GLOBAL STRATEGY AND LEADERSHIP

STUDY GUIDE

4.1

Module 4

Product and market development

Contents

Preview

Objectives Teaching materials

Product and market options

The Ansoff product -market matrix Growth in existing products and markets

Product development: New products for existing markets Market development: Existing products for new markets Unrelated diversification

Other approaches to products and markets

New product development

Stages of the new product development process Linking new product development projects to strategy Intellectual property and new product development Key success factors for new product development

New market development

Expanding into new customer markets Expanding into new geographic markets

Development of new geographic markets Objectives of market entry

Market attractiveness

Market development resources

Researching and selecting new geographic markets Timing of entry

Key success factors for new market development

Accounting issues in global strategy Foreign exchange risks

Preparing multiple sets of accounts Incompatible IT systems

Varying business conduct standards Taxation of revenue

Transfer prices

Common modes of entry into new geographic markets Exporting

Licensing

Franchising

Joint ventures

Strategic alliances

Mergers and acquisitions

Wholly owned foreign enterprises Acquiring an existing overseas business Investing in greenfield operations

Advantages and disadvantages of different entry modes

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Review References Web sites

4.58 4.59 4.61

Appendix

Readings

Suggested answers

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4.3

Preview

With our analysis complete, we turn our attention in this module to using this information to identify strategic options for growth. In this module we begin to combine the results

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of factors that must be considered by an organisation prior to determining which, if any, growth strategy to pursue.

In this module we introduce the Ansoff product-market matrix as a tool for identifying strategic options. This model considers products (or services) and markets on the basis of whether they are existing or new. By using this classification, it is possible to group strategic options into four broad classifications, as follows:

• Market penetration-existing products into existing markets.

• Product or service expansion-new products into existing markets.

• Market expansion-existing products into new markets.

• Diversification-new products into new markets.

Such grouping of options assists in evaluating the options when making strategic choices, which will be covered in Module S.

Product development refers to the processes and actions required to expand an organisation's product or service range. Product development is an important part of the process of strategy development and implementation. The major focus of product development is to either find new ways in which the existing product can be used or new ways to meet existing customer needs. The stages and key success factors for new product development are important for an organisation which intends to expand its product or service range.

Depending on the type of product development, intellectual property considerations can also be crucial to providing the organisation with a strategic advantage in the form of a patent, for example.

Market development refers to the processes and actions required to expand an organisation's customer base and sales of their goods and/or services. Market development is an important part of the process of strategy development and implementation.

The key activities performed in market development include determining alternative

ways to expand a market: this can be a geographical market or a customer market.

There are a number of different activities required, depending upon which type of

market an organisation wishes to expand. A major focus of market development is potential customers and opportunities in the global marketplace. This activity involves considering those factors in light of the capabilities and strategies of the organisation.

Market analysis examines the existing market in terms of potential changes to the customer base and/or the geographic market served, while market development examines the ways in which potential new markets may be entered and serviced by the organisation. It is important to note that, in the contemporary business environment, the definition of market extends beyond the geographic area; online sales now account for a significant proportion of trade for many organisations, so must not be ignored in any discussion of markets. This module provides a detailed discussion of a number of ways in which an organisation can enter a new market, with an emphasis on entry to new international markets.

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In considering the concepts of product and market development as tools for organisational growth, we also discuss the types of resources available to inform strategic choices. The impact of specific accounting issues for an organisation when it decides to enter a new market or undertake significant new product development is also examined. The consideration of accounting impacts is a key factor in assessing organisational

capability, particularly in terms of the cost and resourcing implications of any desired changes, and, while some of the issues discussed may appear more operational than strategic in nature, they are a vital part of an organisation's capabilities and thus are key in successfully implementing a growth strategy.

Objectives

After completing this module, you should be able to:

• identify strategic options for an organisation using the Ansoff matrix, including options for market penetration, new product development, market expansion and diversification;

• discuss issues related to new product development, including the stages of the new development process, intellectual property implications and key success factors

for new product development;

• discuss issues related to the development of new geographic and customer markets,

including key success factors for new market development;

• discuss the objectives of market entry, including the market attractiveness;

• identify various resources for obtaining information for market development;

• evaluate the potential impacts of various accounting issues associated with expansion into new product and geographic markets; and

• discuss various modes of entry for expanding into new markets.

Teaching materials

• Readings Reading 4.1 *

'Mining for new product successes' A.]. Magrath

Reading 4.2*

'Wal-Mart bids Auf Wiedersehen, ends nine-year grind in Germany' M. Troy

Reading 4.3*

'Another British invasion' D. Hazel

*

Note: This reading is not in the printed study material. It is available via ProQuest. Please refer to the instructions in the Segment Outline for accessing readings in ProQuest.

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4.5

Product and market options

As discussed in Module 2, most growth achieved in business results from a combination of annual population growth and inflation. If a business wants to achieve greater than average gtowth, the otgat:lisatiot:l must-Qg..somethit:lg Q~'oml what the...it:ldmtry overall

is doing to generate these greater levels of growth-that is, there must be something different in terms of the products or services they sell, in their geographic or customer market, or in the way services are delivered.

The external environment analysis discussed in Module 2, combined with the internal analysis in Module 3, provides the information for determining how to change an organisation's approach to enable the desired level of growth. It is important that an organisation has a clear understanding of its existing position, identifies its desired position and accurately determines its ability to reach the desired position through the implementation of strategy, taking into account any strategic capabilities it may possess.

One of the better-known tools for assisting in the identification and assessment of strategic options is Ansoff's (1957) product-market matrix, which was first published in his article 'Strategies for diversification' in the Harvard Business Review. The approach shown in this model facilitates the clear identification and categorisation of market and product development opportunities.

The Ansoff product-market matrix

The representation of the Ansoff product-market matrix, as shown in Figure 4.1, provides a useful framework for considering possible alternatives and options.

This matrix looks at options from an organisation's perspective based on two dimensions: product focused and market focused. It is important to note that the

term product may refer to a service rather than a physical item, such as an insurance policy or a home loan, as well as physical products, such as motor vehicles. The market dimension considers geographic markets (e.g. Europe or China), as well as customer markets (e.g. different types of purchasers, such as wholesalers, supermarkets and butcher stores for a meat processor) and customer groups (e.g. Internet purchasers).

Figure 4.1

Strategic options: Ansotf product-market matrix classification

Ansoff's

Market penetration Increasing the amount and value of business with existing customers in existing markets, e.g. increasing the

size or value of purchase.

Introducing new products or services to existing customer markets.

Includes adding features to existing products, bundling purchases, repackaging and so on.

Market development Taking existing products into completely new markets,

e.g. finding new markets overseas. Better customer targeting, further research and market segmentation are needed to develop new markets.

Diversification

Moving into new products and new markets at the same time.

This can be either related or unrelated to current activities.

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As a first step, the organisation needs to clearly identify its current position and concentrate on its existing products and markets, leveraging its existing capabilities as much as possible, until it obtains its maximum market position and penetrationthat is, the market penetration quadrant as shown in Figure 4.1.

The various strategies for growth require different capabilities for successful implementation. The capabilities required by any individual business will vary according to factors such as, for example, the size of the business, the life cycle stage of the business, its current activities, current performance, track record of achievement, leadership team and geographic location.

Over time, organisations should follow a logical development pattern if they are using a 'rational' approach to strategy. Typically, an organisation will begin as a single business with a narrow product and market scope before it ventures into additional products

or markets.

At the point when an organisation is unable to increase its market share from its existing products or markets (e.g. it has reached maximum penetration), it will have to expand out of the current product-market set if it wants to grow. The rational approach to strategy suggests that the organisation has two choices:

• expand by taking existing products into new markets, for example:

• banks expanding into other countries (new geographic markets); or

• banks expanding from retail banking to merchant banking (new customer markets);

• add new products to existing markets, for example:

• banks adding financial services and wealth management products and offering them to existing customers.

These options are represented in the market development and product development quadrants in Figure 4.1.

Expanding into new products or markets in a related area to the current business activities of the organisation usually provides plenty of opportunities for an organisation to focus on and consolidate these new products and/or markets.

The decision as to whether the organisation should develop its product range or markets as the first step depends on its strengths, experience and capabilities. For example, where the organisation has strong product skills but little experience in developing new geographic or customer markets, it should first attempt product development and then, once all opportunities are exhausted in that area, expand into new markets. Alternatively, where the organisation has market development skills, it should move into market expansion first and then, once all opportunities are exhausted in that area, expand into new products.

Diversification is essentially moving into new products and new markets that are either related or unrelated to the current business at the same time. This is higher risk and should only be done where all other related product-market options are exhausted. This option is reflected in the diversification quadrant shown in Figure 4.1.

While the Ansoff product-market matrix presents a model that supports a rational approach, some organisations do decide to expand into unrelated products or markets. This type of product-market expansion is often of questionable value, usually involves higher risk and generally requires capabilities or resources that the organisation does not have.

In the following sections the quadrants of the Ansoff product-market matrix are considered in more detail to examine how an organisation might expand its activities in a way related to its current business activities within the product-market matrix framework shown in Figure 4.1.

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Growth in existing products and markets

The aim of this positioning on the Ansoff product-market matrix-usually the current positioning as previously discussed-is to increase penetration into existing markets with existing products, and so increase market share. This is a useful strategy for organisations tHat are iH tHe start 1:11' elr grelwtH pftftS€s-6f tfleiHife e) ele (me-re-itlfermatielH-6ft-tfle-life

cycle of an organisation can be found in Module 6). These are the stages where market penetration has most likely not yet reached saturation.

There are many ways to achieve greater penetration of existing markets; for example, increasing the product usage of existing customers by:

• increasing the frequency of usage-for example, by providing frequent user incentives (consider Qantas' frequent flyer program, coffee cards at Muffin Break where you buy a certain number of coffees and then get one free);

• increasing the quantity of product used-for example, increasing the pack size

(e.g. 1.S litre bottles instead of 1 litre bottles, providing 30% extra free) or making it easier to use more of the product (e.g. increased size of the opening of a bottle);

• finding new applications for current users-for example, using fewer cleaning agents for a greater variety of applications (later on in this module, Question 4.1 provides details of how Arm and Hammer in the United States have successfully applied this strategy to their core product-baking soda); and

• attracting new customers to gain greater market share of existing customer segments (e.g. selling to another major supermarket chain in addition to supermarkets already being sold to).

Generally growth is expected to be achieved through incremental investment in resources, such as people and infrastructure. Funds for growth will be derived from profits generated from existing business. To increase the share of existing customers and markets, the following questions are useful to consider:

• Who are the existing customers and are there any that have not specifically been targeted?

• Can any product or service be used in a different way by existing customers and markets?

• What capacity is any plant and equipment running at, and is there any spare capacity?

• What are competitors' capabilities and are they the same as the organisation's capabilities? If not, why not, and should these capabilities be developed to enable the organisation to compete more effectively?

• What do customers buy from competitors and what would it take to get them to switch?

• Are there customers who have stopped buying? Why?

• Is a change in pricing, marketing, distribution or other activities required, and what impact will this have on existing customers and employees?

Customer complaints are also a rich source of ideas for business improvement that

can lead to increased business with existing customers (Magrath 1997). Dissatisfied customers whose complaints are handled well often become loyal customers who will recommend your business to others. To take advantage of this, it is essential to have

in place effective systems and processes to handle customer complaints. According to Reichheld (2001), it costs about five times more to attract a new customer than to keep an existing one. Therefore, this is an investment that is usually worth making.

Example 4.1 below provides an example of market penetration.

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Example 4.1: The Ford Falcon-Penetrating the Australian motor vehicle market

Ford Australia is the Australian subsidiary of Ford Motor Company and was founded in Victoria in 1925. Having previously only assembled overseas models in Australia, the company decided to launch an Australian-built Ford in 1955, with the Ford Falcon making its debut with the XK model in September

1960. I he foilowlng table summarises how Ford penetrated the Australian car market by growing sales of its product (i.e. the Falcon) through to 2000 by focusing on product enhancement.

Model Enhancements made
XL Introduced in 1962, this model was based on a Canadian design, with some minor
modifications for Australian conditions.
XM Introduced in 1964, Falcon was able to claim the XM was a car designed and engineered
by Australians for Australian conditions. Changes were made to the front and rear
suspensions, the braking system, clutch, rear axle, engine mounts and exhaust-all as a
result of extensive research on the open road, track and dirt.
XR In 1965, the bigger and more powerful XR Falcon was launched with an entirely new
shape. It incorporated more Australian design input than previous models and featured a
V8 engine for the first time. The XR Falcon was also the first model to carry the legendary
GT badge.
XT to '/Y The next model. the Xl had a more powerful V8 engine, a synchromesh gearbox,
dual circuit brakes and a choice of two automatic transmissions. It was followed by the
XWand xv.
XA to XC The launch of the XA in 1971 saw the Falcon become a uniquely Australian car with no
US equivalent, as it was designed for the local market. With the XB and XC came four-
wheel disc brakes, four-barrel carburettors and the classic Falcon, the Cobra.
XD The XD Falcon was the first to be designed in Australia from scratch. Efficiency,
interior space and weight reduction were the main features of the new design, which
included a plastic fuel tank, plastic bumpers and optional bucket seats.
XE With the XE came the introduction of electronic fuel injection and a Watts link coil-sprung
rear-end.
XF The XF featured Ford's new engine management system, EEC-IV, which managed the
spark timing and air-fuel mix of the engine more efficiently.
EA Apart from a new shape for the Falcon, the EA also had an all-new front suspension
and geometry, similar to that used in the S-Class Mercedes. Other advances included a
four-speed automatic transmission, the high-security Tibbe locking system and a more
fuel-efficient engine.
EB The EB and EB II offered better handling, the return of the V8, and ABS brakes for the first
time on a mainstream Australian sedan. The introduction of Smartlock also meant better
security.
ED The ED offered more modern exterior colours, better side-impact crash protection and
further changes to refine the car's handling.
EF In 1994 the EF Falcon was awarded an Australian Design Award for its engineering
advances. The engine ran more smoothly, had improved torque and power, and a new
EEC-V engine management system developed through Formula One racing. The car also
benefited from significant safety advances, including the world's first airbag-compatible
bull-bar.
EL The $40 million EL program led to further ride and handling improvements, the most
advanced ABS brakes and improved steering. GLOBAL STRATEGY AND LEADERSHIP

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Model Enhancements made
AU Launched in 2000, the AU Falcon saw the introduction of computer-aided design and
engineering, allowing for significant advances in chassis stiffness, aerodynamics and
directional stability.
Prestige models of AU also featured double wishbone independent rear suspension and
variable cam timing. This was also the first car in its class to offer air-conditioning and
automatic transmission as standard features.
The AUII continued the Falcon tradition of innovation. When launched, it was the only
car in its class to include a standard passenger airbag, CD player, l6-inch wheels and
'scheduled servicing' to 60 000 km in the cost of the car. Source: Adapted from Ford Australia (n.d.), 'A brief history of the Falcon's 40 years' <http://www. fastlane.com.au/ford-history/falcon/ford-7S-falcon-40-history.htm> (accessed May 2010).

This is an example of penetration, as the product is unchanged (i.e. Ford Falcon)

and the market is unchanged (i.e. Australia). The changes to each model are product enhancements only, and do not constitute a new product. This example also illustrates the importance of continuous improvement strategies in market expansion; had Ford chosen not to act upon the feedback received from customers, it is likely it would have lost significant market share.

Product development: New products for existing markets

The product development strategy involves modifying and developing products which closely relate to existing products, and then marketing them to the existing market. This is a relatively easy and low-risk strategy because the customer base is known and familiar, and target customers can more easily be involved in product specification. Related product development can occur by:

• adding product features and refinements (e.g. new packaging or pack sizes);

• expanding the product line (for example, adding different flavour options to the current options on offer);

• developing a new generation product (e.g. something based on new technology that allows the product to be presented in a different way, such as 'fresh' food products that can have a long shelf life because of new packaging developments); and

• developing new products (e.g. developing a monthly magazine when the current business is daily newspapers).

The more aspects that one product has in common with another (i.e. the more related it is), the more likely it is that the product development will succeed. Relatedness

can be considered in terms of the nature of the new product or the function it serves, the technology and operating systems involved in producing the new product and the distribution system required by the product.

Where related products are available, the benefits of purchasing the suite of products needs to be clear to the consumer. For example, traditional camera vendors such as Kodak, FujiFilm, Olympus and Canon offer complementary products and services

(e.g. photo printers and online photo services) that allow photo printing and sharing at home as technology in photography becomes more digital. There needs to be a clear benefit to the customer as a result of purchasing both a camera and photo printer from the same company, rather than seeking out products from unrelated suppliers which may be available at a lower cost if purchased separately.

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Cross-selling increases individual customer revenue, and selling more products to existing customers is more cost efficient than selling to new customers, given the high cost of winning new customers. Cross-selling can also have the effect of securing a customer so that defection to other related product or service providers is a difficult and unnecessary change in the customer's mind. Banks have used this approach particularly

well, offering free banking to customers who have their mortgages with them, and enabling easier movement of funds between different accounts using phone and Internet banking than if funds were held in different accounts with different banks.

Similarly, when a customer buys a book from Amazon.com, the online bookseller, the web site automatically provides a list of book titles that customers who have ordered the same book have selected, suggesting that they might also be of interest. Hyperlinks make clicking for more information about these titles and ordering a user-friendly experience. Other online retailers have copied this approach, so it is no doubt an effective strategy to achieve increased sales value from an individual customer.

Example 4.2 shows how Ford Australia has used the product development strategy to expand its market.

