting services. An example is India, known as an exporting country (Blomstermo, Sharma, & Sallis, 2006: 216). E-commerce-based communication, sales, and distribution channels make it possible for an exporter to neither require an intermediator nor be permanently physically present in the target foreign markets. The case study of the upcoming Chinese telecommunication company Xiaomi describes how digital distribution is applied in order to successfully enter foreign markets.

3.3.1.2Contract manufacturing

3.3.1.2.1How it works?

In highly competitive and technologically fast changing industrial environments, manufacturers often consider establishing production capacities in a foreign market. The major reasons for market entry through contract manufacturing (synonymous term: original equipment manufacturing) are the following: a firm takes advantage of lower-cost locations and is able to save logistics costs due to local manufacturing in the target foreign market. The original equipment manufacturing (OEM) strategy allows the brand manufacturer a faster market entry abroad via the contracted firm than through foreign direct investments. This is particularly the case in high-technology industries where product innovations, simultaneously launched on a global scale, are of vital importance in order to gain competitive advantage. While the original equipment contractor (OEC) firm concentrates on the production, the brand manufacturer can bundle the resources in its core competencies, such as research and development or marketing. In other words, contract manufacturing is linked to the ‘make-or-buy’ question (Morschett, 2005: 599, 610). The OEC can combine production for several OEMs and thus realize economies of scale (Plambeck & Taylor, 2005: 133–134). Further incentives for contract manufacturing from the OEM’s perspective are improved sensitivity to local customer needs and avoidance of host country import taxes or quota restrictions (Hollensen, 2014: 369).

How does the OEM system work in practice? The OEM (brand manufacturer) searches for a potential firm in the foreign target market that is able to manufacture, based on the OEM’s desired cost structure, the technical specification and quality standards of the OEM’s products. When the OEM has found a suitable and capable firm, a contract is signed; and the OEC starts production of quantities of the OEM’s product. It is important to mention that the OEC puts the OEM’s brand name on the product at the end of the assembly process. Because the brand is visible on the product, consumers do not realize the product is assembled by the OEC. However, consumers are usually charged at the same price level (market goodwill of the OEM’s brand) as they are used to paying when it is manufactured by the OEM. The lower unit manufacturing costs (because the product is manufactured by the OEC) but higher sales price (as though it was manufactured by the OEM) finally generates higher OEM margins.

According to the conditions (everything is negotiable) between the contracting parties, the OEC may launch individual component assembly operations (semi-products) or manufacture the complete products including services (full operations). Payments by the OEM to the OEC are generally calculated on a per unit basis. In many cases, the OEM contracts with different OECs located at different places around the globe. Thus, the OEM benefits from each OEC’s proximity to the market, which results in an increased flexibility to balance the production capacities of each OEC, if necessary (Hollensen, 2014: 369). This close proximity helps to accelerate the OEM’s time-to-market responses in case of fluctuating order volumes. Additionally, contract manufacturing enables the OEM to undertake foreign operations without making a final investment commitment in the foreign target market. As a result, the OEM reduces its investment risk through its contractual agreement with the OEC (instead of establishing its own operations). The contract between the OEM and OEC can be terminated at any time – for example, if sales volumes in the target foreign markets shrink (Cole, Mason, Hau, & Yan, 2001: 7).

How about the potential drawbacks of contract manufacturing? Disadvantages for the OEM can derive from the OEM’s loss of direct hierarchical control of the manufacturing and administrative (such as quality control) processes. The ongoing fulfillment of quality, based on the technical specification set by the OEM, is of vital importance. In case the OEC does not meet the quality or working condition standards as agreed upon in the contract, this failure may cause serious damage to the OEM’s reputation in the markets. Thus, partner selection, contract negotiation, and quality control procedures have great importance (Hollensen, 2014: 369).

