In this topic, we will discuss:

  • Identifying how companies primarily engage in international business
  • Describing the advantages and disadvantages of each form of international business
  • Describing the circumstances under which one method of entry might be more desirable than others

A corporation might engage in international business in numerous ways. There are several ways in which this can be done and there are advantages and disadvantages associated with each method. The advantages and disadvantages suggest the circumstances under which each method of entry may be desirable. 

I. INTRO

A. An entity might engage in cross-border economic activity in several ways that range from simply buying or selling abroad, to developing a multinational enterprise with global operations.

Some of the alternatives are mentioned below: 

1) Importing/Exporting

2) Foreign Licensing

3) Foreign Franchising

4) Forming a Foreign Joint Venture

5) Creating or Acquiring a Foreign Subsidiary 

B. Next, we will be describing each of these alternatives and the advantages and disadvantages that are related to them. 

Importing/Exporting: 

The most basic form of conducting international business involves selling or buying items from abroad. In other words, this is known as importing and exporting. As we all know, exporting is when the production of goods or services in a domestic country (home country) are sold in another country. On the other hand, importing is when the purchase of goods or services in another country (host country) for use in the domestic country (home country). 

  • Advantages of Exporting: 
    • Exporting comes with the following key benefits:
      • It helps an entity increase sales and domestic output which helps achieve economies of scale in it’s home country. 
      • It avoids the substantial cost of establishing production facilities in a foreign country and the problems associated with this type of operation, yet still being able to tap the sales potential in foreign markets.
      • It provides a means for an entity to achieve experience in engaging in international business, including an understanding of differences in culture and taste, legal and administrative procedures, operating methodologies and as such.  
  • Advantages of Importing:
    • Importing comes with the following key benefits:
      • It helps provide goods that are either not available or only available in limited quantities, in the home country such as precious metals, leather goods, oil etc. 
      • It helps provide goods that are comparable to those provided in the home country, but at a lower cost due to comparative advantages in the foreign country. 
      • It helps produce better quality goods than similar goods produced in the home country, due to better technology or skills in the foreign country. 
  • Disadvantages of Importing/Exporting:
    • Exporting and importing can have the following disadvantages: 
      • Cost of transportation might make the total cost of importing or exporting too burdensome to warrant its use. 
        • This is particularly true of goods with a low value-to-weight ratio (i.e. they are relatively heavy for the value of the good). 
        • When the cost of transportation is added to the cost of the basic good, the good or an acceptable substitute could be produced or acquired in the domestic market at less cost. 
        • Existence of trade barriers in the form of quotas or tariffs in home country and/or the host country may constrain the extent to which importing and exporting are appropriate. 
          • If the domestic government imposes import quotas, a good may not be available or available only in limited quantities. Likewise, if a foreign government imposes export restrictions, the availability of goods may be restricted. 
          • If tariffs are imposed on imports by either the domestic government or by a foreign government, the cost of goods imported or exported is increased accordingly, which may make their total cost uncompetitive. 

Foreign Licensing:

Foreign licensing grants a foreign entity (the licensee) the right to use intangible property (patents, copyrights, trademarks, formulas, etc.) in return for a royalty based on sales or other agreed measure. As with other forms of foreign market entry, licensing is appropriate in many cases. However, in some case, it may be inappropriate. 

  • Advantages of Foreign Licensing:
    • Licensing can provide the following benefits:
      • Increased revenue through receipt of loyalties
      • Avoid costs and risks associated with opening operations in a new foreign market
      • Avoid trade barrier issues in the foreign country
  • Disadvantages of Foreign Licensing:
    • Foreign licensee may misuse access to the home entity’s patents, technological processes and/or other proprietary information. 
    • Licensor (home country) entity may not have control over manufacturing, marketing, distribution and customer service consistent with its standards and as needed for maximum result. 
    • Licensee may not have the management and technical capabilities to fully realize the benefits of the license. 

Foreign Franchising:

Foreign franchising is a special form of licensing in which the franchisor not only sells intangible property, such as a trademark, to a foreign franchisee, but also mandates strict operating requirements for the franchisee. 

  1. Foreign franchising is used primarily in service, hospitality and retail areas like hotels, restaurants etc.
  2. Franchisor frequently provides ongoing assistance. 
  3. Franchisor receives royalty payment from franchisee. 

​​​​​​​Advantages of Foreign Franchising: 

Franchising can provide the following benefits, which are similar to those of foreign licensing:

  1. Provide increased revenue through receipt of royalties. 
  2. Avoid costs and risks of opening facilities in a foreign market. 

Disadvantages of Foreign Franchising:

Franchising can have the following disadvantages:

  1. Possibility of foreign franchisee misusing proprietary information
  2. Quality controls of franchisee may not meet the standards of the franchisor

Joint Venturing:

A joint venture is an entity that is established and jointly owned by two or more otherwise unrelated entities. In an international context, at least one of the owners is located in the foreign country in which the joint venture is established. 