Example 4.2: Ford Australia-Growth through new car models

In 1925 Ford Australia commenced operations assembling Model T vehicles. Since then, the company has grown its market share of the Australian motor vehicle market by introducing new models to meet consumer needs across various size categories as follows:

Size category Models introduced
Small/hatchback The Laser was produced in Ford's Homebush plant in Sydney from 1981 until
September 1994 when the plant closed, after which it was fully imported
from Japan.
The Laser was replaced by the European Ford Focus in 2002. It is currently
offered in sedan and hatchback variants with a 2.0L engine, which is one of the
market leaders in sales.
The Fiesta, heavily promoted as a product of German engineering, has also been
a decent seller.
Mid-sized Mid-sized cars assembled in Australia included the Ford Anglia, Escort and
Cortina from the United Kingdom, which were adapted for the Australian market.
For example, from 1972, the Cortina was available with the option of either a
3.3 litre or 4.1 litre six-cylinder engine, and the Escort could be offered across
the range with the Cortina's 2.0L motor.
The Cortina's replacement, the Mazda-based Telstar, was initially assembled
in Australia. In 1989 the Telstar sedan was replaced by the locally assembled
Nissan-based Ford Corsair. When Nissan shut down its Australian manufacturing
operations in 1992, the imported Telstar resumed its former position. In 1995 the
Telstar was dropped in favour of the Mondeo, imported from Belgium.
Ford Australia dropped the Mondeo in 2001, arguing at the time that the market
segment in which it competed was in decline, but in 2007 it announced that it
would introduce the new Mk IV model in Australia. GLOBAL STRATEGY AND LEADERSHIP

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4.11

Size category Models introduced
; Large family car The Ford Falcon was introduced in the 1960s. Since its initial offerings, the Falcon
has proved to be Ford Australia's most popular car. Ford has manufactured
over three million units since 1960, and has topped the sales charts on many
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utility body styles. However, in the past, panel vans and hardtops were offered.
Falcons have dominated the ranks of taxis in Australia and New Zealand, along
with Ford Fairlanes, and have been widely used as police cars, especially in
performance variants.
Four-wheel drive Since 2004, the Ford Territory has been built on the same production line as the
Falcon. The Territory has regularly been the most popular four-wheel drive in
Australia since its release. Source: Adapted from Wikipedia (n.d.), 'Ford Motor Company of Australia' <http://en.wikipedia. org/wiki/Ford_Motor_Company_of_Australia> (accessed May 2010).

The introduction of different types of cars is an example of new product development. The market is unchanged, however, as it remains limited to Australia.

As with the Ford example above, Example 4.3 is also an example of new product development.

Example 4.3: Amazon.com, Inc.-Growth through product expansion

Amazon.com, Inc. is a multinational electronic commerce company with its headquarters in Seattle, Washington. As of January 2010 it is America's largest online retailer. Jeff Bezos founded Amazon. com, Inc. in 1994 and launched it online in 1995. While initially limited to delivery within the United States, Amazon.com soon expanded to international locations.

The company started as an online bookstore, but soon diversified to other product lines: VHS, DVD, music CDs and MP3s, computer software, video games, electronics, apparel, furniture, food, toys, and so on.

Source: Adapted from Wikipedia, 'Amazon.com' <http://en.wikipedia.org/wiki/Amazon.com> (accessed May 2010).

Amazon.corn's core business was online book retailing. It has added new product categories to this core book category to expand. The market is unchanged as the company sells its products online to international locations.

Market development: Existing products for new markets

An alternative approach to product development is to find new markets for existing products. Some risk exists because, although the products are unchanged, it is not clear how the 'related' markets will respond to products that have not been specifically designed for them. Related market development can occur in two ways:

• targeting new customer segments in the same geographic region; and

• expanding geographically.

For example, a bank, retailer, manufacturer or other business might believe that it has limited opportunities to develop further within its own country. Consequently, it may choose to take its existing products and services into other countries to grow (rather than diversify its existing product range within its current country). Similarly, a bank might seek new customer groups to sell its products to, targeting retail,

small businesses or wholesaler customers.

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Example 4.4 shows how Fonterra, a New Zealand company, has used the market expansion strategy.

Example 4.4: Fonterra-Geographic market expansion

Fonterra Co-operative Group Ltd is a New Zealand-based dairy company. It was established in 2001 when dairy farmer members of a New Zealand-based dairy cooperative voted to form a company.

Historically, the company's growth was based on the consumption patterns of dairy-based products in New Zealand. However, in the 1960s growth in domestic markets began to slow as the country's consumption of dairy products reached saturation levels.

To generate further growth, Fonterra began to seek new markets for its dairy products. The company started exploring new markets when Britain (New Zealand's largest export market) first contemplated joining the European Economic Community during the 1960s. Having successfully established exports to Britain, Fonterra developed further export markets over the next two decades. By 1995 the company had over 80 subsidiaries and associated companies supporting the distribution of its products in overseas markets. As a result of this market development strategy, Fonterra, in 2010, is responsible for more than one-third of international dairy trade.

Source: Adapted from Fonterra (n.d.), 'About us' <http://www.fonterra.com/wps/wcm/connect/ fonterracom/fonterra.com/Our+Business/Fonterra+at+a+Glance/ About-Us/» (accessed April 2010).

This is an example of market expansion, as Fonterra is selling its existing dairy product range to new geographic markets through exporting.

Example 4.5 below is another example of market expansion, as Staples sells its office product range to different customer segments or markets that have a need for

office products.

Example 4.5: Staples. Inc.-Customer market expansion

US-listed Staples is the world's largest office products company. Opening its first store in 1986, Staples pioneered the office products superstore concept with the first office products superstore focused on serving the needs of small businesses in Brighton, Massachusetts.

After expanding rapidly in the United States, Staples expanded into Canada in 1991 and Europe in 1992. Once Staples reached market penetration through opening new stores, Staples' management studied business customers and their purchasing behaviour, looking for future growth opportunities. Staples' research team discovered that going to a retail store to make purchases was appealing only to small businesses, students and consumers. As businesses grew in size, they no longer wanted to have to go to the store to purchase their office products.

Based on this information, Staples began to segment the office products market into different customer groups, and looked at how it could service the needs of the customer segments that did not want

to shop in a store. In 1993, Staples launched a Contract and Commercial division to serve multi-site organisations and Fortune 1000 businesses, diversifying the company's customer base away from solely retail customers.

In the United States today, Staples has segmented its customer markets based on business size. The company effectively reaches each of these customer segments of the office products market through a variety of distribution channels that have been specifically designed to be convenient for each segment's purchasing requirements as follows:

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Customer segment Staples solution

Retail customers and Staples retail superstores:

very small businesses

Small businesses and retail customers who visit the company's stores for

their ourchashu needs.

Pricing is based on the store pricing on the day of purchase.

Small businesses

Staples business delivery:

Staples' business delivery operations combine the activities of Staples' direct mail catalogue business, operating since 1990, the Staples. com web site, and its Canadian Internet sites.

Staples' business delivery is primarily designed to reach small businesses and home offices, offering next business day delivery for most office supply orders in a majority of markets.

Staples' business delivery is marketed through catalogue mailings, direct mail advertising, a telesales group generating new accounts and growing existing accounts, and Internet and other broad-based media advertising.

Pricing is based on the catalogue or web site price on the day of order.

Small and medium businesses

Medical professionals

Quill:

Medium to large businesses

Founded in 1956 and acquired by Staples in 1998, Quill is a direct mail catalogue and Internet business with a targeted approach to servicing the business product needs of small and medium businesses in the United States.

To attract and retain its customers, Quill offers outstanding customer service, Quill brand products and special services.

Quill also operates Medical Arts Press, a speciality Internet and catalogue business offering products for medical professionals.

Pricing is based on the catalogue or web site price on the day of order.

Staples contract:

Staples' contract operations focus on serving the needs of mid-sized businesses and organisations (20 or more office workers) through Staples Business Advantage and Fortune 1000 companies through Staples National Advantage. Contract customers often require more service than is provided by a traditional retail or mail order business.

Through its contract sales force, Staples offers customised pricing and payment terms, usage reporting, the stocking of certain proprietary items, a wide assortment of eco-friendly products and services, and full service account management.

Source: Adapted from Staples (n.d.), 'Our story' <http://www.staples.com/sbd/context/about/ media/index.htmb- (accessed May 2010).

Since 'new' products and markets can be defined widely for many organisations, expansion within the first three categories of product-market options (market penetration, product development and market development) usually provides sufficient opportunities for growth. Beyond these three options, the risks are significantly greater as the organisation may need different capabilities, such as new techniques for production

and marketing, from those of its existing activities.

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Unrelated diversification

On the rare occasions where an organisation has exhausted all other growth opportunities from the market penetration, product and market development quadrants of the Ansoff matrix, it may consider diversifying into unrelated products and markets. This could mean that the organi5lltion is moving into a completely different industry.

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Unrelated diversification cannot be recommended, unless it is based on some related capability that can somehow be applied. For instance, an organisation might argue that it has a capability in managing manufacturing operations which it could apply

to produce different products. Therefore, so long as the activity was manufacturingbased, the products manufactured would not matter. Usually though, there is so little capability overlap between unrelated product-market businesses that the risk of failure is high.

Despite the inherent risks involved, there are some situations where unrelated diversification may be appropriate, for example:

• counter-seasonal diversification-wherein businesses dependent on a seasonal market could diversify into products that require resources to be used in the 'off season';

• counter-cyclical diversification-an approach that can be used by firms in industries which are cyclical, such as building industries; and

• where there are limited industry prospects in the organisation's existing and related product markets.

Despite these underlying risks, some organisations do use unrelated product and market diversification successfully to provide new growth opportunities for their businesses, with an increased focus on risk evaluation and implementation due to the very different nature of these options compared to the rest of their operation business model.

Perhaps the best example of growth through diversification is that of General Electric, as explained below in Example 4.6.

Example 4.6: General Electric-Growth through diversification

General Electric has a tradition of growth through innovation and acquisition. The company traces its origins to Thomas A. Edison, who established the Edison Electric Light Company in 1878. In 1892,

a merger of Edison General Electric Company and Thomson-Houston Electric Company created the General Electric Company.

Having experienced strong growth over the past 130 years, General Electric's strategy has been to focus on strong businesses that provide innovation to 'create the world of tomorrow'. This has seen the company become a large, diversified organisation. General Electric's current business operations are focused on infrastructure, finance and media industries, with a leadership position in the areas of energy, oil and gas, health care, aviation, transportation, water and consumer products.

GE launched its Renewal Strategy in 2009, revising the company's strategy as 'an innovative technology and services company that can solve some of the world's most difficult problems, grow earnings and have substantial cash available to reinvest in the Company or return to shareowners.

In the future, General Electric will operate in the markets the company has chosen, in which it can have a meaningful competitive advantage.'

Source: Adapted from General Electric (n.d.), 'OUf history' <http://www.ge.com/company/history/ index.htrnb- (accessed May 2010).

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General Electric is an example of growth through unrelated diversification, as there is little or no commonality of the various business units within the company, other than a focus on innovation and strong growth. Another commonly cited example of growth through unrelated diversification is the Australian-listed company Wesfarmers, which has operations in supermarkets, home improvement and office supplies, coal mining,

energy, insurance, chemicals and fertilisers, and industry safety projects. Wesfarmers, like GE, aims to provide a satisfactory return to its shareholders by conducting existing operations in an efficient manner and by seeking out opportunities for expansionwhere it can apply its capabilities to introduce efficiencies and, therefore, improve returns to shareholders.

Case Study 4.1 provides background information on a US manufacturer of baking soda (sodium bicarbonate). Read the case study and then answer Question 4.1.

Case Study 4.1 : Arm and Hammer product development

Arm and Hammer is a US-based manufacturer of baking soda. Baking soda (also known as sodium bicarbonate) and soda ash (also known as sodium carbonate) are naturally occurring substances found in all living things and regulate pH balance (that is, the balance between alkalinity and acidity).

Arm and Hammer was founded in 1846 and, until the 1930s, its main product, baking soda, was sold principally as a raising agent for baking. When heated and combined with acidic ingredients,

baking soda gives off carbon dioxide, which causes a cake or dough to rise.

In addition, when baking soda comes in contact with either an acidic or an alkaline substance,

it neutralises the pH and also resists further changes in the pH balance in a process called buffering. Since the 1930s the company has used the neutralising property of baking soda to develop many new products. More recently, growth has been achieved through acquisition.

The following table summarises the company's key product development activities since 1930.

)

Year Product development
1930s Uses baking soda in personal care products for the bath, body and teeth.
1950s Introduces baking soda products for baby care, camping and other personal care uses.
1970s Introduces powdered laundry detergent.
1972 Introduces a baking soda product for the fridge and freezer to keep food fresh.
1980 Introduces liquid laundry detergents.
1981 Introduces a carpet deodoriser.
1988 Introduces toothpaste.
1992 Introduces cat litter deodoriser.
1999 Introduces a spill-proof box for its fridge and freezer deodoriser products.
2000 Introduces baking soda products in a plastic shaker dispenser (previously, the only
packaging was boxes).
2001 Acquisition of laundry brands as part of the acquisition of USA Detergents, Inc.
Acquisition of the consumer products business of Carter-Wallace, Inc., purchasing
antiperspirant and pet care brands outright, and the remainder of the business,
including condoms, depilatories and home pregnancy and ovulation test kits,
in a 50-50 joint venture with a private equity company.
2003 Introduces product in resealable plastic pouches.
2003 Acquires former Unilever oral care business in the United States and Canada.
2005 Acquisition of the Spin brush battery-operated toothbrush business from Procter & Gamble. 4.1 6

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2006 Acquisition of Orange Glo International, a premium-priced leader in the laundry pre-wash additive category, bathroom cleaners, and household cleaner products.

Year Product development

2009 Swimming pool pH maintenance tablets sold through pool care outlets.

Products are typically sold through the supermarket distribution channel with the Arm and Hammer brand having more grocery aisle space than any other brand in the United States.

Source: Adapted from Arm & Hammer (2010), 'About us' <http://www.armandhammer.com/ aboutus.aspx> (accessed May 2010).

Ouestion 4.1

Using Ansoff's product-market matrix classifications, justify how you would classify (from Arm and Hammer's perspective):

• using baking soda in personal care products for the bath, body and teeth;

• selling baking soda products in a plastic shaker dispenser;

• acquiring the Spinbrush battery-operated toothbrush business from Procter & Gamble; and

• selling swimming pool pH maintenance tablets through pool-care outlets.

Other approaches to products and markets

Solutions, not products or services

Some organisations plan to meet total customer needs and provide a 'solution' that meets all of those needs for a customer, rather than base their strategy on the products and services that they can produce. For example, IBM derives over 40 per cent of its revenue using this 'solutions' strategy (Foote et al. 2001). IBM perceives itself as being able to build and run the entire infrastructure of a company's IT operations, not just the operating platform or hardware. Even in establishing the system, IBM may integrate individual products and services from competitors into the total solution, rather than providing products solely from its own product range. This approach makes the organisation a trusted advisor and also makes it difficult for competitors to displace it.

Another example of this approach is Coca-Cola. Part of its vision is to 'refresh the world'. The aim of the organisation is to provide a range of products that a consumer can consume at any time of the day or for any reason. In this way Coca-Cola is looking at the reason a person needs refreshment (i.e. benefit) rather than the product that they consume (i.e. water, cola, snack food) and aims to provide a solution for all consumers' refreshment needs.

If an organisation views its product or service as a commodity, the only strategic option available is to compete on price-a very limiting (and generally unprofitable) strategy. However, even products such as electricity and petrol-which appear at first sight to be 'commodities'-can be seen as different 'products' by connecting services to the base product and selling the package or bundle (Forsyth et al. 2000). For example, in the case of electricity, some electricity companies offer 'green' energy (i.e, energy from sustainable energy sources, such as wind and solar power) at a higher price. They may also offer energy efficiency consulting services (e.g. services to improve the electricity usage of housing and factories) which reduce the base use of power, but provide a different stream of income.

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Vertical integration

Vertical integration involves moving up or down the value chain and is another approach for considering product-market options. Moving 'up' the system is called 'backward integration'-this involves either acquiring control over suppliers or developing new supply operations....MOldng 'down' the system is called 'forward

integration'-this involves either gaining control over customers or developing new customer outlets and distribution operations.

The most important argument for vertical integration is to obtain strategic control

of the value chain. This can give advantages of certainty, quality control or supply reliability. Gaining cost control is another possible advantage. This can occur through the avoidance of marketing and purchasing costs for the two links in the value chain, such as the elimination of supplier margins.

For example, in the chicken meat processing industry, access to quality breeding stock is

a key success factor. The breeding and processing of chicken meat in the industry value chain are not particularly profitable activities. However, because of the critical importance of access to quality breeding stock to assure the supply of efficiently produced chicken meat, large chicken meat processors have had to vertically integrate into chicken breeding to guarantee the supply of high-quality, disease-free breeding stock.

Example 4.7 below on Diana Ferrari, a small company in Australia, is an example of forward integration, as the company had previously been a manufacturer rather than a retailer.

Example 4.7: Diana Ferrari-Growth through forward integration

Diana Ferrari was founded in 1979 in Victoria. Australia, originally as a small leather shoe-making business, focused on fashion footwear at mid-range prices. The company grew by providing quality fashionable ladies shoes and stocking products in major department stores and footwear retailers across Australia.

In conjunction with the expansion of its product range, the company opened its first retail concept store in 2000. Previously, Diana Ferrari had been a manufacturer only. The company currently has more than 28 retail stores and 10 clearance outlets, with plans to open more stores across Australia in the near future. The company-owned stores are marketed as a complete wardrobing solution for all occasions, so that women can purchase all their fashion needs in one location.

Source: Adapted from Diana Ferrari's corporate web site <http://www.dianaferrarLcom.au/inner. aspx?pageID= S&mainID=O> (accessed May 2010).

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There are several risks associated with vertical integration.

• There is often little capability overlap between different stages of the value chain (refer to Module 2 for a discussion of the value chain). For example, a retailer is unlikely to be an effective manufacturer, and the converse is also true.

Vertically integrated organisations are generally more volatile in activity and profitability than non-vertically integrated organisations because changing demand at one stage of the value chain also affects the other stages.

As vertically integrated organisations supply their output to internal customers, they may become less concerned with cost control in their internal operations than their market-based competitors.

Vertical integration can create organisational inflexibility. If the technology from one stage of the value chain becomes outdated, or there is a change in the distribution channels that are needed or used for the products or services being sold, the vertically integrated organisation may find itself more inflexibly

committed than its non-vertically integrated competitors.

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The critical aspect for an organisation to consider if it is thinking about vertical integration is whether it has the capabilities, or whether it can acquire them, to be successful in a new area of operations.

A good example of a vertically integrated global industry is the oil industrv. Muhinational

companies such as Shell, ExxonMobil and BP operate in all or most of the stages of the oil supply chain, from crude oil exploration, drilling, transportation and refining through to the sale of petrol. These companies need a wide range of technical and commercial skills to successfully operate each link in the value chain.

Information about ExxonMobil's key activities can be found on their web site at <http:/www.exxonmobil.com/corporate/about_what.aspx> (accessed May 2010). You should read this and then respond to Question 4.2.

Question 4.2

Vertical integration in the global oil industry

For each of the stages of the supply chain (crude oil exploration, drilling, transportation, refining, sale of petrol), what capabilities do you think the organisation needs to have in place to operate successfully?

New product development

New product development and delivery is critical to creating new wealth and the growth and survival of business, and is a major concern for many organisations, regardless of size. The successful development and delivery of the right product or service can mean the difference between an organisation's continued success and growth and its decline and failure. Success has been made even more challenging because of increased financial pressures, global market considerations, and offshore manufacturing in many industries in lower labour cost countries such as China.