Furthermore, there is a risk for the OEM that the cost and desired benefits become unbalanced because of transaction costs related to the contract partner’s selection process and negotiation procedures (ex-ante costs) and ex-post costs, such as monitoring and control of delivery punctuality, assembly quantity, and assembly quality (Williamson, 1991: 279). The more OEM activities initiated by the original brand firm, the higher the complexity, which provokes expanded information and communication structures. The original brand manufacturer has to decide which value-added activities (products and services) are transferred to a contracting firm. There is another risk when the OEM outsources activities that contributed to the ability of the OEM in the past to differentiate itself from its competition (Kita, 2001: 1). In the worst case, core competencies of the brand manufacturer are transferred to the OEC. As a result, the OEC acquires knowledge through its absorptive capability, which helps to develop the overall manufacturing and business expertise of the OEC. Thus, after a certain period of time, the OEC may become a competitor to the OEM on the global markets by learning from its OEM contracting partner.

The terms contract manufacturing and outsourcing should be clearly separated. The first serves as a method for increasing the OEM’s manufacturing capacities at home by utilizing the OEC’s capacities in the foreign target market (manufacturing activities continue at the OEM).

If, however, the OEM decides to terminate the manufacturing of a certain product at its home base and, instead, shifts the entire production to another firm, this is called outsourcing. In contrast to internal sourcing of materials, components, or products and services within a firm, outsourcing is the process of employing an external provider to perform functions that could be performed in-house (Bertrand & Mol, 2013: 751; Potkány, 2008: 53).

Outsourcing enables a firm to flexibly handle its customer-order management. The firm’s manufacturing capacities are located outside the firm’s hierarchy as an alternative to owning the production facilities. The management is often better able to focus on its core competencies, such as marketing or research and development, to achieve competitive advantage (Cheng, Cantor, Dresner, & Grimm, 2012: 890). Experience curve effects and the specific manufacturing expertise of the contracted firm enables the company to perform tasks more effectively (Caruth, Pane Haden, & Caruth, 2012: 5–6). Outsourcing may help to reduce the fixed costs of the internal manufacturing facilities and thus lower the breakeven point, which helps to improve a firm’s return on equity (ROE). Suppose a corporate executive’s performance is evaluated on the basis of the contribution to the firm’s ROE; the management tends to have a strong incentive to increase outsourcing (Kotabe & Murray, 2004: 7–10).

However, the more the brand manufacturer shifts value-added activities to contracted firms, the less the brand manufacturer is involved in the value-added activities processes. The engineering expertise; technological knowledge; and, finally, the innovation capabilities and quality consciousness of the branded firm incrementally decreases over time. Further potential drawbacks of shifting value-added activities to outside firms are changes in employee morale and erosion of organizational loyalty. An organizational-cultural misfit between the contract partners may lead to a lower product and service quality, which damages the brand manufacturers reputation (Caruth et al., 2012: 6).

In the case of Philips (The Netherlands), it became increasingly difficult to remain efficient and innovative concerning new product developments in the consumer electronics industry. In 2008, Philips announced that it would transfer more than 70 percent of its television set manufacturing orders to contract manufacturers such as TCL Corporation (China), TVP (Taiwan), Hon Hai Precisions (Taiwan), and Funai Electric (Japan). In parallel, these previously rather less-known Asian-based electronics firms strengthened their technological and manufacturing expertise through learning during contract manufacturing relationships with OEMs such as Philips, among other reasons (Digitimes.com, 2008). Around five years later, in 2013, Philips sold the remnants of its audio, video, multimedia, and accessories activities to Japan’s Funai Electric for Euro 150 million in cash and a brand-license fee. The Dutch group reported the management targets of becoming primarily a maker of healthcare, medical equipment, and lighting products and, thus, terminated its once-core business of consumer electronics (Van den Oever, 2013). Other ‘international latecomers’, such as Flextronics of Singapore and Hon Hai Precision Foxconn of Taiwan, successfully used contract manufacturing as a learning tool on their way to becoming major players in the electronics industries (Tung & Wan, 2012: 3–4).

3.3.1.2.2The case study of Foxconn/Hon Hai Precision Industry Company (Taiwan)

In 1974, the Taiwan-based firm Hon Hai Precision Industry Company, better known in Western markets by the name Foxconn Technology, was founded by Terry Gou (Hon Hai Precision Co., 2013). During the first years of its existence, the company produced channel-changing knobs for television sets. In 1988, it began to invest in mainland China by establishing production locations in several regions of the country and by expanding its business to computer assembly. Nowadays, Foxconn is the largest original equipment manufacturer (OEM) in the world (Yiwei, 2014).