Advantages of Joint Ventures:

Benefits that are associated with joint ventures are mentioned below:

  1. Host country co-owner (partner) has knowledge of the local customs, language, political system, business environment and competitive conditions. 
  2. Costs and risks that are related to entering the foreign market are shared with one or more other parties. 
  3. Resistance from the local political system, labor and other businesses might be less likely when there is a local stakeholder. 

Disadvantages of Joint Ventures:

The following disadvantages are associated with joint ventures:

  1. Foreign (host country) co-owner might misuse access to another partner’s patents, technological processes or other proprietorship information. 
  2. Domestic (home country) entity does not have absolute control over the joint venture entity, which may prevent the domestic entity from integrating the joint venture into its overall strategy. 
  3. Shared ownership arrangement can lead to differences over goals, objectives and strategy, and may result in conflicts and battles for control. 

Wholly-Owned Subsidiary:

As the title implies, the use of a wholly-owned subsidiary involves the home country entity owning 100% of a foreign entity over which it has complete control. This might be accomplished in two ways:

  1. Acquiring an entity already established in the foreign country through a legal acquisition.
  2. Establishing a new entity in the foreign country. 

Acquiring an Already Existing Entry:

  1. This approach would involve a business combination in which the home country entity acquires control of an existing foreign country entity in a legal and accounting acquisition. 
  2. Both entities would continue to exist and operate as separate legal entities, with the home country parent having control of the foreign country entity (subsidiary) through its ownership of the equity of the foreign entity. 
  3. Acquisition of a pre-existing foreign entity may have the following advantages: 
    • It provides a quick entry into the foreign country, without the time consuming process of establishing a new entity and developing the capital assets such as property, plant and equipment and presence necessary for operation. 
    • There is a known level of operating results and related historic information that is not available when a new entity is established. 
    • When executed in a timely manner, it may serve to “block” or preempt competitors from seeking to enter the same foreign market by establishing a quick presence. 
  4. Acquisition of a preexisting foreign entity may have the following disadvantages:
    • Lack of understanding by the acquiring home parent of the acquired foreign subsidiary’s national values, culture and business environment may result in conflict. 
    • The corporate culture of the acquired foreign entity may be difficult to integrate with that of the home country parent. 
    • Synergies or other benefits expected from the acquisition don’t materialize, or they take longer to achieve than expected. 
      • Studies by KPMG and McKenzie & Co. have reported that only about 30% of all mergers and acquisitions result in creating value for the acquiring entity. 
      • That percentage would not be expected to be higher for international acquisitions. 

Establishing a New Entity:

  1. This method of obtaining a wholly-owned foreign subsidiary involves establishing a new entity in the foreign country. This approach is sometimes referred to as a “Greenfield venture”. 
  2. Establishing an entirely new entity in a foreign location may have the following advantages:
    1. The foreign subsidiary can be built from the “ground up” or built from scratch, to have the kind of culture you want, operating styles and procedures needed to integrate with the strategy established by the home country parent. 
    2. Home country parent is better able to transfer organizationally embedded competencies, skills, routines and culture. 
    3. Establishing an entirely new entity in a foreign location may have the following disadvantages:
    • Time consuming to establish and make operational
    • Costly to acquire the capital assets needed for operation
    • Anonymity of future revenues, costs and other operating aspects bring greater risks. 

Advantages of Wholly-Owned Subsidiary:

Whether established through acquisition or developing a new entity, a foreign wholly-owned subsidiary may have the following benefits:

  1. Home country entity maintains control over patents, technological processes, and other proprietary information.
  2. Provides the home country entity the ability to coordinate strategy with other operations and adapt as needed. 

Disadvantages of a Wholly-Owned Subsidiary:

Whether established through acquisition or developing a new entity, a foreign wholly-owned subsidiary may have the following disadvantages:

  1. Capital investment required for start-up is generally the most costly approach.
  2. Greater unknowns about outcome and associated risk. 
  3. Cost and risks are the burden of a single entity, the founding home country parent entity. 

To conclude this topic, there are many forms of entry into international business activity. There are also advantages and disadvantages associated with each form, such as:

  • Engaging in importing/exporting provides a low-cost, low-risk means of initially pursuing international business. Additionally, it may provide further insights into other aspects of engaging in international business. 
  • When the protection of patents, technological processes, and other proprietary information is important, an entity should generally avoid the usage of licensing and joint ventures. The use of wholly-owned subsidiaries is a better option to maintain control of proprietary elements. 
  • When there is foreign opposition to the establishment of an operation in the country, use of a joint venture may avoid some of the resistance that a wholly-owned subsidiary may encounter. 
  • When the home country entity is pursuing a global strategy, use of a wholly-owned subsidiary may provide the needed integration and operational control not available in other forms of entry into a foreign location. 
  • When there is a need to minimize cost or risk in establishing foreign operations, the use of licensing and/or franchising may be desirable.