Companies with high market shares need new products to grow business, and in fast-moving industries, such as electronics, it is estimated that 50 per cent of industry sales come from new products or services introduced during the last five years.

Some organisations today specifically aim to achieve a fixed percentage of revenue from new products. The 3M company has operated for over 100 years (3M 2002) on the basis of innovation and product development, and is a commonly quoted example of a company that continually makes its own products obsolete by developing new products to replace them.

By being successful in new product development, organisations can significantly outperform other businesses in terms of revenue contribution to growth and development productivity. New products may also be able to attract higher prices and profit margins, depending on their benefits over existing products. Success in new product development is attributed to superior project execution, market-driven portfolio management and effective management support systems (Ettore 1995).

Most organisations have many more opportunities for investment than their resources will generally allow. Despite this, new product development efforts continue to fail.

It is estimated that from 3000 raw ideas there is only one commercial success-that is, a product that makes enough money to undertake the research to invest in further new products (Hultink et al. 1997)-and this success rate has not improved over the past

30 or 40 years.

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Typical causes of failure are:

• Developing the wrong product or service-inadequate product or service for market requirements, or the product or service is overtaken by technology or competitor products.

• Inadequate planning and control-cost overruns, poorly designed or incorrectly

designed products or services, and overpriced products or services.

• Schedule delays-missed window of opportunity because of poor timing.

• Performance issues-the final product or service developed does not meet customer requirements or expectations.

An understanding of what makes new products successful and the practices and characteristics that distinguish the successful from the unsuccessful new products is critical for identifying criteria to maximise both the value of individual projects and, in combination with a number of other strategic decisions, the value of an organisation's new product portfolio.

Cooper and Kleinschmidt (2000) have undertaken extensive research to understand the critical factors that underlie successful product developments in Australia. According to their research, the determinants of success are broadly grouped into four areas:

• Product advantage-its elements (such as value for money, relative product quality and superior end-user benefits).

• Execution-up-front or pre-development activities, marketing tasks, technical tasks and project organisation.

• Company environmental variables-marketing and technical synergies, top management support, perceived risk, the firm's power over the technology development and customer influence.

• Opportunity variables-market conditions and technological conditions.

Market research is an integral component of the new product development process.

It should be considered an investment in reducing the uncertainty and risks associated with new product development. This includes the research approaches used for remote environment analysis considered in Module 2.

Different market research techniques are used at different times. Each has advantages and disadvantages, and some are more difficult or more expensive than others. However, it is important to understand that customers cannot describe what does

not exist. All they can articulate are their needs and the context within which these needs exist. Greatest success comes from qualitative rather than quantitative research. Traditional market research and focus group methods work for product development which extends the functionality of existing products and services, but they do not work at all well for what are termed disruptive technologies-those few product developments that can change the basis of competition in an industry.

Success in new product development in any organisation requires the whole organisation to understand and focus on what the customer market values. However, being tightly focused on highly valued requirements or outcomes is necessary but not sufficient for success. The organisation must also have the means to execute delivery more effectively and efficiently than the competition. If this is achieved, new product (and service) development will be a strategic capability of the organisation.

The ability to learn faster than your competitors may be the only sustainable competitive advantage (Arie de Geus, Royal Dutch Shell, cited in Senge 1990, p. 4).

And what an organisation learns and implements must be what the customer cares about.

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In his article 'Mining for new product successes' (Magrath 1997) suggests that there are seven proven strategies that can reduce the risks associated with bringing new ideas

to market:

• mining customer complaints;

• mining observed behaviour with existing offerings;

• mining customer aspirations versus needs;

• mining neglected or overlooked customer segments;

• mining extremes of science or art;

• mining 'holes' on competitor line-ups; and

• mining lead-user customers for applications.

Reading 4.1, 'Mining for new product successes: provides an overview of approaches some organisations have taken to increase the chance of success in bringing new products to market. You should read this now.

Note: This reading is not in the printed study material. It is available via ProQuest. Please refer to the instructions in the Segment Outline for accessing readings in ProQuest.

Stages of the new product development process

New product development (NPD) encompasses a wide range of activities, depending on the type of product being developed and/or the extent of change from an existing product. The key steps of the new product development process are summarised

in Figure 4.2.

Figure 4.2

The key steps of a generic new product development process

Steps Description
Generating and capturing ideas Generating product ideas is the first step for most product development
processes-what are the consumers' unmet needs or what product
enhancements can be made?
Screening ideas Once a number of ideas have been identified, they must be evaluated against
a variety of criteria, such as the problem they solve for customers, the
potential investment costs to develop the product, the fit with the company's
existing strategy, the potential costs, profits and ROlon the product.
Product development This involves the development of a working prototype of the product,
transforming it from the concept into a tangible product that can be test
marketed.
Test marketing Marketplace testing helps to identify any changes to features and price, and
verify market demand.
Commercialisation Commercialisation means taking the successfully built and test marketed
product, and making it a success in the overall marketplace.
Launch Launching the product in the market is the next step.
Service It is also important to support the product in the marketplace. New and complementary products can also be acquired by organisations through mechanisms other than their own product development capability. This includes licensing agreements and acquisitions. Such mechanisms would require having the business skills, systems and processes to identify, acquire and effectively integrate these offerings into the existing product and service portfolio of the organisation in order to realise the benefits of business growth.

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While the above can be a useful approach, it is broadly agreed that an organisation should not outsource its core capabilities. These represent its advantage in the marketplace and, if they are eroded, the organisation opens itself up to greater competition from potential competitors. An organisation has to be clear about what its core capabilities are and what its customers really value from it, over and above what

they obtain, or could obtain, from competitors. Therefore, if product development is critical for success in the industry, the organisation would want to retain a core function of new product development to meet industry requirements as a strategic capability.

In-house systems and processes need to support the steps of new product development, although some of the steps can be out sourced (such as prototype development and market testing). Note that this is a broad overview of the steps in the process and that they can vary to reflect the specific requirements of different industries.

Linking new product development projects to strategy

The vision, mission and strategy of an organisation are set in operation by the decisions and strategic choices that the organisation makes on where to spend money. According to the management of a number of businesses surveyed by Cooper et al. (2006), strategy remains a word in a document and does not begin until spending starts.

If an organisation's strategic mission is 'to grow via leading edge product development', this must be reflected in the number of new projects underway that will lead to growth. Projects need to be assessed for their consistency with the business strategy, and spending breakdown must reflect strategic priorities. This can be achieved by building strategic criteria into project selection tools and setting aside allocations of resources (e.g. financial, etc.) destined for different strategic priorities.

Some examples of where strategic choices about resource allocation can be made include:

• strategic goals-what should be spent on projects that defend the base, diversify the business or extend the base;

• product lines-how much should be spent on line I, 2 or 3;

• project types-how much should be spent on new product developments, maintenance projects, process improvements;

• familiarity matrix-how much should be spent on different types of markets and technologies (as opposed to familiar ones); and

• geography-how much should be spent on various geographic regions.

Once this resource allocation has been decided, the actual situation versus the desired situation can be mapped. Projects should then be prioritised so that decisions can be made about how to address any gaps or overlaps identified.

The major strength of this approach is that it leads to the alignment of an organisation's business and product strategy. However, it is a time-consuming process and making resource allocation choices is not necessarily easy.

There are a number of dimensions upon which projects can be scored, such as:

• fit with business or corporate strategy;

• inventive merit and strategic importance to the business;

• durability of the competitive advantage;

• reward, based on financial expectations;

• competitive impact of technologies (base, key, pacing and embryonic technologies);

• probabilities of success (both technical and commercial);

,

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• research and development costs to completion;

• time to completion;

• capital and marketing investment required to exploit the technology;

• skills availability;

• political importance; and

• provldmg a project to keep a good new product development (NPD) team together.

New product projects then need to be considered in the context of a portfolio of projects that the organisation may be currently supporting. Some key considerations to achieve a 'balanced portfolio' include the following:

• Risk versus reward-Organisations need to develop their own criteria for risk based on their business strategy. One of the most popular approaches is to show the portfolio of projects on a risk versus reward evaluation scale, with the axes being an index of a number of criteria (possibly weighted, but this is not necessary).

• Timing issues-Timing is an important consideration in attempting to achieve

a balanced portfolio. Organisations should be aiming for a constant stream of

new innovations in the short, medium and long term. It is therefore critical

that resources be appropriately allocated to projects that will deliver outcomes

in the required time span. Organisations must manage their work flow to avoid undertaking many projects at the same time only to then have periods of inactivity. This helps the organisation to manage cash flow and bring a steady flow of new products to market.

• Project type issues-Most companies also seek a balance of spending across project types, such as genuine new products versus product improvements, extensions and maintenance. Again, the importance of various categories will be influenced by the business strategy (e.g. whether the company wants to position itself as a leader or follower of innovation). Various approaches can be used to classify project types, such as technology characterisation, product type and product geographic market. The organisation needs to develop an approach that will ensure resources are available to support its preferred balance of project types.

• Resource allocation issues-Some companies use a strategic buckets approach to such resource allocation. This approach means that certain 'buckets of money' are allocated to areas that have been identified as being of strategic importance to the business. This might include a certain percentage of the available budget being allocated to new products, existing products, or new markets or geographic regions.

New product development as a strategic capability

If new product development is truly a strategic capability of an organisation, that organisation may be getting new products to market so fast that it is already launching the next iteration of a product before its competitors have had the chance to copy the original product. This is especially true of those organisations that operate in the fastmoving consumer goods (FMCG) area. These organisations may choose not to protect their intellectual property (IP), except perhaps for product name copyright, and rely on having first-mover advantage in the market place.

This has become a more widely used strategy in recent years as globalisation has speeded up knowledge exchange and technology transfer around the globe. Organisations can

no longer pilot launch new products in selected markets-rather, they need to have in place strategies to go global from the outset, pricing the new product at a mass market price. This strategy is a response to high-value innovations being reverse engineered in locations with much lower costs of production and subsequent flooding of the market with cheaper versions of the new product. While the originator of the product may not yet have been able to realise the economies of scale, the cheaper version of the product would have already have done so. Kim and Mauborgne (2000) call this the 'price corridor of the mass'.

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Intellectual property and new product development

'Broadly speaking, the term "IP" refers to unique, value-adding creations of the human intellect that result from human ingenuity, creativity and inventiveness' (World Intellectual Property Organisation (WIPO) n.d.).

In most countries around the world, national legal systems of IP rights exist which have made it possible to harness the commercial value of the outputs of the new product development process for creating and marketing new and improved goods and services in domestic and export markets.

The grant of an IP right by a government provides the owner of such legal property the right to exclude all others from commercially benefiting from it for a defined

period of time. In other words, the legal right prohibits all others from using the underlying IP asset for commercial purposes without the prior consent of the IP right holder. The different types of IP rights include trade secrets, utility models, patents, trademarks, geographical indications, industrial designs, layout designs of integrated circuits, copyrights and related rights, and new varieties of plants. Consider the Coca-Cola company, which has a patent on its recipe for the cola beverage 'Coke', or a pharmaceutical company that obtains a patent for a new medicine it has developed for reducing blood pressure.

However, protection is often only sought and provided in selected geographic jurisdictions (principally because of the high costs associated with IP protection in multiple jurisdictions). A key consideration of new product development is the freedom to operate with IP, whether it has been created by the organisation itself or whether the use of specific technology or know-how is being licensed from another organisation.

Infringing intellectual property rights

Organisations need to ensure they confirm the ownership of any IP which they plan

to use. They can expend considerable effort and expense in creating and establishing new markets for products generated with IP they think they own, only to find out later that they may, in fact, have infringed another organisation's IPi this can lead to costly litigation. This is a strategy often discovered too late by small to medium-sized firms that use all their resources to establish a market position, only to find out that a large market competitor has been watching them all along and waiting till they have done all the hard work in creating and establishing a market for a new product or service before challenging their right to use the technology, product or service. Importantly, a challenge may simply be on a component of IP being used, but without it the product or service cannot be provided.

For example, in the pharmaceutical industry it is common for pharmaceutical companies to have multiple layers of patents on a product. Termed primary, secondary and sometimes even tertiary patents, such patent protection acts as a strong deterrent to competitors. An example is GlaxoSmithKline PIc's asthma reliever medication, which has a primary patent (on the chemical molecule salbutamol) and secondary patent on the delivery device (metered dose CFC-free inhaler). When the primary patent expired several years ago, the company was protected from generic competitors launching a competitor product for a year due to the secondary patent it held.

)

Protecting intellectual property rights

If an organisation invests in intellectual property rights (e.g. patents and trademarks), it must also be prepared to invest in protecting those rights in a number of market jurisdictions. If it cannot afford to do this, it risks investing in a product and/or brand that will be diluted in value by counterfeiting of some sort.

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Counterfeit products cost companies billions of dollars each year, especially in the mass consumer goods market (e.g. DVDs, designer watches, software). This means that an organisation cannot fully exploit the financial rewards that are due to it from the resources and intellectual capital invested. Since it has not earned as much, it has fewer resources to devote to its next product, service or invention. That might mean there is

no next product and the world as a whole is denied the benefit.

The pharmaceutical industry is one of the industries where this has had a major impact. Based on product and process patents, Asian companies have been able to offer cheaper or generic HIV drugs to South Africa, which a majority of South Africans would not have otherwise been able to afford. On the other hand, pharmaceutical companies have invested billions of dollars in research and development (R&D) that has not always yielded the maximum financial results, and which they insist affects their future ability to invest in R&D.

Example 4.8 outlines how intellectual property is sometimes dismissed in non-Western countries (often due to cultural differences) and frequently circumvented by making slight changes to the product or process. New Balance found this out the hard way. Sometimes even third-party manufacturers for a multinational company (MNC) manufacture greater quantities of the MNC's products than those ordered and sell them to parties other than the owner of the product.

Example 4.8: New Balance wins landmark lawsuit in China against counterfeit brand

Boston, August 29, 2oo6-Global athletic footwear leader New Balance Athletic Shoe, Inc. announced today that it had won a significant trademark infringement lawsuit in China against Chinese footwear maker Qiuzhi Footwear. The court awarded New Balance a monetary award of 600 000 RMB

(USD $75 000) and ordered Qiuzhi to stop producing its 'New Barlun' athletic shoes.

In 2002, New Balance discovered a group advertising itself as 'American New Barlun (Hong Kong) Limited' conducting business in China and promoting a relationship with the 'American New Balance' company. New Barlun (which when spoken quickly sounds much like New Balance) had acquired trademarks which were similar to those of New Balance and combined them with packaging, advertising, and slogans also similar to the brand. New Barlun began selling franchises and

opening retail stores throughout China. New Balance took immediate action, working with China's Administration for Industry and Commerce (AIC) with limited success.

In 2003, New Balance discovered that New Barlun was a front established in Hong Kong by a Chinese company called Qiuzhi Footwear. New Balance then sued Qiuzhi in the court of Hangzhou. Harley Lewin, of Greenberg Traurig LLP, coordinated the legal battle on behalf of New Balance.

After almost three years of litigation, the Court agreed with New Balance's arguments and found Qiuzhi liable to New Balance for trademark infringement and unfair competition. The Court agreed that New Balance'S use of an 'N' logo on footwear is particularly connected to New Balance products, and that although Qiuzhi owned a similar trademark, their use of an 'N' was confusing and deceptive to consumers. The Court also agreed that Qiuzhi's use of the name 'New Barlun' infringed on the New Balance trademark.

New Balance, headquartered in Boston, MA, is a leading manufacturer of technologically innovative widthsized performance footwear and athletic apparel for women, men, and children. The range of product categories includes running, walking, training, basketball, tennis, cleated and kids. New Balance employs more than 2800 people around the globe, and in 2005 reported worldwide sales of $1.54 billion.

Source: New Balance (2006) 'New Balance Wins landmark lawsuit in China against counterfeit brand', New balance Athletic Shoe Inc., 29 August <http://www.newbalance.com/corporate/ pressroom/2006/08/corporate_2006_08_29_191.php> (accessed April 2010).

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Key success factors for new product development

According to Drake et a1. (2006), to be successful in new product or service development and to maximise the returns from investment in innovation, organisations need to have in place the following:

• fight €f)l'lt~t have in plaEe-organisatieHal SM13pef+-for new pF€)aMEt ae-ve#tpHHmt

as a growth strategy in alignment with overall business strategy;

• business leadership and organisational alignment-have formal systems and processes for evaluating product and service concepts to identify the most promising concepts with agreement to stop projects that are not working quickly and reinvest in new projects; and methods for reviewing failed projects to integrate any learning into new projects and to update assumptions to continually model risks and rewards based on updated information that is uncovered during the project implementation process;

• customer input-use customers as the source of product and service concepts, involving them early and using a formal product development methodology for capturing unmet needs and converting them into product design specifications; and

• right capability-use cross-functional development teams with representation from key organisational divisions and use outsourcing and partnering to, for example, license new technologies and produce new products and services. Rather than investing in new infrastructure, focus on developing organisational capability in rapid new product and/or service development (as well as sharing risk in the process) (Drake et al. pp. 33-4).

New market development

Like new product development, new market development is assessed from the perspective of the organisation, and can either be the development of new customer markets, the development of new geographic markets, for the organisation or a combination of both.

Typically, an organisation will have some capabilities that it feels it can exploit as the basis for developing these new customer or geographic markets as indicated in Table 4.1, below.

Table 4.1

Basis for entering the market

)

Basis for enhanced customer value Basis for low-cost position
• Superior technology • Low-cost raw materials
• Superior quality • Low-cost labour
• Innovative design • Economies of scale
• Better functionality • Economies of scope
• Customisation • Cumulative volume
• Better related services • Customer base
• One-stop shopping • Network externalities
• Solution selling • Efficient process
• Brand image • Technology
• Responsive distribution • Tirne management
• Customer relationships • Productivity management
• Customer services
• Financing Source: Adapted from Lasserre, P. (2003), Global Strategic Management, Pangrave Macmillan, Basingstoke, Hampshire, p. 47.

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Expanding into new customer markets

Customer markets can be defined as aggregates of consumer groups with similar

needs. Several different approaches to defining customer markets can be used either by themselves or in combination. Organisations may target new segments of the market witi'i existing pr600ets in 6reer-terinerease sales. S6me-preooet-m:e>di:&eatiem--may-be

required, such as new packaging, but to meet the criteria of being an existing product differences are limited.

Grouping customers by distribution channel is a very common approach, as distribution is so important to revenue generation. This might be addressed by an organisation employing account managers and sales representatives to service specific distribution channels.