Foxconn manufacturers and delivers components, modules, and services and provides solutions ranging from the design and manufacture of components and system assembly to maintenance and logistics (Hon_Hai_Precision_Company_Ltd., 2013). As the largest contract manufacturer, especially for global consumer electronics companies, Hon Hai Precision Company employs about 1.5 million people in China. The enterprise is the major assembler of PCs for Hewlett Packard, Dell, and Acer; and it manufactures iPhones and iPads for Apple Inc., PlayStations for Sony, the Nintendo Wii, and Amazon’s Kindle Fire. Moreover, TVs for Sharp, Sony, and Toshiba are produced at Foxconn factories (Kan, 2012). Foxconn represents one of the largest suppliers for Apple Inc. About 40 percent of its revenue is generated by the OEM partnership with Apple. Apple’s relationship with Foxconn is so extensive that the Taiwanese firm has been building factories for the exclusive purpose of assembling Apple products (Kan, 2012). In 2013, sales hit a record high of USD 130.8 billion; and the company’s net income rose to about USD 3.5 billion (Agence_France, 2014).

Nevertheless, in recent years, several scandals erupted because of labor rights violations at Foxconn factories. In addition to miserable working conditions, including overtime issues, unpaid wages, and accidents, suicides of employees were revealed in the media. Finally, Hon Hai and Apple Inc., the most important buyer of Foxconn products, were forced to implement reforms that included a reduction of working hours, overtime wages, and safety procedures in order to improve the poor reputation of both companies. The Fair Labor Association was hired to control working conditions (O’Toole, 2013). In recent years, Foxconn announced several times that robots would be utilized in the production line in order to raise efficiency and decrease labor costs. This change could also be a chance to distance the company from accidents, suicides, and other conflicts at the factories (Mozur & Luk, 2012).

China Labor Watch released a report about conditions at ten factories in China, including the ones operated by Foxconn, Quanta, Catcher Technology, Samsung, and Compal Electronics. According to Debby Chan, a project manager for the Hong Kong-based Students and Scholars Against Corporate Misbehavior (SACOM), ‘We never said that Apple was the worst in the industry. Samsung, HTC, Motorola, Amazon, and Nokia have the same problems’ (Kan, 2012).

SACOM has been one of the most vocal advocates for change at Foxconn. The issue was first raised in 2010, when a string of worker suicides prompted former Apple CEO, Steve Jobs, to defend the supplier. In a widely reported email, Jobs said, ‘Although every suicide is tragic, Foxconn’s suicide rate is well below the China average’. Since then, Apple has taken a more active role in addressing problems at Foxconn factories – for example, by working with the Fair Labor Association to audit facilities for labor violations. While labor groups remain unconvinced that the progress is sufficient, Apple’s influence over its suppliers could help improve working conditions in factories across China. In addition to Foxconn, Apple uses 155 other suppliers, some of which have also drawn allegations of poor working conditions (Kan, 2012).

Chapter review question

1. Describe the opportunities and challenges, from the perspective of Apple’s management, of working with Foxconn.
2. How do you evaluate Foxconn’s potentials for its future business?

3.3.1.3Licensing

Contractual licensing relationships describe the transfer of knowledge between one licensor and usually various licensees. The licensor, as the owner of knowledge – for example, concerning a product technology – needs to have a registered patent or trademark, which legally protects the licensor from illegal use of its intellectual property.When applied as an international market entry mode, the licensor grants exclusive rights to a licensee located in the target foreign country to use the intellectual property for a defined purpose for a certain period of time as agreed to by both parties in the contract (Aulakh, Jiang, & Li, 2013: 700).

In other words, licensing describes contractual transactions in which the owner of knowledge-based resource assets sells to another organization or individual the right to use these intangible resources for a defined purpose. Under the licensing arrangement, the licensor transfers, but does not give up, this ownership of the knowledge in exchange for the payment of royalties by the licensee (Luostarinen & Welch, 1997: 31–32). The royalty to the licensor, agreed to and documented in the contract, is normally calculated and paid based on each product unit sold by the licensee. License agreements offer the advantage to the licensee of gaining access to advanced, but legally protected, intellectual knowledge. The licensee takes the entrepreneurial risk and undertakes financial investments in facilities for material procurement, manufacturing, marketing, sales, and distribution of the products and services in the target foreign markets where the licensed knowledge is used (compare Figure 45).

Licensing can be attractive for rather small firms that have limited financial resources because it allows them to build up operations outside their home country. Furthermore, licensing as an international market entry mode is desirable in industries characterized by relatively short product and technology life cycles, such as high-technology industries.

Potential drawbacks for the licensor come along with the fact of having no control over the operations and quality of the products and services created by the licensee. Innovation can be commercialized quickly with little investment risk. However, the success of a technological innovation in the market is totally dependent on the commitment and effectiveness of the licensees (Grant, 2013: 255). Because of the licensee’s operational value-added activities, the licensor is unable to realize experience curve and economies of scale effects. The licensor’s reputation can be damaged when the licensee does not appropriately follow the quality, safety, or environmental protection standards agreed to in the contract. In parallel, depending on the licensee’s learning capabilities, there is a threat that a new competitor is built up, based on the licensor’s knowledge and expertise. Many firms made the mistake of thinking they could maintain control over their knowhow within the framework of a licensing agreement. RCA Corporation, for example, once licensed its color television set technology to Japanese firms. The Japanese companies quickly assimilated the technology, improved on it, and used it to successfully enter worldwide markets, taking substantial market share from RCA (Hill, 2012: 495).

3.3.1.4Franchising

Franchising is a contractual agreement between a franchisor and usually many franchisees that are legally and financially separated (Hendrikse & Jiang, 2007: 13). Combs et al. (2004: 907) describe the process of franchising as follows: the franchisor sells to the franchisees (typically small business owners) the right to commercialize goods or services under the franchisor’s established brand name (market goodwill) and a proven business concept. During the contractual relationship, the franchisor provides ongoing commercial, administrative, and technical assistance. In return, the franchisee typically pays an initial start-up fee, royalties based on the sales, and advertising fees – all of which depend on the conditions agreed to in the franchising contract. The franchise system combines the advantages of ongoing research and development activities, marketing, and economy of scale potentials offered by the franchisor with the regional market knowledge, cultural sensitivity, and entrepreneurial talents of the franchisee. The franchisees are most familiar with the local customer preferences and, thus, can better fine-tune their local sales behavior. From the perspective of the owner of the business concept, franchising allows a relatively fast entry into target foreign markets (Zentes, Morschett, & Schramm-Klein, 2011: 140 – 142). The responsibilities and expectations of the franchisor and franchisee are illustrated in Figure 46).

Potential drawbacks for a franchisor derive from the limited hierarchical control over the franchisee, which is an independent contractor, not an employee of the franchisor. Franchisees can harm the reputation of the franchisor and its business concept if they do not follow the quality, hygiene, and working condition standards specified in the contract. Moreover, the franchisor depends on the franchisee as an information source because the latter has direct contact with the customers. Therefore, market forecasts and necessary product and service modification, which may influence the business concept, depend on the franchisee’s information input. Having this in mind, the franchisor can lower the risk of franchisee dependence by simultaneously investing in financial and managerial assets, such as wholly owned operations in the target market (Dunning, Pak, & Beldona, 2007: 545).

Conflicts in the franchisor-franchisee relationship mainly arise from disagreements over objectives such as sales and profits, which may result from poor communication or failure. The potential for conflicts is reduced if franchisor and franchisee view each other as partners in running a business with common objectives and operating procedures. This approach requires a strong common culture with shared values established by means of intense communication between franchisor and franchisee. Another way of reducing disputes is to establish an efficient and transparent monitoring and reporting system between the franchisor and franchisee – for example, real-time access to computer-based inventory and accounting systems (Hollensen, 2014: 379).