For example, a wine-making company may traditionally sell to wholesalers (also known as wine merchants), who then sell to retailers, and consumers buy the products from the retailers. The wine-making company may then decide to sell directly to selected retailers. For this it would most likely need to employ a sales representative to manage these accounts. It may then decide to try to supply a completely new market segmentfor example, restaurants. To do this it will need additional capability in sales and after-sales service, as well as being able to distribute small quantities to many customers. For both these situations, the products are unchanged; it is the market participants

who change.

Online customer markets are a further customer grouping which is growing at increasing rates each year. As the Internet becomes more accessible and secure, online purchases are becoming more popular with larger segments of the market. Online shopping is growing in popularity across a range of areas; in some sectors, such as online supermarkets, it

is becoming more popular as a result of the time-saving and convenience it offers to consumers. In other areas, such as books, music and clothing, it is growing in popularity because it allows consumers access to products that may not previously have been available in their geographic area. According to a Nielsen survey (2008), consumers around the world are increasingly shopping online and over 8S per cent of the world's online population has used the Internet to make a purchase, up by 40 per cent from when a similar survey was undertaken two years earlier.

Expanding into new geographic markets

Once a company is successful in its existing markets, it would seem natural for it to expand its business by extending its operations to new markets either domestically or internationally.

An organisation is also likely to have strategic reasons for seeking out new markets, which could include:

• market-related factors-the size and growth of the local market is limited;

• resource-related factors-access to skilled labour, natural resources and/or capital is constrained in current markets;

• efficiency-seeking factors-labour and other factors of production can be sourced at lower cost in other markets; and

• quality of the business environment-governments are offering incentives for locating in specific areas, or the political and legal landscape is more stable.

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Organisations may be attracted to enter geographic markets where access to knowledge and learning opportunities may be greatest. Many companies from Japan and Europe, for instance, established specific research and development operations in California to network with the companies of Silicon Valley. Companies may also consider entering

a new geographic market to establish regional coordination centres. For example,

many airlines, such as Ietstar or Cathay Pacific, have established regional offices in Singapore or Hong Kong to serve as regional hubs for their wider investments and activities in East Asia (Lasserre 2003).

At the same time, consumers in different markets may have varying preferences and producers may need to adapt their products and services accordingly. For example, local Asian markets are very price sensitive and customers are unwilling to pay a premium for products and services, other than for luxury brands. Tariff barriers, import duties and industry business models have historically made it very difficult for Australian, US and European companies to enter the Indian and Chinese markets with products from the home country and have therefore had to set up local manufacturing operations.

Developing an internationally focused strategy involves changing perspectives and competitive positions. The internationalisation of business involves the process of increasing the activity of international operations across borders. This necessitates substantial changes in perspective and positioning. The process of internationalising strategy therefore determines the development and change of the company's ambitions, ideas, scope, activities and organisation (Melin 1992). The strategic thinking of a multinational company will orientate it towards particular objectives, which can influence many aspects of the commercial approach of the company, as well as its structure, culture and employment practices. But strategy itself is heavily influenced by the culture of the company's home country and the cultures encountered in different countries and regions.

Development of new geographic markets

Figure 4.3 outlines the growth options for international business, beginning with the fully domestic company in which all activities are integrated in the home market.

Often international activity begins with sales through overseas agents that can develop

to include marketing and servicing activities. At some stage the opportunity of assembly overseas may become attractive and then it may become more logical to produce the major components overseas in foreign subsidiaries. However, production may be in a different overseas country from the countries where most of the marketing and sales

take place, as sales may be concentrated in high-wage economies and production in low-wage economies. The final stage of internationalisation is when all of the production, marketing and servicing functions are integrated overseas. Normally, corporate operations would only be deemed 'global' when all this activity was fully integrated in a range of overseas countries, with sales and marketing occurring in many countries.

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Figure 4.3

International growth options

Home Country A

Home Country B

Home Country C

Foreign production subsidiary

Home Country 0

Integrated foreign subsidiary

Source: De Wit, B. & Meyer, R. (200S), Strategy Synthesis: Resolving Strategy Paradoxes to Create Competitive Advantage, 2nd edn, Thomson Learning, London.

The ability of a company to internationalise depends on its ability to appreciate the environmental differences, understand the risks and implications, and then counter or adapt to them successfully. It should be noted that not all host countries have totally different environments from the home country of a prospective business. Sometimes companies do not have to adapt too much, for instance, in cases where the strategy is to deliberately target similar markets as a learning exercise for internationalisation.

Objectives of market entry

In venturing overseas, companies may be looking to develop new markets; secure access to critical resources, cost efficiencies or new knowledge; or establish a base for regional coordination. Timing is crucial and having first-mover advantage may be attractive. However, it is less risky to follow other companies when the pitfalls are well known. The scale of entry is also important. A small but significant investment might involve less risk than attempting to achieve large-scale penetration in a new market at an early stage. Finally, the mode of entry must be viable and allow further investment and development later (if this is attractive). Among the modes of entry most employed are:

• exports;

• licensing;

• franchising;

• joint ventures;

• strategic alliances; and

• foreign direct investment in wholly foreign-owned enterprises.

The strategic objectives of market entry are assessed in relation to the other criteria of entry by Lasserre (2003) (see Table 4.2).

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Table 4.2

Strategic objectives of market entry

Market Resources Learning Coordination
Expectations Market penetration Access to natural Understafj(j state 6f1ffe -Seruplfase-for 9rooal
and development resources art technology or regional development
Capture a share of Access to skilled Close to best practices Establish logistic
the market low-cost labour centres
Learn to compete
Access to suppliers in difficult and Close to financing
sophisticated markets institutions
Key performance Growth Costs Know-how Speed
indicators (KPls) Market share Quality Process improvement Control
Gross margin Supply access Synergies
Timing Window of opportunity First mover in order to As soon as the country Three stages:
pre-empt resources is recognised as • initiation
First mover v. follower 'competence' centre growth

• coordination
Type of countries All types prioritised as Resource-rich countries Countries with Hubs
a function of market strong technological
potential, quality and and know-how
competitive context infrastructure
Mode of entry Depending upon risks, Wholly owned Joint venture Representative office
opportunities, timing (if allowed and if R&D centre Global HQ
and skills low risk)
All modes of entry Joint venture Observatory Regional HQ
may apply (if requested) Logistic centre
Long-term sourcing Training centre
contracts
Financial HQ Source: Adapted from Lasserre, P. (2003), Global Strategic Management, Pangrave Macmillan, London, p. 190.

In terms of market development, any country offering a market of sufficient size and rate of growth is potentially attractive. However, relevant considerations include the distribution of income among the population in the country, the stability of growth and the existing degree of local and international competition in the market. The countries with the largest and most mature markets are regarded by the large multinationals as being the most important to be in. These include the United States, Japan, Germany, France and the United Kingdom, as well as countries with the fastest-growing markets, including China and India.

However, there is another dimension to internationalisation that may be of much greater substance in practice. There is a universal tendency of small and medium-

sized enterprises to internationalise by becoming familiar with their neighbouring country markets. Such companies feel confident in operating in countries that have similar business cultures to their own. For example, in the Asia-Pacific region there are many small companies that operate in several neighbouring countries, often through extended families and acquaintances. Though these companies are often small in scale, the cumulative total of this international business activity may be very effective in generating a dense pattern of trade and international business links.

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Access to resources remains a major reason for overseas market entry, including:

• mineral resources, such as oil, iron ore and copper;

• agricultural products; and

• human resources, whether in terms of plentiful supplies of low-wage labour or scarce supplies of highly skilled people.

Selecting the right market to enter is critical to increase the chances of success and the likelihood of further overseas investments. An early failure in overseas expansion can set back the likelihood of internationalisation for a company by many years. The objectives for entry may be multiple but should be clearly articulated and prioritised. This will influence subsequent decisions on timing and mode of entry.

Market attractiveness

Selecting attractive new markets requires research. Importantly, the criteria for business attractiveness are dynamic and subject to change over time. This might involve a gradual improvement of conditions or a sudden deterioration. Research needs to take this into account.

Critical questions to be addressed by any company contemplating new market development include the following:

• The size and value of the proposed market. This might be in terms of the number of units sold, which can be roughly calculated by multiplying the number of customers by the average sales per customer and the number of sales per customer per year.

It's important to remember that what might be considered a large opportunity by one organisation may be considered insignificant by another-it's all relative.

• Market growth. All the factors applied to remote environment analysis can be applied to understand what is driving the growth of this segment and confirm whether it is attractive in terms of future growth.

• Market profitability. All the factors applied to industry analysis in Module 2 can be applied to understand what is driving the profitability of a particular industry or segment and confirm whether it is attractive in terms of future profitability.

The organisation must decide on the degree of accuracy required in gathering this information. It may not be necessary, for example, to know that a market is worth

$67 million annually-it is enough to know it is worth over $50 million. It may be enough to know that a market falls between the upper and lower estimates of $100 million to

$200 million per annum. However, there will be occasions when high levels of precision are needed, perhaps because the investment is large within the context of the total market.

In general, a generous tolerance on market size is permissible under the following conditions:

• when an investment is very small within the total market;

• when the study is a preliminary scan of the market; and/or

• when the key objective is to decide how something, rather than what, is going to be achieved.

On the other hand, a higher degree of accuracy would be expected where:

• the investment is large within the total market and the investor aims to achieve a significant share within it;

• market sizes from different years are needed to show a trend; and/or

• it is necessary to split out segments of the market which could be attractive targets.

In international markets, it is not just the size and growth but the nature of demand that can influence decisions on investment. As the gross domestic product (GDP) of a country grows, there is a significant impact on disposable income and the growth of

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the middle class (both India and China now have a large middle class with significant disposable income, which explains the arrival of the luxury goods industries in these markets). What may have been expensive consumer goods in developing countries, such as refrigerators, washing machines, televisions and telephones, become mass consumer goods acquired by increasing numbers of working families. In gauging the

potential of new markets overseas, the following factors are also relevant to consider:

• Obsolescence and leapfrogging of products-The international product life cycle theory of marketing, whereby products reaching saturation in advanced markets can be produced in developing markets for consumers experiencing this product for the first time, may be displaced by the leapfrogging of products. The diffusion of ideas and technology is now so rapid in the world that even people entering the market for the first time want state-of-the-art products if they can obtain them. For example, in China, where landline telephone technology was not widespread, consumers 'leapt' from not having telephones at all to using advanced mobile telephony.

• Prices-In different countries people will pay for essential products even if they are scarce and expensive. For example, food is more expensive in Japan than in many other countries and takes up a larger share of disposable income. The expenditure patterns of consumers will vary in different countries according to what they view as essential.

• Substitution-In some countries it is possible to find substitutes for products that are highly valued in other societies. For example, in Hong Kong the cheap and efficient public transport system reduces the market for automobiles significantly.

The next consideration is how the product will get to market.

• Distribution-How will the customers in the market be reached? Does anyone have control over distribution channels to reach these customers? Can new methods of distribution be established?

• Value proposition-It is likely that the target customers are already being serviced, so it is important to consider and understand what it is about the product or service being offered that could entice these customers away from competitors. Is the offer better than the current suppliers' offer to the proposed customer segment? How?

The organisational capabilities required to enter the market need to be considered along with whether they are available, for example:

• Resources-Does the organisation have the resources to enter the market?

If not, how can it get them?

• Capacity-Does the organisation have the capacity to supply the market?

If not, how can it get it?

• Service-Does the organisation have the capacity to service the market?

If not, how can it get it?

Organisations then need to make an evaluation of the likely risks. It is critical to identify all the risks involved in implementation (for example, operational, timing and resource risks) and understand their likely impact on achieving the desired market position. Module 5 provides more information on how to approach a risk analysis.

Using a standard approach makes it easier to directly compare possible market alternatives as objectively as possible, to answer the following questions (Lasserre 2003):

• Do the market potential and competitive conditions offer prospects that will enable the company with its competitive advantages to generate returns equal to or higher than the cost of capital?

• Will the specific investment in some significant way develop the company's capability, assets or competitiveness with regard to competition in other markets?

• Are the risks of operating in this particular market acceptable for employees, shareholders and the company's reputation?

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Market development resources

Market development requires careful investigation of the business and social environment in a new market. The external and internal analyses carried out by the organisation

are supplemented by information about the desired market in terms of assessing of the flli~eftt af the arganisatian's intemal capabHtties anc:Hts-des-rl'ed-posiLiolI in the market

or industry. Key to effective strategy implementation is a natural fit of the organisation in its desired position, and in order for this to happen a number of external resources can be used. Globally, various government and other business facilitation organisations can be used as primary resources in analysing how to expand an organisation's market. It is important to note that an organisation may choose to commission private research to ascertain the suitability of an international expansion strategy; however, this is generally quite costly and not practical for many organisations. In the following section some of the government and non-government organisations that provide useful and current market and industry information are introduced.

Global financial organisation resources

Global financial institutions can playa variety of roles in market development, with their principal involvement being to provide information and act as a link to local institutions and networks. Many national governments have established organisations to facilitate international trade, or provide financial or advisory assistance to those organisations that want to operate within their countries.

A number of international bodies carry out extensive research on a range of topics. As a result of this, the web sites of such organisations can provide useful information about various national markets and issues affecting economies. This information can be an important first point of reference for organisations looking to expand their geographic market, as the research is easily accessible and current and can thus inform the decisionmaking process. An example is the World Bank report 'Paying taxes 2010-The global picture' <http://www.doingbusiness.org/features/taxes2010.aspx> (accessed May 2010), which provides information on the ease, or difficulty, of complying with taxation requirements around the world. This report states that Singapore makes it easy for companies to comply with taxation requirements. This information, combined with the fact that Singapore offers generous tax concessions to businesses setting up operations there, may inform the strategic decision-making process to establish operations in Singapore. Appendix 4.1 contains details of a number of such international organisations.

Regionally focused organisation resources

Certain organisations are focused on their national or regional location with the goal

of promoting trade or investment in that region. This may be by assisting imports into that region, or by facilitating business investment into particular countries. Depending upon the region or country of interest, it is worthwhile to check the assistance or opportunities these types of organisations may be able to offer. The information obtained from such sources can often be combined with information from organisations such as the World Bank to give a good picture of the business opportunities that exist in certain locations. It is cost-effective to use such resources for business research rather than commission your own research, at least in the initial stages of expansion.

In addition to gaining knowledge of the regulations and potential government incentives which may be available, developing and maintaining a network of business contacts is useful in market development. Many organisations operate with this purpose in mind, with some key examples being local chamber of commerce groups. You should have a look at the web sites of some of these groups to get a clear view of their roles and activities. The web site of the Hong Kong General Chamber of Commerce <http://www.chamber.org.hk> (accessed May 2010) contains a wealth of information about its activities.

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The organisations noted in Appendix 4.1, as well as a number of other government and non-government groups, can assist in market development in foreign markets by enhancing your awareness and knowledge of potential differences between your home market and a new geographic market. Some examples of the issues which may affect an organisation's ability to implement a strategy of expanding into a new international

market include:

• the laws and regulations of that country, including taxation laws, corporate governance systems and customs restrictions;

• foreign exchange regulations, as it can be difficult to repatriate future profits back to the head office. For example, China is often seen as a location where this issue requires careful planning;

• barriers to entry (in selected industries in some countries), which may prohibit, or at least discourage, foreign firms from entering some industries. For example, some sectors of the health care market in Japan are closed to foreigners;

• the attitude of the regulators in the target market to bringing in expatriate

workers (and their families). Companies are often uncomfortable about making a substantial investment in a country where they cannot relocate known and trusted employees from head office. Hong Kong and Singapore are generally considered liberal in terms of allowing expatriates and their spouses to enter and work;

• considerations of corporate social responsibility (CSR). For example, it may be accepted practice in some countries for workers to be paid low wages and work long hours, but if this practice were reported in the head office location, it could be embarrassing and might have a serious impact on potential profits. For instance, poor management of chemical wastes may be accepted in some countries, but is not acceptable in a growing number of countries which are implementing strict environmental protection laws.

Example 4.9 below illustrates how market attractiveness criteria were assessed in order to identify promising markets for confectionery from 16 countries in Asia.

Example 4.9: Identifying growth opportunities for confectionery in the Asia-Pacific region

Evaluation criteria used to assess country attractiveness included:

• the size of the confectionery market-a score based on market size, confectionery market value, consumption per capita, price per kilogram, tax rate and the weighted average cost of capital;

• growth of the economy-a score based on the size of the urban population, GOP (PPP; purchasing power parity) per capita, GOP growth per annum, levels of unemployment, the inflation rate

and electricity consumption per person; and

• economic and political risks-a score based on an assessment of the stability of the government, likelihood of restrictions on trade, general views on foreign direct investment (FOIl, tariff and nontariff barriers and the legal system.

For each component of the three factors assessed, 16 was the score for the most attractive country and 1 was the score for the least attractive country.

The scores generated were then sorted to rank the markets in order of attractiveness. Weightings were not applied, but could be if more emphasis on political and economic risk were required. However, the aim of the exercise was to rank the best prospects and communicate this information to encourage internal discussion. Communication is generally facilitated by keeping analysis straightforward at this stage of decision-making, and weighting selected criteria can create confusion.

Table 4.3 below shows that the analysis identified the most attractive markets as being Japan and Singapore and the least attractive (by quite some way) as Myanmar and Laos.

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Table 4.3

Market attractiveness of various countries in the Asia-Pacific region for confectionery sales

Market attractiveness
sue Growth Risk Total
Japan 46 74 38 158
Singapore 35 69 46 150
New Zealand 39 53 49 141
Australia 42 47 50 139
Malaysia 28 65 35 128
Taiwan 23 69 34 126
Hong Kong 33 38 38 109
South Korea 20 56 33 109
China 21 58 28 107
Thailand 14 60 31 105
Philippines 26 35 31 92
Cambodia 10 42 26 78
Indonesia 27 35 16 78
Vietnam 14 36 20 70
Myanmar 14 32 11 57
Laos 10 21 23 54 In order to do this analysis, ran kings were made based on actual data for each of the factors contributing to the assessment. This data was collected from various public sources, company reports and market intelligence. Assumptions also had to be made in some cases. For example, the size of the confectionery market for Cambodia, Laos and Myanmar was derived by using the same per capita confectionery consumption as Vietnam and multiplying that figure by the respective populations of those countries, because per capita confectionery consumption data for these countries was not available.

Electricity consumption per capita is an interesting factor that was specifically incorporated for the confectionery industry. This is because some types of confectionery (specifically chocolate, which represents around 60 per cent of the total confectionery market) need to be refrigerated, particularly in the warm Asian countries. It is therefore an infrastructure requirement for successful entry into a new market for confectionery, and electricity consumption per capita is regarded as an indicator of whether a market has this infrastructure in place. This also explains why urban population growth was chosen as a component of market growth (rather than overall population growth),

as rural populations in developing countries are unlikely to have the necessary infrastructure in place.

For a confectionery company, the next step in this analysis would be to assess how much market share it already has in each of these markets, in order to determine how much capacity exists for market penetration in existing markets, as achieving greater market penetration in existing markets is less risky than establishing a presence in completely new markets.

Despite these approaches, companies can still get it wrong. Even the world's largest corporate employer, Wal-Mart (with over one million employees), experienced mixed success with its international expansions (Kaiser 2006). Just over a decade ago, Wal-Mart, the world's biggest retailer, expanded by buying stores in Britain (229), Canada (122), Germany (95), and South Korea (4). It also opened its own stores in Argentina, Brazil and China.

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Ten years later the company exited South Korea and Germany, and it is predicted that it will leave Argentina as well. The strategy of being everywhere is being replaced with a more focused allocation of resources to where the best returns are. Along

with Wal-Mart, other large retailers (such as France's Carrefour and Britain's Tesco), have been withdrawing from less profitable markets, including South Korea, Mexico,

Japan and Taiwan, and focusing on China, India and Latin America instead.

While global expansion has obvious growth benefits for mega-retailers that have reached saturation point in their own markets, the risks are also increased. Wal-Mart's lack of success in Germany reportedly cost the company almost US$l billion. This failure was attributed to a lack of understanding of the local tastes and lack of knowledge of local labour regulations. The need to manage poor performance in Germany shifted senior management's attention away from other areas of the business.

Reading 4.2 outlines the mistakes Wal-Mart made when attempting to operate in the German market. You should read this now.

Note: This reading is not in the printed study material. It is available via ProQuest. Please refer to the instructions in the Segment Outline for accessing readings in ProQuest.

After a comprehensive assessment of the relative attractiveness of different markets and a decision to proceed with overseas expansion, what remains is to work out an effective entry strategy. Successfully entering and operating in a foreign market requires the right decisions with regard to the following:

• selection of market-identifying the market to enter that is the most promising;

• entry objectives-why the company is entering the new market and what it hopes to achieve;

• timing of entry-when to enter to achieve the greatest impact;

• scale of entry-what level of investment to make to maximise opportunity and minimise risk; and

• mode of entry-what operation is most feasible and will provide the best platform for lasting success.

Researching and selecting new geographic markets

Deciding which markets to enter and gathering the data required for a rigorous analysis before making an overseas investment is a demanding task. Once it was a case of taking a trip to the country concerned to talk to the relevant government authorities, prospective partners and clients (and it is still popular-e.g. several organisations run executive

tours of China to familiarise companies in the first stages of weighing up the prospects

of investing). Fortunately, there is now a variety of academic experts, consultancies

and government agencies that specialise in assessing the suitability for investment of diverse overseas countries. Information to assist in completing an assessment of different countries is available from various sources, including the World Economic Forum Global Competitiveness Report <http://www3.weforum.org/en/index.htm> (accessed May 2010).

There are a number of country competitiveness indices, such as the IMD World Competitiveness Yearbook. The World Bank has recently begun compiling a new index in which countries are benchmarked against one another in a region and then against OECD averages. Six key indicators are covered:

1 the life cycle of companies:

2 business entry regulations;

3 labour regulations;

4 contract enforcement;

5 access to credit markets; and

6 bankruptcy provisions.

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The Doing Business web site <http://www.doingbusiness.org> (accessed May 2010) has updated OECD, regional and country reports measuring and commenting on the relative competitiveness of different countries.

The data that the Doing Business surveys provide allow an overall comparison of the ease

of doing business internationally. Singapore comes first, with New Zealand second, and the United States third. Each of these countries has in different ways made conscious and deliberate efforts to simplify business procedures and regulations. The annual Doing Business survey covers:

• procedures necessary to set up a company;

• relative costs involved in employment;

• degree of investor protection;

• international tax rates in the countries concerned; and

• other indices relevant to a company entering a new market.

There are also figures on how many days it takes to start up a company with respect to negotiating different regulations. For example, it takes two days in Australia, five days in Singapore, 105 days in Indonesia, and 116 days in Brunei.

To establish a company in Australia, Brunei, Hong Kong and several other countries, zero capital is required, whereas in China 190 per cent of the annual income per capita is necessary to start a company and in East Timor it is 595 per cent-such high costs must seriously depress small business formation. The relative strength of corporate governance and investor protection in the Asia-Pacific region ranges from very strong protection in New Zealand, Singapore and Hong Kong, to little protection in Vietnam and Laos. Similarly, there are differences in tax rates, ranging from a total tax rate as

a percentage of profit in Singapore of 23 per cent to 73 per cent in China.

Timing of entry

It can be as expensive to move too early as it is to leave investments too late. Judging what is the best window of opportunity is paramount. If the objective is market penetration, the move has to be made when sufficient demand exists but competition is not too intense.

If the objective is to secure access to resources, the right moment is when there is a realistic opportunity to secure rights of access, without competitors pre-empting this.

Different phases of timing can be recognised, including the premature phase when there is unlikely to be sufficient demand or revenues. Many multinational companies misjudged the timing of their entry into China's market, arriving before the market had developed sufficiently to make their companies viable. Some companies persisted and carried losses while waiting for the market to mature, whereas others wrote their investments off as business development funds. Being the first mover is often the only way of gauging whether a viable market exists. Followers at least have the benefit of the leader's experiences. Once a market is firmly established, the competitive forces will be sufficient to make the market unattractive, except to companies with substantial resources or differentiated products and confidence that the market will continue

to expand. Alternatively, highly innovative products can make inroads even into apparently crowded markets (Lasserre 2003).

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Key success factors for new market development

In order to determine strategies for entry into new markets, organisations need to consider a number of factors. One of the major considerations is whether the organisation will enter a new domestic market or an international market and how different the nature of this cHstomer is from e~(i5ting-c.H&temer-5. It is--i-ffifJOf.ta.H.t-tfiat th~9R'lflaHy e,'alHat@

their decision in conjunction with their long-term strategy to ensure they do not make the mistake of expanding for its own sake.

The successful development of new markets, either from a geographical or customerbase perspective, depends on several common factors:

• the identifiable benefits of expanding into the new market must be in line with the long-term strategic goals of the organisation;

• the organisation must ensure that it has sufficient cash reserves to finance the new business until such time as it becomes self-supporting; and

• the organisation should perform both internal and external analyses.

Companies determining their competitive strategies for internationalisation need to consider other factors that will affect the basic strategy they select, including the scale, scope, innovation and responsiveness of their strategy. Dunning (1981) suggests that there are three conditions for the existence of a global multinational company:

• the location-specific advantages of overseas markets must provide the requisite motivation for the company to invest there;

• the company must have strategic competencies to counteract the disadvantages of the relative unfamiliarity with foreign markets; and

• the company must have some organisational capabilities so as to get better returns from leveraging its strategic strengths internally rather than through external mechanisms such as contracts and licences.

Any company intent on expanding into an overseas market must be able to satisfy all three of Dunning's (1981) conditions. It is too often the case that the attractions of

an overseas market blind companies to the fact they do not have the competence to overcome the disadvantages of working in an unfamiliar market. As a result, expensive investments in local offices and plants have to be written off, when a less ambitious licensing agreement may have worked well. For example, the early ventures of Australian banks and financial institutions in both the United States and China often failed due to unfamiliarity with the marketplace. As a result, Australian bank investments overseas in recent years have been more carefully selected and modest in scale.

Whatever the economic, technological and competitive factors pushing companies towards further internationalisation of their activities, their success will depend

on the effectiveness of their international business strategies. For Alfred Chandler (1990), the evolution of the global company is the final stage in the transformation of industries in search of economies of scale, economies of scope and national differences in the availability and cost of productive resources.

Question 4.3

Considerations for international expansion

Consider some general questions you should ask of management if they are considering an international expansion.

)

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Accounting issues in global strategy

A strategy which involves moving into new markets, or diversifying the products or services offered, will bring with it new accounting challenges not present in the existing I3l:tSiT1ess. Sl1efi issl1es !telel !telelitianal casts and-tn cIs of complexity to dn existing

operation. It is vital that these costs and complexities be anticipated and budgeted for as part of the business case for the strategy implementation, and that they be included in the operating budget of any program of strategy implementation. The identification and assessment of these issues can sit across both the external and internal analyses. For example, considerations such as taxation and governance will be identified when performing the external analysis, but must also be considered when assessing the internal capabilities to meet any additional requirements in these areas. These issues can affect the decision of whether to enter a new market.

Foreign exchange risks

Foreign exchange risk is becoming an increasingly common issue for organisations

due to the globalisation of business. While it used to be an issue faced solely by large multinational companies, it is now becoming an everyday occurrence for organisations of any size. It is vital that accountants have a clear knowledge and understanding of the impact of foreign currency transactions upon their financials, and how to account for them correctly. lAS 21 The Effects of Changes in Foreign Exchange Rates provides guidance on how to account for foreign currency transactions; this standard can be accessed through the CPA Australia web site. Exposure to exchange gains and losses can occur

in a number of ways as an organisation expands, due to the many different methods

of expansion available. Some of these variations are discussed below.

• Market expansion into new geographic areas without physical presence in those countries-Where a business is domiciled in a country and carries out all of its operations in that country, any foreign exchange risk may be minimised. If an organisation changes its operating strategy to incorporate online or international sales or purchases, there can be a risk of exchange losses or gains occurring. These risks can be from both the customer and supplier side of the business, and must be considered as part of any business expansion strategy.

• Entering a new international market by establishing a wholly owned enterprise-When an organisation establishes a physical presence in a foreign country on its own behalf, it will be exposed to significant exchange risks. In its new market the organisation will be carrying on operations in the local currency. This means the financial statements for the foreign operation will reflect minimal exchange risks. However, the process of consolidating these reports into the reports of the parent company will reflect any exposure to such risks. The initial funds to establish

the foreign operation would have been provided by the parent company to pay establishment costs in the foreign currency; senior staff would be likely to have been sent from the parent company and would therefore have significant salary costs.

• Product diversification-Where a decision is made to diversify into new products, there is often a high probability that the capability to manufacture all or part of the new product does not exist in the home country. The introduction of exchange risk to the costing of a product can create complications in that it introduces an aspect of uncertainty to the production costs, which must be acknowledged in all costing activities.

Where any of these issues arise, it is likely that the company will encounter foreign exchange risks associated with the contracts entered into. The addition of exchange risks can add significantly to the costs of products due not only to fluctuations in exchange rates, but also to the increased need for specialised staff to account for such

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transactions. This can add to the complexity of the reporting process as, in order to manage the exchange risk, the company may decide to enter into currency hedging, including forward exchange contracts or other tools (these instruments are discussed in detail in the Financial Risk Management segment).

Example 4.10 provides an illustration of some of the issues surrounding foreign exchange.

Example 4.10: Foreign exchange risks

'l:{Z Co Ltd is a US-based company which has established a wholly owned enterprise in the Philippines. It is earning most of its revenue in the local currency, the Philippine peso. The customers, who are mostly Filipino, are likely to demand that they be invoiced in pesos. The product being sold is primarily being imported from Europe, the research and development activity behind the product is carried out

in Europe, and many of the managers are Europeans who insist on being paid in a currency with which they are familiar, euros.

The reporting currency of the parent company is US dollars (USDl. so all of the transactions and balances will need to be converted into USD for reporting purposes.

As a consequence, there will be numerous transactions in different currencies that then need to

be translated into USD, each with the potential for gains and losses. The business may decide to undertake currency hedging, but this would add complexity and cost. The qualifications and experience level. and hence the cost, of the necessary qualified personnel to manage and report on these more complex transactions would probably increase.

The complexities and costs of operating in multiple currencies need to be foreseen at the time of strategy formulation and included as a factor when deciding on a market development strategy. Also, most companies, if they carry out hedging at all, do not carry out complete hedging over all of their currency risks. Hence, following an international expansion strategy, increased volatility in the reported financial results should be anticipated, as not only may the risks of investing in new and relatively unfamiliar markets be present, but there will also be an increased degree of volatility in the reported financial results due to currency movements.

Preparing multiple sets of accounts

All companies are familiar with preparing accounts. However, implementing an expansion strategy can create a need to prepare and lodge multiple sets of accounts for different operating entities or in different jurisdictions. Generally a set of accounts, which are also used as the basis for filing a tax return in each market of operation,

will be required in each jurisdiction and for each entity. Depending upon the strategy being implemented, an organisation may have a number of entities operating in different geographic locations or, if the expansion has been one of acquiring new entities in the same domestic market, there may be a number of entities with different reporting dates and different requirements.

All jurisdictions have a prescribed 'financial year' which is the standard accepted reporting period for that jurisdiction, but this can vary between locations. Some countries have a

31 December year end, others a 30 June year end, and yet others a 31 March year end. This is complicated further by the fact that many entities elect to use a 'substituted accounting period', which means they select their own year end. This creates an additional level of complexity for the finance and reporting function, particularly if

there are related entities with differing year ends. These issues can affect the reporting function, regardless of whether the expansion is domestic or international, as shown in Example 4.11.

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Example 4.11: Different reporting dates

LOG Go Ltd (LOG) is based in Sydney, Australia. The company purchases a new entity, PTL Go Ltd (PTL), which is based in Melbourne, Australia. The management of LOG identify several accounting issues

as a result of the acquisition. LOG reports using a year end of 30 June, while PTL uses a substituted

accounting period, and I'\as a year end of 31 December. rreditferent year ends make It more complex to accurately show inter-company transactions in both sets of accounts. There is also greater difficulty reconciling inter-entity loan accounts and dividends paid from one company to another. Although both entities are in the same country, there is a need to ensure that the accounting staff at both entities are suitably qualified to deal with the complexities arising from the different year end dates.

The global progression towards the implementation of International Financial Reporting Standards (lFRSs) will provide some relief in relation to this factor, as it will lead to increased uniformity between the reports required of the parent company and those required of a related foreign entity. Where IFRSs are not in use, the preparation of multiple sets of accounts can create an unwelcome additional administrative burden. Depending on the size and scale of the operations of the foreign entity, its accounts

may need to be audited, in addition to the audit of the group accounts, adding further complexity and cost without additional revenue. The audit of the annual 'local' accounts may be undertaken by the auditor after the group accounts have been finalised, but could require the auditor to use a lower threshold of significant error than could

be tolerated when auditing the group accounts. This may result in a more detailed examination by the auditor, given that the magnitude of the transactions in those accounts will be smaller compared to the group accounts.

Having to prepare local accounts in addition to group accounts may be considered

a non-value-adding exercise by the parent company, but is a likely result of choosing a strategy of international expansion. All of these costs must be factored in when a company considers its strategy for market development.

Incompatible IT systems

One area of cost which may be overlooked when deciding on a strategy for market development may be for new or upgraded IT systems. If a company chooses to develop its own operation in the new market, the necessary infrastructure and expertise may

be developed over a period of time as the new enterprise grows. However, if a company uses a market development strategy of acquiring an existing operation in a new market, it must factor into the acquisition cost any costs related to changes required in the

IT systems which already exist in that operation.

Greater complexity is added when acquiring new businesses which use different accounting packages from those used by the acquiring entity, especially if the parent entity is trying to consolidate reports from different operating entities. Of particular note is the instance where data from one entity needs to be manually entered into a second system to report consolidated performance. For example, if one entity uses the MYOB accounting package and the other uses a mainframe system, such as SAP, a number of issues can arise, including incompatibility of systems, varying hardware requirements

and difficulty in compiling information for the whole group. While it may appear that the answer is to simply ensure the preferred accounting package is implemented across

all entities, this is more complex than it may initially seem. Some of the factors to be considered include the cost of installing and establishing the package at the new location, including any relevant licensing fees, potential software or other system upgrades required to operate the package, and the availability of qualified staff to implement the package and train existing staff in the use of the new system.

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Once a decision has been made as to how to address the issue, another key factor is that of data integrity. If a decision is made to transfer all current year information to a new system, it is essential that decision makers take into account how the annual reports will be prepared and by whom. There can be serious problems if this transition is not managed correctly. The factors to be considered include:

• The date on which financial information is to be transferred to the new system, (i.e. whether to choose a year end, month end or other relevant date).

• Whether the new system should operate alone from the transition date or whether two systems should run together for a period of time. Note that the latter is rarely a cost-effective option, as it requires the double handling of all transactions and increases the risk of human error through having to enter the same information in two different places.

• How to transition payables and receivables information into the new system.

Where the system requires the direct allocation of payments and receipts against invoices, there can be significant complications in this transition. The decision must be made as to whether to allocate relevant payments in the existing system or set up new invoices in the new system. Whichever option is selected, it is vital that detailed records be maintained of all debtors and creditors as at the date of transition so as to enable accurate processing of payments and receipts against these.

• Ensuring that the information from the existing system is retained in an accessible format and location so it can be accessed as required.

Varying business conduct standards

Market development activities often take organisations into parts of the world with which they are unfamiliar. This creates a situation where the corporate governance

and business conduct standards typical of the new market may differ greatly from

the standards generally employed by the parent company for business conduct, corporate governance or disclosure. All countries have their own independent legal systems with laws governing business conduct in their jurisdictions. Legislation such

as the Corporations Act 2001 (Cwlth) in Australia, or the Companies Act (Cap. SO,

1994 Revised Edition) in Singapore, sets the framework for business operations in

that jurisdiction. Corporate legislation governs business in such areas as appointment and duties of a board, issue and trading of shares and reporting requirements. Such legislation is generally quite strictly enforced, with breaches often resulting in hefty fines and/or custodial sentences. It is imperative that organisations and associated individuals adhere to the relevant legal requirements of each country in which the organisation is operating, as penalties vary significantly between countries and can be severe.

In addition to company law, many countries legislate in the area of consumer law to protect consumers and ensure free trade within national boundaries. Areas which are often specifically regulated include requirements to ensure goods for sale are of safe construction, and to prevent businesses using unfair practices to gain an advantage over other businesses. For example, India regulates its consumer market by use of the Consumer Protection Act, 1986 Act No. 68 of 1986, while in China the rights of the consumer and general business conduct are covered by a group of statutes including the Product Quality Law of the People's Republic of China-2000.

In China, directors of the company involved in the contamination of powdered milk used in infant formula were prosecuted and sentenced to death in January 2009 for breaching product safety rules. While most corporate indiscretions do not incur such harsh punishments, this example illustrates the significant differences between

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countries in dealing with breaches of the law. It is vital that, prior to any international expansion, an organisation carefully review relevant legislation to ensure that its business practices will be aligned with the legal requirements in that jurisdiction.

It would be foolish to argue that a parent company would significantly change its

standard of business conduct, corporate governance or disclosure when it either develops or acquires a business in a new international market. Therefore, careful evaluation of these issues prior to market entry is vital. For example, in an instance where the strategy calls for a business to be acquired from what was previously a family owned and operated business, it is necessary to consider the existing business practices of that business. The strategy should foresee and allow for the fact that a range of business practices will already be in place in the acquired business, which the existing customers, suppliers and other stakeholders of that business will be familiar with

and expect to continue. Indeed, these business practices may be fundamental to the continued ongoing operations of the business, such that changing them may threaten the business' continued viability.

Alternatively, the parent company may be subject to various legal constraints, which could include Sarbanes-Oxley Act 2002 (US) or the Foreign Corrupt Practices Act

(US), both particularly relevant for companies with operations in the United States.

A market development strategy requiring international operations must take into account the legal requirements governing both its existing operations and its planned international operations. The legal consequences for the business should be carefully assessed in terms of the internal capabilities of the organisation prior to implementing any strategy of international expansion. Regulation can add a significant cost to operations, including the need to have qualified staff to establish any required frameworks and monitor regulatory compliance. Some companies prefer to make sales via distributors in highly regulated and complex markets as a result of the additional costs they can incur.

Taxation of revenue

All countries have their own taxation systems. These generally encompass income tax and include other state and national taxes, such as sales taxes.

Taxation rates and compliance requirements vary significantly from one country to another. These variations can add significant levels of complexity and costs to business operations and reporting requirements. As noted in previous sections of this module, issues such as foreign currency transactions, multiple reporting deadlines and

different methods of reporting all add to the complexity of the accounting function. The differences in taxation laws between different countries also require that an organisation have access to a taxation expert. This can be through recruiting staff

with relevant skills or enlisting the services of a local taxation firm. Regardless of the approach used, securing such expertise will add a further cost to the business.

Some of the key taxation requirements of a number of countries are summarised in Table 4.4 below. It is important to note that the information provided is of a general nature, and that there are significant differences, depending upon the mode of entry chosen, the industry type and the method of establishment. Any plan to enter a new national market requires careful investigation of the taxation requirements,

and benefits, applicable at that time and for your specific industry.

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Table 4.4

Key taxation requirements of some countries

Substituted Application
n ..
'df'V"VU N'UV', v. JU' .vu
Country Tax year end (SAP) allowed company tax rate forward losses Capital gains tax
Australia 30 June Yes-on approval 30% Yes-indefinitely Yes-special
calculation.
but taxed at
marginal rate
China 31 December No 25% Yes-five years No-any profit
included in ordinary
income
India 31 March No 30%-domestic Yes-eight years Yes-rates vary.
40%-foreign depending on how
long the asset
is held
Malaysia 31 December Yes-but rates 26% Yes-indefinitely for No. but may be
apply from items classified as classed as ordinary
1/1-31/12. so SAP business losses. income. depending
will be assessed No for items upon the source
using rates from classified as non-
two tax years business losses.
New Zealand 31 March Yes-with approval 30% Yes-indefinitely No-profit
is included in
ordinary income
Singapore 31 December Yes-but rates 20%-however. Yes-indefinitely No-profit included
apply from numerous industry in ordinary income
1/1-31/12. so SAP concessions
will be assessed available
using rates from
two tax years
United Kingdom 31 March Yes-but rates 21%-30%. Yes-carry back to Yes-special rules
apply from depending upon previous 12 months apply. but taxed at
1/1-31/12. so SAP size of company or carry forward ordinary rates
will be assessed indefinitely
using rates from
two tax years
USA 31 December Yes 15%-35%. Yes-carry back Yes-but taxed at
depending upon two years or carry ordinary rates
taxable income forward 20 years Note: The information contained in this table is based on a wholly owned enterprise which meets the requirements for residency in the relevant country.

Source: Adapted from CCH Editors (2008), International Master Tax Guide 2008/9, 5th edn, CCH Australia Ltd, North Ryde, NSW.

)

As you can see from Table 4.4, the taxation consequences of expanding to an overseas location can vary significantly. Additional constraints or concessions may apply, depending upon the type and nature of your industry. If your industry typically incurs losses during the start-up stages, you would be well served by choosing a country that allows losses to be carried forward. If your industry typically incurs losses at various stages throughout its life cycle, you may be best served by selecting a country which allows both the carry-back and carry-forward of losses. If your organisation is operating in more than one country, it may be advantageous to choose a country with the same year-end date as your home country or one which allows the use of a substituted accounting period so you can align the year ends for all your businesses and simplify reporting.

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Taxation compliance can be complex, so it may be beneficial to refer to resources such as the World Bank report Paying taxes 2010-The global picture, which discusses the relative ease of compliance in different countries. By combining this information with that in Table 4.4 and conducting minimal research yourself, you can build a comprehensive picture of the suitability of taxation requirements in a number of markets.

Any discussion of taxation compliance must include broad-based consumption taxes and state duties. These taxes are levied by different levels of government and can add to the compliance requirements of the organisation. Consumption taxes include various sales taxes, for example, the goods and services tax (GST) in Australia and value-added tax (VAT) in the United Kingdom. In some countries these taxes are levied by state governments and thus vary from state to state, while in other countries they are levied at the national level. The collection, reporting and payment of such taxes add a further level of complexity to the operations of the business, so it is important to consider such taxes before making the decision to expand internationally.

Transfer prices

The issue of transfer pricing from a taxation perspective is also important and is closely related to the different corporate tax rates that exist. Where a company has subsidiaries in multiple countries, it is preferable for it to generate as much of its profits as possible in the country with the lowest level of corporate tax. The opposite is also true in that it is in the best interest of the company to minimise the profits generated in higher-taxing countries.

One mechanism for achieving this outcome is transfer pricing. Transfer pricing relates to the prices set for the internal exchange of goods or services between different parts of a company (which may be in different countries). From a performance measurement perspective, we attempt to set a transfer price that enables both the control and motivation of employees in each location. However, from a taxation perspective,

we attempt to set a transfer price that maximises profits in lower-taxing countries.

Obviously, governments are not keen on companies limiting their tax bill in this manner and take action to limit abuses of transfer pricing. Many countries impose significant fines and penalties for breaches in this area. For example, GlaxoSmithKline was prosecuted by the US Internal Revenue Service in 2006 for not engaging in arm's-length pricing between its US and UK operations; the company had to pay US$3.4 billion in additional tax and forfeited a further US$1.8 billion claim for a tax refund. Detailed rules and regulations are in place to ensure companies place proper values on transfers, and these are strictly enforced.

The major accounting firms provide detailed reports on transfer pricing, including the rules, regulations and penalties for major trading nations. They also provide transfer pricing advisory services for companies to optimise their operating, tax and legal structures. This area is incredibly complex and each transaction, or set of transactions, needs to be assessed on its merits. Additional information can be obtained from organisations such as the Australian Taxation Office and the OECD.

Ouestion 4.4

Identify and discuss some of the ways in which accounting issues can affect the potential success of a strategy of international expansion.

The accounting issues discussed above must be considered as part of a careful analysis of internal capability and market attractiveness prior to any decision to operate in

a new geographic market. The list of concepts covered in this section is not finite.

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All organisations will have varying internal capabilities, and each strategy will differ in its requirements. All of these considerations can potentially add complexity and cost to the accounting and reporting function, and thus to overall operational costs. As a result of increased reporting and compliance costs, or the need for significant investment

in systems, there is also a risk that the general administrative overhead burden for

the organisation will increase. Further, as operations become more complex, there is a greater need for highly qualified and experienced finance personnel, which will add further costs to operations.

Common modes of entry into new geographic markets

The choice of entry mode is dependent on the market circumstances and strategic objectives of the company. The critical elements informing this decision are the assessment of the market attractiveness of the country, and whether the company is intending to invest only in limited commercial activities or is prepared to make

a significant investment in developing assets, building competencies and engaging in significant local production of goods and services. Finally, the ownership of the enterprise is crucial, depending on whether the company is ready to become part of a joint venture or is committed to full control and ownership of the overseas assets (see Figure 4.4).

Figure 4.4

Investment and ownership in different entry modes

)

Ownership
None or limited control Full or absolute control
High Joint venture with minority, equal or Wholly owned subsidiary by greenfield
non-absolute position investment
Consortium partner Full or dominant acquisition joint venture
with absolute majority (above 66%)
Intensity Low Arm's-length arrangements Regional headquarters
of Distributor Marketing subsidiary
investment
Licensing Procurement office
Agent Representative office
Representative Technical observatory
Franchisee
Correspondent The major modes of new product and market entry are detailed in the following sections.

Exporting

\

i

The experience of exporting is often the first stage in the internationalisation of

a company, The idea of exporting often occurs simply because orders are received

from overseas, or when companies realise that competitors are exporting to overseas markets. Exports offer the opportunity to significantly increase sales revenue for both manufacturing and service companies. Companies are attracted to exporting not simply to expand their markets, but because exports often open up the prospect of higher profitability. Profits may be higher for overseas sales because there is less competition or because the market is at a different stage in the life cycle of the product. Overseas sales

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may involve different tax regimes or regulations on prices that can be managed to

raise profits. Inevitably, however, exports also involve the additional costs of transport, distribution and servicing. These costs have to be taken into account when considering the benefits of exporting.

As companies move from being almost accidental exporters to becoming experienced exporters on a large scale, they pass through a number of stages. An export strategy that effectively negotiates each stage of the international business transaction

chain is required and encompasses:

• ordering;
• credit checks of buyers;
• transport;
• customs;
• financial transactions;
• distribution; and
• servicing. Mistakes at any stage in this chain of transactions may be costly, such as misunderstanding the complexity of customs clearance, choosing unreliable agents or distributors, failing to modify products to other countries' standards, or failing to print servicing and warranty messages accurately in the local language.

Exports may be achieved directly or indirectly by the means described in Figure 4.5 below.

Figure 4.5

Approaches to international markets

Approach Description
Indirect selling Indirect selling is through an intermediary who takes on the responsibilities
of obtaining the goods and exporting them to overseas customers.
Intermediaries can be specialist agents or international trading companies
handling many companies or products.
Export management companies Export management companies are large-scale intermediaries that serve
and trading companies as the export arm of major manufacturers, selecting markets, distribution
channels and promotional campaigns, and offering exclusive representation
in defined territories. Trading companies originated in the Netherlands,
United Kingdom and Japan centuries ago when it was discovered that such
companies could market and distribute products more efficiently than could
single manufacturers, particularly at a distance in unknown markets.
Direct selling As overseas business grows, the desire to have more control over the
export and sales process develops. Also, the desire to use their distinctive
capabilities to create greater competitive advantage influences companies to
establish their own export marketing and sales networks around the world.
This may begin with a network of sales representatives before developing
into an overseas marketing and sales department. Direct selling to retailers is
another possibility, as retail chains have grown in scale and coverage across
many countries. Consumer products can be sold to international supermarket
chains (such as Wal-Mart and Ahold) and reach stores around the world.
This offers exporters the chance to be 'born global'.
Direct selling via the Internet Though there have been many 'false starts' in the advance of electronic
commerce, the revenues from e-commerce have expanded substantially in
recent years. The Internet offers an opportunity for small and medium-sized
enterprises to market their goods worldwide. The Internet is often quicker
and cheaper to use for marketing and sales, can improve customer service,
and, as electronic payment systems improve, can facilitate direct sales of
consumer goods. GLOBAL STRATEGY AND LEADERSHIP

Licensing

Franchising

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In licensing agreements a company (the licensor) grants rights to another company (the licensee) in a country or region for a period of time. The licensee pays a royalty to the licensor. These rights may be exclusive, meaning the licensor may not award tHese rigfttsffi !U'l6tHer part, ter tHe-pft'l'tifttlftl.'-e6Hfltl'-y-eI fegiefHef a spe€#ietl-t4me.

Alternatively, the license may be non-exclusive, in which case the rights may be awarded to multiple parties in a country or region that may compete in the marketplace for the same period of time. Licences are usually defined in terms of the intellectual property involved in intangible assets, which includes:

• patents, inventions, formulas, processes, designs and patterns;

• copyrights for literary, musical or artistic compositions;

• trademarks, trade names, brand names;

• franchises, licences, contracts; and

• methods, programs, procedures and systems.

When a company develops a new product, it may represent only one of a changing portfolio of product ranges and individual products. It may not be economical to set up overseas manufacturing and sales facilities for this one product during the short life cycle of the product. Perhaps the particular overseas market is not large enough to justify an overseas investment. A local company in the overseas country may be able to set up production in a shorter time, at less cost, and make the product viable in the marketplace.

When technological change is rapid, licensing and cross-licensing agreements

(where the parties exchange licences) become a reasonable way of conducting international business. The payments for licences vary according to contracts based

on the sales potential. Sometimes, developing countries insist licensees should be able to export licensed goods and licensors demand higher royalties. Licensees normally must make an up-front payment to cover the immediate costs of technology transfer, which involves the transfer of tacit knowledge through consultation and adaptation and not simply the transfer of reports or blueprints. Licensing arrangements involve fewer costs and operational complexities for the licensor. However, the licensor does not benefit from any learning about the new market. Finally, there is a risk in licensing advanced technology to overseas companies, since there is always the possibility that rival companies will copy proprietary technology.

Franchising is a more highly developed form of licensing in which, along with the exchange of intellectual property, there is an ongoing relationship where the franchisor offers operational assistance to the franchisee in the form of sales promotion, training and business advice. In many franchises the franchisor offers store layout design, proprietary equipment and supplies of materials. For example, the Starbucks coffee chain will assist franchisees with all of these services, together with market analysis for store location and staff development.

Part of the competitive advantage of this form of franchising is the economies of scale

and higher quality achieved through economies of central purchasing. In encouraging the overseas expansion of the franchise, the franchisor may deal directly with local franchisees in different countries or establish a master franchisee in a region or country with the rights to develop other franchisees in this territory. Franchises are dependent on product and service standardisation, high brand recognition through marketing and promotion, and good cost and quality controls. In new country environments, any of these criteria may be difficult to achieve if supplies are unreliable, new brands do not break through resistant cultures, or franchisees manage poorly. Often franchises need to make significant modifications to their offerings to secure acceptance in particular regions.

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For franchise operators, growth is necessary to increase revenue and profits. This often means franchises must look overseas if they are to grow after they have reached saturation point in their domestic markets. In the past, most international franchises appeared to be US companies, such as McDonald's, which dominated the fast-food business in many countries. However, as the formula for effective franchise delivery and

standards of technology and service have become more widely disseminated, successful franchises have originated in other parts of the world. These have often projected differentiation rather than standardisation. For example, Pret a Manger originated in London, emulating the freshness of handmade, chemical-free food combined with the glitz of chromium Art Deco interiors. Pret A Manger creates handmade natural food, and now operates internationally-for example, in the United Kingdom, Hong Kong, Singapore and the United States, with 14 outlets in New York.

The franchise industry in Australia is now thriving, often with similar principles,

that is, offering originality and quality rather than standardisation and homogenisation. The local Australian market is not large enough to support large-scale franchises, and in expanding overseas most franchises first try New Zealand, then move on to markets such as Singapore, India, Hong Kong, China or the United Kingdom. A franchising code of practice has enhanced the reputation of Australian franchises, as it requires a high level of disclosure and compliance which aims to protect franchisees and customers. The franchise model is a robust vehicle for expansion, with limited capital investment and risk exposure for the parent company.

Joint ventures

joint ventures can come in many different forms:

• cooperation in a limited and specific way, such as a specific geographic region for certain amounts of time;

• a joint venture business, possibly a new company. This can be a very flexible option as the number of shares in the company are specified and different rules as to how and by whom it will be managed can be agreed upon; and

• a business partnership or a limited liability partnership.

Businesses of any size can use joint ventures to strengthen long-term relationships or

to collaborate on short-term projects. joint ventures are usually designed to have a limited life span and only cover part of a company's activity, thus limiting commitment and exposure.

joint ventures are a particularly popular form of cooperation between businesses in different countries and often can be the only means of entering new markets, as some overseas countries have regulations that require businesses to be partly locally owned and managed.

They also provide a mechanism for overseas businesses to enter Australia.

Language, culture and customs have an enormous influence on the success of international ventures, and building effective relationships with another business can be complex and time-consuming. Problems are likely to arise if:

• the objectives of the joint venture are not clear and well communicated;

• the joint venture partners contribute different levels of expertise, commitment, investment or assets to the venture, contrary to the original agreement;

• different cultures and management styles result in poor integration, understanding and cooperation;

• insufficient leadership and support is provided in the early stages; and

• the joint venture partners are not aligned in their approach to business.

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Before starting a joint venture, businesses need to be clear about their objectives.

For example, smaller businesses often want to access a larger partner's resources,

such as a strong distribution network, specialist employees and financial resources. Larger companies might benefit from working with a more flexible, innovative partner or simply from accessing new products or intellectual property.

Whatever the aims, the joint venture agreement needs to:

• recognise what each partner is contributing to the venture;

• identify what the joint venture is expected to achieve and by when, as well as what will happen if expectations are not met; and

• agree on approaches to measuring performance.

A clear agreement is an essential part not only of building a good relationship, but

also of concluding a business relationship effectively and professionally without loss

to business reputation. Businesses and markets all change over time and, while a

joint venture may be able to adapt to these changes, sooner or later most partnering arrangements come to an end. Hence, a contractual joint venture, such as a distribution agreement, should always include termination conditions.

Historically, the joint venture has proved a popular means by which international companies share ownership of a venture with a local company. A joint venture may be the only alternative. Governments (particularly in developing countries) often insist on the joint venture form as a means of securing technology transfer and retaining some degree of ownership and control of the business development in their economy. This was the case in China in the 1980s and 1990s in many industry sectors.

The joint venture is often a preferred means of market entry for international companies, as it can be a way of reducing establishment costs and minimising risks by working with a partner who is informed about the local market, culture, tax, legal and political system. Often, large international companies will enter joint ventures in a range of countries, initially with a limited purpose, for instance to explore the market or to produce and sell a particular product suited to the market. However, if a joint venture is working well, the international partner may redefine and expand its objectives.

While some joint ventures are short-lived, others may prove viable for many years.

The inherent principle of a joint venture is some degree of partnership in ownership, control, strategy, operations and revenue. However, for practical reasons the partners often take on different roles. Often, there will be more than two partners in the joint venture and invariably there will be a division of labour and responsibility if the entity is to perform efficiently. It may be the case that the international company provides most of the finance and the local company provides the land and most of the staff. Joint ventures take many forms, including joint ventures between:

• high-technology and other leading companies;

• multinational companies and state industries; and

• international companies and smaller, local companies in developing countries.

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Example 4.12: Examples of joint ventures in advanced industries

NUMMI-New United Motor Manufacturing, Inc. (NUMMI) was an automobile manufacturing plant in Fremont, California. The company was in an old General Motors plant and formed a joint venture between GM and Toyota. When it reopened for production in 1984 as a joint venture, it was the first

automotive JOint venture plant In tlie UnltedStates. GlVI saw this initiative as an opportunity to learn about the ideas of lean manufacturing from the Japanese company, while Toyota gained its first manufacturing base in North America and a chance to implement its production system in an American labour environment.

Sony Ericsson-Sony Ericsson is a joint venture to manufacture mobile phones, established in 2001 by the Japanese consumer electronics company Sony Corporation and the Swedish telecommunications company Ericsson. The objective of this venture is to combine Sony's consumer electronics expertise with Ericsson's technological leadership in the telecommunications sector. In recognition of the capability of the joint venture, both Sony and Ericsson have stopped making their own mobile phones.

Joint ventures and strategic alliances to gain market entry, share technology and achieve economies of scale and scope will continue as popular vehicles for corporate expansion. Companies may balance several hundred joint ventures and strategic alliances at different stages of development and decline. When these business partnerships come

to an end, it is often not because they have failed, but because they have fulfilled

their immediate purpose and the companies involved have moved on to new

challenges (often by one or other company taking full ownership of the joint venture). Inevitably, however, joint ventures do involve tensions over ownership, control and strategy between the partners (celebrated by the phrase 'same bed, different dreams'). These tensions can result in legal disputes and contested ownership of assets.

Often, circumstances change. For example, as an overseas market matures, a joint vehicle that was developed for market entry becomes less necessary. So, at a time when foreign banks, including Credit Suisse and Morgan Stanley, were signing preliminary agreements in 2007 with mainland China joint venture partners in anticipation of early movement on approvals in Beijing, they were also abandoning joint ventures in other parts of Asia. In India, the investment banking fee pool became sufficiently large for several foreign banks to exit joint ventures with local partners and continue on their own. For example, Morgan Stanley in 2007 ended an eight-year link with JM Financial, a Mumbai-based broker, though it cost the US bank $445 million to buy itself out.

Strategic alliances

A strategic alliance is a formal, mutually agreed upon, commercial collaboration between companies. While partners of the alliance exchange and/or integrate selected business resources for mutual benefit, they remain separate, entirely independent businesses.

Strategic alliances take many forms and companies may choose an alliance that involves simple market exchanges or cross-licensing agreements, or they may form a more complicated partnership that includes cooperative manufacturing arrangements or joint-equity ventures.

Alliances are formed for [oint marketing, sales, distribution, production, design collaboration, technology licensing, or research and development. Relationships can be vertical between a vendor and a customer, horizontal between vendors, local or global. Alliances are often established formally in a joint venture or partnership.

Strategic alliances offer several advantages, including improved competitive positioning, entry to new markets, access to critical skills and sharing of the risks or costs of major development projects.

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Other benefits include economies of scale, resulting in:

• increased versatility;

• reduced costs through increased production;

• enhanced purchasing and financial arrangements;

• a stronger negotiating position with suppliers, customers and/or regulatory

agencies:

• greater access to critical resources; and

• opportunities for large-scale marketing efforts.

Strategic alliances today are broad and can cover product development, manufacturing and marketing. However, there is a significant difference between forging alliances and making them work. This is due to the strategic and environmental disparities among partners, lack of common experience and perception, difficulties in inter-company communication, conflicts of interest and priorities, and personal differences among individuals that manage the interface. However, alliances involve more shared decision-making, can lead to management and staff issues, are more difficult to manage and are not always successful.

Building cooperative ventures requires careful partner selection. The physical assets

of the intended partner have to be assessed, including the condition and productivity of plant and equipment. The less tangible assets of partners also have to be gauged, including the strength of brands, quality, customer relationships, levels of technological expertise and organisational competence. A common experience is a sometimes unanticipated but escalating commitment. This is particularly so when those who manage the selection and those who manage the practical alliance are different people. The key operating managers should be involved in the implementation stages of the alliance, and in the pre-decision negotiation processes. This creates continuity and long-term understandings (Bartlett & Ghoshal 1995).

Aiming for simplicity and flexibility in the scope of an alliance rather than broad and all-encompassing equity participation is often helpful. The key to success is simple and focused partnerships. Three factors add to the complexity of alliances:

• complicated cross-holding and equity;

• cross-functional coordination and integration needs; and

• the breadth and scope of joint activities.

At each stage, negotiators should ask whether something is absolutely necessary in order to maintain simplicity that admits the possibility of change later. To manage the boundary, the interface can be:

• structured as an independent legal entity;

• managed by both or one of the parent companies; or

• simply administered by a joint committee.

If the alliance involves manufacturing and marketing a new product on a worldwide basis, an independent entity is required. But if the aim is simply marketing each other's existing products, a few simple rules to determine the marketing parameters will suffice. Irrespective of the objectives of the alliance, the process of collaboration creates a flow of information across the boundaries of competing companies. Ensuring the

full exploitation of knowledge sharing and preventing the outflow of knowledge the company wishes to retain demand precise arrangements and understandings.

)

Alliances, unlike acquisitions, are based on the equality of both partners. But forming committees and management structures based on parity often leads to deadlock rather than dynamism. To negotiate on the basis of integrative rather than distributive cooperation is better. In building successful cooperative ventures, it is important to avoid easy but not ideal solutions and not enter into an alliance as the second-best option. It is useful to remember that alliances need not be permanent. Finally, flexibility

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is the key both in making the relationship work and in allowing an exit if it cannot be made to work (Bartlett & Ghoshal 1995). Of course, sometimes it is simply best not to go into a joint venture in the first place, where the possibility exists of launching a wholly owned enterprise.

Alliances are essentially an intermediate strategic device and part of a system that includes many other transactions. Around half of all cross-border strategic alliances terminate within seven years, so it is important for managers to have a good idea of what comes next. Most alliance companies are finally purchased by one or other of the partners and termination of the alliance does not mean failure. But the prevalence of early terminations suggests it is important to consider whether parties are likely to be buyers or sellers. Understanding the sequence of likely future transactions is important since alliance partners will be competitors in the future.

Question 4.5

Strategic alliances

Why do organisations form strategic alliances?

Mergers and acquisitions

Another way to expand a business is through a strategic acquisition of and/or merger with another business. An acquisition is when you buy another business and end up controlling it. A merger is when you integrate your business with another and share control of the combined businesses with the other owner(s).

Acquiring a company that is already operating in a desired market is an alternative to establishing a subsidiary. An acquisition strategy can bring more immediate results, possibly with less expense and risk than starting a new subsidiary business operation. Of course, blending the culture and operational practices of a company operating in a different market with those of the home company may take time but may be more readily achievable than starting from scratch in an unknown market.

Value of mergers and acquisitions

The essential purpose of engaging in mergers and acquisitions (M&As) is to enhance the value of the companies involved. In theory, the economics of M&As suggest that

a merger or acquisition may be justified only if the combined entity is worth more than the value of the independent entities prior to the merger.

According to Lasserre (2003), strategically, M&As can create the following types of value:

• Consolidation-Bringing together companies operating in the same business area; this is called a horizontal M&A (e.g. Electrolux/Zanussi, SmithKline/Beecham and BHP Billiton).

• Global reach-Merging with or acquiring overseas companies that provide an extension into international markets (e.g. Vodafone/Mannesmann).

• Vertical integration-Merging businesses that are suppliers or buyers of each other's products.

• Diversification-Companies coming together from different business domains

(for example, Sony, a hardware company for entertainment, taking over Columbia, which produces films and music).

• Options-Acquiring a firm in a new technology or market to monitor its evolution (for example, in both the software and bio-technology businesses it is a frequent practice to buy up interesting innovators).

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There are two critical aspects to M&A value creation:

1 Short-term one-offvalue-Short-term value realisation may come from the one-off post-merger realisation of cash benefits through tax concessions, disposal of assets, debt leverage or possibly immediate cost savings.

2 Long-term strategic value-This comes from competitive advantage gained from the

merger or acquisition, because it provides enhanced efficiency through greater economies of scale and specialisation or through differentiation with a wider range of products, or accelerated growth or enhanced markets. These are the synergies sought in M&A strategic assessments (Lasserre 2003).

Most M&As fail to deliver the value that was promised. A lot of blame for failure-the term 'murders and acquisitions' has been used-is attributed to the focus on financial matters and systems of due diligence at the expense of looking at the intangible assets that are critical to a successful merger, such as business culture, human capital, company structure and corporate governance. Module 6 provides more details about these implementation and leadership issues.

Mergers and acquisitions are more likely to be successful when specific action plans developed for integrating the two businesses take into account the intangible assets of the merging organisations.

International M&As are becoming more frequent as globalisation of markets and competition advances. In the late 1990s there was a series of large-scale M&As in industries including oil and gas, telecommunications, pharmaceutical and finance. Again, in the mid-2000s there was a wave of merger and takeover activity fuelled by access to cheap debt and rapidly growing international equity markets. This pattern of cyclical growth and decline of merger and takeover activity suggests that the enthusiasm for this responds to economic circumstances. At other periods, organic growth using the company's own resources is often regarded as a much sounder (and less risky) strategy.

There are different orientations towards M&As regionally. Historically, in the relationship-based governance and investment systems of Europe and Japan, mergers and takeovers were not common, and hostile takeovers never happened. In contrast,

in the Anglo-American market-based economies, particularly the United States and United Kingdom, the rate of mergers and takeovers has traditionally been much higher. As market systems have universalised, merger and takeover activity has spread to other regions, though there remain differences. For example, few Japanese companies grew during Japan's long recession in the 1990s and early 2000s, but they are now expanding their activities once more. However, these companies prefer greenfield (i.e. where

there are no existing facilities or company operations) sites rather than acquisitions. Continental Europe is catching up with the United States in its rate of M&A activity, but it is of a different kind. These mergers are largely friendly ones across national boundaries (as the European Union continues to expand in size and influence), essentially bringing together companies with similar structures and cultures.

Merger and acquisition activity appears to be concentrated among smaller service companies that grow through acquisition and larger multinational companies that consolidate products and markets globally.

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Conditions for the success of mergers and acquisitions

The conditions that might offer success to international M&A projects include:

• a purchase price that reflects the reality of likely post-merger costs and risks;

• a clear and realistic strategy for the combined business;

• clarity on mission-critical issues and performance metrics;

• achievement of the objectives of the merger or acquisition (e.g. cost, growth, cash,

product benefits);

• new and better ways of achieving business results (e.g. economies of scale);

• retention of customers;

• high morale and productivity; and

• retention of investor confidence.

However, hazards that are often confronted in risky merger and takeover activities include:

• unintended legal errors that threaten corporate reputation;

• a performance management system that does not support the strategy;

• incompatible and/or dysfunctional IT systems;

• duplication of efforts inside the business;

• costs getting out of control; and

• lack of an appropriate infrastructure for handling M&A implementation issues.

Barriers to performance frequently arise from:

• poorly informed management decisions and behaviour;

• lack of focus by management teams on pursuing the strategy;

• lack of knowledge and experience in handling M&A implementation issues;

• loss of key talent;

• high levels of internal conflict;

• focus on internal issues and not on strategy, marketplace or competition;

• management time being tied up with legal issues;

• inability to attract new talent; and

• a workforce that is not committed to a future with the new business.

Figure 4.6 summarises the essential lessons for getting M&As right according to the Chartered Institute of Personnel Development (CIPD)(2003).

Figure 4.6

Essential lessons for getting M&As right

Lesson Description
Target for compatibility Find a merger/acquisition target that is suitable not only in relation to business
strategy. but also in terms of culture and capability.
Focus on business Maintain focus on the business objectives to be achieved through this particular
objectives merger or acquisition.
Organise early to learn Get organised early to learn, as well as to find and assess possible targets. and
and plan to plan for integration with the new business.
Manage risks Accept from the start that business performance will depend on learning to manage
the risks and uncertainties that this specific merger or acquisition will bring.
Integrate expertise in Ensure from the beginning that expertise in organisation and people
organisation and people management is integral to decision-making and planning.
management from the start
Get the basics of Put the basics of legal compliance. communication. loyalty building,
organisation and people right HR processes and procedures. and corporate citizenship in place.
Integrate at the right speed Judge the speed required for different aspects of integration by considering their
impact on the performance of the organisation and people. Source: Adapted from the Chartered Institute of Personnel and Development (2003), International Mergers and Acquisitions: A CIPD guide to the HR Role in Their Success, CIPD, p. 8.

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Wholly owned foreign enterprises

An international company can have full ownership and control of a foreign enterprise if:

• the foreign government allows foreign ownership in key industry sectors;

• the international company has vital resources, such as patents, trademarks, d@~igns and Q~@raUQnal ~fQG@SS@S lot QQ@S..QQ.t wi.sJ:l tQ tran~--tQ..a;QQ.tI:.l@.I-partnerj

• the potential overseas market is large enough and growing at a rate that will allow the international company to compete successfully; and

• the international company has the capital and resources to make the investment, and the risk appetite to launch the venture.

A wholly owned foreign enterprise allows the company to share a common organisational culture, appoint its own managers, manage investment and earnings, determine strategic development and integrate this within the global strategy of the company as a whole. However, a choice needs to be made between acquiring an existing company in an overseas market and transforming it into a subsidiary, or, alternatively, investing in a greenfield operation.

Acquiring an existing overseas business

The decision to acquire an existing company in an overseas market will depend on the quality and attractiveness of companies available for purchase. It was often the case with old established European companies that they were not for sale, since the small number of family and related shareholders had no intention of parting with the company at any price. Similarly, in Japan for a long time, there was a reluctance to sell companies and they were certainly not sold to foreigners. In this sense, companies are often seen as a legacy to pass on from one generation to another, rather than as

a bundle of assets to be bought and sold. However, in other circumstances, whole industries are put up for sale-for example, in the mass privatisation that took place in many countries in the 1980s and 1990s. In the United Kingdom all of the public regional water companies were privati sed in the 1980s and several were acquired by the French company Vivendi.

In the case of the UK water utilities, while the companies were very traditional,

the markets were strong and there was plenty of scope to take the acquired companies in more entrepreneurial directions. This acquisition of market share is valuable.

Other attractions of acquiring an overseas company are brand recognition and goodwill, an existing labour force and management, and a functioning operation. This can be

a faster and more efficient way of entering an overseas market, although there will

often be significant work over time in transforming the acquired company to achieve

its real potential. Sometimes, international companies find it too difficult to transform the overseas companies they acquire. BMW discovered this after acquiring the UK car company Rover in 1994; it sold it in 2000 after finding it could not make the new venture profitable (but BMW did keep production of the best Rover product, the new Mini).

The Rover company was bought in 200S by the Nanjing Automobile Corporation, which merged in 2007 with the Shanghai Automotive Industry Corporation. This is indicative of a new direction in international business where manufacturing companies in developing countries acquire significant assets of established manufacturing companies in the West. The most important illustration of this was the acquisition

of the IBM personal computer and laptop business by Lenovo of China in 200S.

This acquisition had business logic to it, as for many years the majority of the components for IBM personal computers and laptops were being manufactured in China and much of the assembly was taking place there. It was therefore only a small step to shift responsibility for manufacturing to a Chinese company, though the headquarters of the company remained in New York and much of the design work would inevitably remain in the United States. Meanwhile, IBM continued to move progressively from manufacturing into high-value-added computer services.

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Investing in greenfield operations

The attraction of investing in a greenfield operation is the chance to start a new company with new people, plant and equipment. An original image for the company may be created with marketing, and customers will not have any preconceptions. Often, a greenFielEl investment wtU--ffi€ttn state at the art te€Hnet~~raEltt€ts.

For example, the arrival in the United Kingdom of Japanese companies such as Nissan, Toyota, Mitsubishi and Fujitsu in the 1970s and 1980s was warmly welcomed as bringing new production technology and advanced products to the failing UK manufacturing economy. The construction of a succession of greenfield operations

by Japanese companies for production for the UK and European markets was initially intended to avoid protectionist barriers. In both the consumer electronics industry and later in the automotive sector, local production helped Japanese products become more accepted in the market. There are now thousands of Japanese investments across Europe. However, as greenfield investments have matured, there have also been significant dis investments, due either to local conditions or to shifts in international markets for the products concerned.

For many years foreign direct investment (FDI) in the form of acquisitions and greenfield investments was heavily concentrated in the advanced industrial countries (specifically in the triad regions of North America, Europe and Japan). However,

as developing countries have eased their restrictions and regulations on foreign ownership, more FDI has been directed towards the developing world (in recent years most significantly towards China and India). In the 1990s and early 2000s, it seemed as if every multinational company in the world was eager to secure entry into China. Initially, in most industrial sectors, overseas companies wishing to invest in China needed to form joint ventures. However, from the mid-1990s wholly foreign-owned investments were increasingly allowed. China has accepted that it is possible to secure technology transfer, skill development and retention of profits while allowing greater autonomy for overseas companies.

Advantages and disadvantages of different entry modes

The choice of entry mode depends on the market circumstances and strategic objectives of the company. The critical elements informing this decision are the assessment of the market attractiveness, and whether the company is intending to invest only in limited commercial activities or is prepared to make a significant investment in developing assets, building competencies and engaging in significant local production of goods

and services.

Additionally, the ownership of the enterprise is crucial, depending on whether the company is ready to become part of a joint venture or is committed to full control and ownership of the overseas assets if the market is overseas.

There is no one optimal entry mode. Often, companies will graduate from one entry mode to another as resources become available and new opportunities arise.

Facing largely unknown markets, with incomplete information and experiencing uncertainty, organisations generally undertake the expansion process in a series

of increments, adopting appropriate entry modes, including indirect exporting,

direct exporting, licensing, joint ventures or direct investments in marketing and production in overseas subsidiaries. At each stage in the development of the new market activity, a decision has to be made regarding the extent of resources to be committed, the amount of risk involved, the control of the enterprise and the potential profit involved.

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Reading 4.3, 'Another British invasion: considers the expansion of a number of British retailers into the lucrative US market, indicating an increasing trend of globalisation of major retail channels.

While some of these retailers are taking existing formats and applying them to local consumer markets, there are others that are entering the United States with a new format. You should go through the reading now and consider the need for exporting and investing in global markets.

Note: This reading is not in the printed study material. It is available via ProQuest. Please refer to the instructions in the Segment Outline for accessing readings in ProQuest.

Comparison of different modes of entry

A comparison of the positives and negatives of different entry modes'-in terms of finance, speed of entry, market penetration, market control, political exposure, leakage of technology, complexity and potential for return-suggests careful judgment is necessary (see Table 4.5 below). Too much emphasis on one factor can lead to blindness to other considerations.

Table 4.5

Comparing various entry modes

Representative Agent/
Wholly owned Acquisition Joint venture Licensing office distributor
Up-front investment. HIGH HIGH MEDIUM LOW LOW/MED LOW
financial and managerial
Speed of entry SLOW QUICK QUICK MEDIUM LOW POSSIBLY
QUICK
Market penetration MEDIUM HIGH MEDIUM/HIGH MEDIUM/LOW LOW MEDIUM/LOW
Control of market HIGH HIGH MEDIUM NIL LOW LOW/NIL
(customer knowledge)
Political risk exposure HIGH HIGH MEDIUM LOW LOW LOW
Technological leakage LOW LOW HIGH/MEDIUM HIGH LOW LOW
Managerial complexity HIGH HIGH HIGH LOW MEDIUM LOW
Potential financial return HIGH/RISK HIGH/RISK MEDIUM/HIGH LOW RISK LOW RISK LOW RISK
HIGH/MEDIUM HIGH/MEDIUM RISK HIGH RETURN RETURN? RETURN?
RETURN RETURN HIGH/MEDIUM LOW PAYOUT
HIGH PAYOUT HIGH PAYOUT RETURN
MEDIUM
PAYOUT Source: Adapted from Lasserre, P. (2003), Global Strategic Management, Palgrave Macmillan, London, p. 205.

Ouestion 4.6

Modes of entry

Outline the relative advantages and disadvantages of the following modes of entry:

a exporting;
b licensing;
c franchising;
d joint ventures; and
-1 e wholly owned subsidiary.
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Review

It is relatively easy to come up with attractive-sounding proposals, but there may be hidden practical traps. Each idea takes time to implement, and the returns may not be as expected Ip. makip.g strategic choiGes, th@l;e-a.re mtllt.iphil QPUQaS-..u~Q..GQ-m~iQRS

of options available, all of which need to be carefully considered relative to the organisation's product offering and market position prior to finalising any strategy. The key to successful growth is careful research. In this module we have focused on the concepts of product and market development, key accounting considerations in this area and modes of entry into new markets.

We have introduced Ansoff's product-market matrix, which provides a tool to enable an organisation to determine where its capabilities lie in terms of product and market expansion. This framework allows the organisation to build a picture of where its strengths are, and to then examine how best to build upon those strengths.

In Modules 2 and 3 we discussed the external and internal analyses which are the foundation of any successful strategy. In this module we have examined those areas where an organisation must assess not just its own capabilities, but its ability to carry out the key tasks in its strategy to reach its desired position. A key area of cost and complexity which can easily be overlooked in strategy development is that of the key accounting issues. Foreign currency risk and accounting, conflicting IT systems and complexities of international taxation and corporate governance regimes can often add complexities in terms of both the environment in which the organisation operates and the ability of its staff to properly carry out the functions which result from the implementation of an expansion strategy.

Expansion into a new market can be achieved in a number of ways. Our discussion focused on expansion into new international markets. Organisations should evaluate their options for international expansion based on a number of internal and external factors. Different entry modes require differing levels of commitment and resourcing to succeed. Organisations should consider whether they are equipped to operate a wholly owned enterprise or greenfield operation in their desired market. Often the first step in international expansion is forming a strategic alliance with an existing organisation in the new market. Other options include franchising or licensing agreements. Mergers and acquisitions can be costly and carry a high level of risk, so may not be a good strategic choice for a first international move. Most importantly, an organisation must consider its own capabilities in light of conditions which exist in the desired market, with a particular focus on its own industry.

Module 5 now examines the concept of strategic choices-that is, evaluating the strategic fit of the options available to the organisation. The analysis and research we have discussed to date have provided the information needed to make choices and, in so doing, influence the strategy of the organisation.

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References

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International Monetary Fund <http://www.imf.org/external/about.htm>.

Organisation for Economic Cooperation and Development (OECD) <http://www.oecd.org/pages/O,3417,en_367340S2_36 761681_1_1_1_1_l,OO.html>.

Singapore Economic Development Board (SEDB) <http://www.edb.gov.sg/edb/sg/en_uk/index.html>.

Staples <http://www.staples.com>.

World Bank

<http://web. worldbank.org/WBSITE/EXTERNAL/EXTABOUTUS/O" pagePK:S0004410-piP K:36602-theSitePK:29708,OO.html>.

World Trade Organisation -chttp.r/www.wto.org».

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!

GLOBAL STRATEGY AND LEADERSHIP

APPENDIX 4.1

Appendix 4.1

Internationally focused organisations

International organisations which can be used as sources of accurate and current economic and business research include the following:

1 The International Monetary Fund (IMF) conducts research and, among other activities, grants loans for technical assistance and training. As stated on their web site, the purpose of the IMF is 'to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world'.

Information on the IMF's activities is publicly available at: <http://www.imf.org/> (accessed May 2010).

\, )

2 The World Bank provides loans, grants and credits for many uses, such as education, health, public administration, infrastructure, financial and private sector development, agriculture, and environmental and natural resource management. According to their web site, the World Bank 'is a vital source of financial and technical assistance to developing countries around the world. Our mission is to fight poverty with passion and professionalism for lasting results and to help people help themselves and their environment by providing resources, sharing knowledge, building capacity and forging partnerships in the public and private sectors'.

Information on the World Bank's activities is publicly available at: <http://www.worldbank.org/> (accessed May 2010).

3 The World Trade Organisation (WTO) has as its goal helping producers of goods and services, exporters and importers to conduct their business. The WTO is involved in administering trade agreements, providing a forum for trade negotiations and dispute resolution, and technical training in developing countries. The WTO's role in dispute negotiation operates at the highest levels only, generally in disputes between large national industry bodies. The WTO's web site contains a number

of case studies which provide real-life examples of the role it plays; you are encouraged to read these case studies.

Information about the WTO, including its mission statement, is publicly available at: <http://www.wto.org/> (accessed May 2010).

)

APPENDIX 4.1

GLOBAL STRATEGY AND LEADERSHIP

4 Organisation for Economic Cooperation and Development (OECD)-As stated on its web site, the 'OECD uses its wealth of information on a broad range of topics to help governments foster prosperity and fight poverty through economic growth and financial stability'. It continually monitors events in OECD countries and others, and collects data to enable short- and long-term projections to be formulated on

various economic topics. It is recommended that you visit <http://www.oecd.org> (accessed May 2010) for further information about the OECD and its role.

Of particular importance are guidelines issued by the OECD on a variety of issues. Of most relevance to this segment are the OECD guidelines for multinational enterprises, which apply to all entities operating, or wanting to operate,

their business on a multinational scale.

Regionally focused organisations

1 Austrade is an Australian government organisation which offers assistance to Australian companies looking to develop export markets and to foreign entities wanting to establish trade within Australia. Austrade can assist with business introductions in your target market, and offers details on how to invest in Australia or assistance for Australian businesses in meeting the costs of expanding into new export markets. Further information on Austrade's activities can be obtained at: <http://www.austrade.gov.au/> (accessed May 2010).

2 Asia-Pacific Economic Cooperation (APEC) is an organisation with 21 member countries from the Asia-Pacific region. APEC's goal is the facilitation of economic growth, cooperation, trade and investment in the Asia-Pacific region.

As noted on its web site, 'APEC is the only inter governmental grouping in the world operating on the basis of non-binding commitments, open dialogue and equal respect for the views of all participants ... Decisions made within APEC are reached by consensus and commitments are undertaken on a voluntary basis'. <http://www.apec.org> (accessed May 2010). Detailed information about APEC is publicly available at: <http://www.apec.org> (accessed May 2010).

3 The Singapore Economic Development Board (EDB) seeks to attract foreign investment into Singapore. The EDB is a government agency established with the goal of enhancing the economy of Singapore by increasing foreign investment and expanding existing domestic organisations. The EDB invests alongside business

to encourage selected industries to enter the Singapore market and strengthen

the Singapore economy. The agency has in place a number of incentive programs designed to make entry and operation in the Singapore economy an attractive option for foreign organisations. Information relating to the operations of the agency and the many incentive schemes is available at: <http://www.edb.gov.sg/> (accessed May 2010).

)

GLOBAL STRATEGY AND LEADERSHIP

READING 4.1

Reading 4.1

Mining for new product successes

ALLAN. J. MAGRATH

Note: This reading is not in the printed study material. It is available via ProQuest. Please refer to the instructions in the Segment Outline for accessing readings

in ProQuest.

GLOBAL STRATEGY AND LEADERSHIP

READING 4.2

Reading 4.2

Wal-Mart bids Auf Wiedersehen,

ends nine-year grind in Germany

MIKE TROY

Note: This reading is not in the printed study material. It is available via ProQuest. Please refer to the instructions in the Segment Outline for accessing readings

in ProQuest.

GLOBAL STRATEGY AND LEADERSHIP

READING 4.3

Reading 4.3

Another British invasion

DEBRA HAZEL

Note: This reading is not in the printed study material. It is available via ProQuest. Please refer to the instructions in the Segment Outline for accessing readings

in ProQuest.

GLOBAL STRATEGY AND LEADERSHIP

SUGGESTED ANSWERS

4.1

Module 4

Suggested answers

Ouestion 4.1

Using Ansoff's product-market matrix classifications, justify how you would classify (from Arm and Hammer's perspective):

Using baking soda in personal care products for the bath, body and teeth

• Product development: Introducing new products or services to existing customer markets. Includes adding features to existing products, bundling purchases, repackaging and so on.

This classification is justified on the basis of developing new products from the basic raw materials of the existing business, and on the assumptions that these products will be sold through the same distribution channels (typically the supermarket channel) and that the brand will attract existing customers to try a new product from the company.

Selling baking soda products in a plastic shaker dispenser

• Product development: Introducing new products or services to existing customer markets. Includes adding features to existing products, bundling purchases, repackaging and so on.

This classification is on the basis that the product is the same and the plastic shaker container is just repackaging an existing product.

Acquisition of the Spinbrush battery-operated toothbrush business from Procter & Gamble

• Related diversification: Moving into new products and new markets at the same time.

This can be either related or unrelated to current activities.

This classification is on the basis that the company does not produce toothbrushes currently, but that toothbrushes are a complementary product to its current product range, which includes toothpaste (it purchased the Unilever Oral Care business in the United States and Canada three years earlier).

4.2

SUGGESTED ANSWERS

GLOBAL STRATEGY AND LEADERSHIP

Swimming pool pH maintenance tablets sold through pool-care outlets

• Related diversification: Moving into new products and new markets at the same time.

This can be either related or unrelated to current activities.

I hIS classIficatIOn would be made on the basIs that the product IS new to the company as are the distribution channel (pool-care outlets as opposed to the typical supermarket channel) and the end user (swimming pool owners as a distinct market segment which is targeted through pool-care outlets).

It is important to note that options can sometimes be classified in more than one way. This is acceptable if based on appropriate evidence that the potential implementation risks are properly understood.

For example, the move by Arm and Hammer into swimming pool pH maintenance tablets through pool-care outlets is riskier than the other options discussed. This company appears to have strong product development capabilities, and has implemented options in a sequential manner over time. There is less evidence that the company has market development capabilities, which are required for the swimming pool option. So, if this company is at a point in time where it has to choose between which option to implement and in which order, this last option appears to present the most risk. However, as you

will have noted from the implementation timeline, this is the most recent company development and is probably a result of the company having exhausted the market penetration options available to it.

Ouestion 4.2

Oil is formed from organic materials, buried deep within layers of rocks, which decompose in the absence of oxygen to form petroleum. The organic materials are formed from the remains of plants and animals which, over millions of years, have fallen to the floor of shallow seas and been covered by layers of sediment (e.g. salt, sand, clay).

Supply chain stage Description Capabilities required
Exploration Exploration of oil is conducted both Ability to collect data from potential
on land and on continental shelves sites
across the world. It is a very expensive Workforce skilled in the reading of
exercise, as detecting oil deposits
involves seismic surveys and the use geological data
of advanced technology (such as laser Expensive equipment
and satellite).
Drilling Over the decades, drilling technology Oil drilling equipment (technically
has advanced greatly, allowing oil advanced)
producers to access more deposits, Major capital access for setting up oil
thus resulting in an increase
in reserves. wells and constructing pipelines
Engineering project management
Market development capabilities
Environmental health and safety
compliance GLOBAL STRATEGY AND LEADERSHIP

SUGGESTED ANSWERS

4.3

Supply chain stage Description Capabilities required
Transport After the crude oil is extracted from Large capital investment in specialised
oil wells, it is transported to the transport vehicles
production units through pipelines, Import/export
train cars and large oil trucks.
Regulatory compliance
Environmental health and safety
compliance
Refining At the production unit, it is processed Product development
and refined into different products Industrial marketing
that include liquefied petroleum gas
(LPG), gasoline, jet fuel, kerosene, Environmental health and safety
middle distillates including heating compliance
oil and diesel fuel, residual fuel oil
and asphalts. Purchasing (spot market)
Processing economies of scale
Sale of petrol These products are then transported Distribution outlets (e.g. petrol stations)
to their actual points of sale-from Environmental health and safety
where they are supplied to the
eventual consumers. compliance
Consumer protection compliance Question 4.3

In answering this question, you move from theory to practice. There is no definitive list of questions to ask and in many cases there is no 'right answer'. However, considerations could include:

• the location-specific advantages for investing in the country under consideration;

• what other countries were examined and on what basis they were rejected;

• the rationale for why the company would be successful in this market and the

assumptions and dependencies inherent in this;

• why physical entry is better than other mechanism, such as contracts and licences.

• what specific business entry regulations and labour regulations are in place;

• what the legal system is and what practices are used to enforce contracts;

• what access there is to credit markets;

• what bankruptcy provisions are in place;

• how stable the political environment is and what might change this; and

• how stable the economic environment is and what might change this.

What is important is to have considered the various options, the implications of each, then to have made a decision and acted accordingly. The CFO cannot know the answers to all the questions-what they are looking for is a process whereby the management team uses the best resources available to consider the options. The CFO wants to help facilitate a rigorous planning process.

Consider the questions and 'what-Its' that you went through in answering this question. The planning process may actually be more important than the plan!

4.4

SUGGESTED ANSWERS

GLOBAL STRATEGY AND LEADERSHIP

Question 4.4

In your answer you should consider factors such as the organisation's familiarity with the target country and any similarities or differences in the legal environments of the two countries. It is important to consider the organisation's existing business practices

and how well they fit with those of the target country in order to evaluate areas such as corporate governance and legal costs. Where there are distinct differences between the two countries, the operating costs will be affected by the need to operate in the new environment.

It is also important to consider the internal capabilities of the organisation. Factors such as the availability of qualified staff in the new operation can have a significant impact on operating effectiveness. Any costs of recruiting and hiring qualified staff or relocating existing staff to the new operation should be included in the establishment costs of

the operation. This can be complicated by immigration laws regarding foreign workers. It is vital to have suitably qualified staff in any businesses, particularly where issues

such as foreign exchange transactions, currency hedging or the use of new reporting requirements are relevant.

You should also consider any required infrastructure expenditure to establish the new operation. Where there are variations between the systems in use, it may be necessary to purchase new hardware to operate the venture. Also, there would be costs associated with training existing staff on any new systems introduced.

A further consideration is the taxation regime of the target country. Where the tax system is complex, there is a need for an accountant with strong local taxation knowledge.

For any expansion strategy to succeed, it is vital that there be strong financial management. This is even more important when the strategy requires operating across national borders.

Question 4.5

International companies engage in an increasing number of strategic alliances, which they form to serve different purposes. The primary purpose of an alliance can be:

• a means of entry to an unfamiliar market (as with a [oint venture);

• a means of accelerating the learning of a new technology;

• to share the research and development costs of new products; or

• to share marketing costs or distribution channels.

Multiple alliances are formed to cover every aspect of the international company's activities where it does not have the resources, capability or desire to do this alone. Even for large and well-financed companies, there are too many opportunities, and technology is too complex, to be able to master every opportunity as it arises. Alliances provide a network of support and capability that almost all companies value highly.

GLOBAL STRATEGY AND LEADERSHIP

SUGGESTED ANSWERS

4.5

Ouestion 4.6

Advantages and disadvantages of modes of entry into new markets.

Bntrv.mods Advantages nr
Exporting Exporting avoids the often substantial Exporting from the company's home
costs of establishing manufacturing base may not be appropriate if there are
operations in the host country. lower-cost locations for manufacturing
Exporting may help a company the product abroad.
achieve experience curve and location High transport costs can make exporting
economies. uneconomical.
Tariff barriers can make exporting
uneconomical.
When a company delegates its marketing
to a local agent, problems might arise
from this. For example, foreign agents
may carry the products of competing
firms, so their loyalties may be divided.
Licensing The company does not have to Licensing does not give a company
bear the development costs and the tight control over manufacturing,
risks associated with opening a marketing and strategy that is required
foreign market. for realising experience curve and
location economies.
There is a risk associated with licensing
technological 'know how' to foreign
companies.
Franchising Franchising has the same advantages as The disadvantages are less pronounced
licensing. than in the case of licensing.
The main drawback lies in quality
control.
Joint venture A company benefits from a local As with licensing, a company that enters
aV) partner's knowledge of the host into a joint venture risks giving control of
country's competitive conditions, technology to its partner.
culture, language, political systems and A joint venture does not give a company
business systems. the tight control over subsidiaries that
When the development costs and/ it might need to experience curve or
or risks of opening a foreign market location economies.
are high, a company might gain by If their goals and objectives change or
sharing these costs and/or risks with a
local partner. if they take different views as to what
their common strategy should be,
In many countries, political the shared ownership arrangement can
considerations make joint ventures the lead to conflicts over control between the
only feasible entry mode. investing companies.
Wholly owned This gives the company the tight This is generally the most costly method
subsidiary control over operations in different of serving a foreign market. Firms doing
(WaS) countries that is necessary for engaging so must bear the full costs and risks of
in global strategic coordination. setting up overseas operations.
It provides better protection for
I intellectual property rights. Source: Adapted from Fu, X., Cosh, A., Hughes, A., De Hoyas, R. & Eisingerich, A. (2006), A Study of the Experiences of UK Mid-Corporate Companies in Accessing and Working in the Emerging Asian Economies, UK Trade & Investment, Glasgow, pp. 14-15.

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