The entry modes for international/foreign market operations.

Essay: Critically discuss the various modes of entry for which an organisation can
internationalise their operations. Is there one mode that is preferred above others?
Introduction
This essay will discuss the entry modes for international/foreign market operations. Foreign
market entry mode decisions are typically influenced by company and target market factors
such as: the organisation’s objectives, its international experience, internal resources and
capabilities, investment risk, government requirements, environment, access to local
knowledge and partners and ease of access to capital and other resources. This essay will
argue that there is no one mode that is universally preferred above others; rather, appropriate
entry mode decisions should be made based on careful consideration of the organisation’s
objectives and circumstance.

Reasons for internationalising business operations

Organisations engage in international business operations for various reasons including
globalisation, saturation of home market, lower production costs in the host country,
favourable foreign market environment and attractive foreign investment policies, with the
ultimate goal of increasing profit, expansion and tackling competition. A major decision for
organisations engaging in international operations is that of how to enter a foreign market
once it has chosen the target market it wants to operate in (Kumar & Subramaniam, 1997;
Twarowska & Kakol, 2013; Wach, 2014).

How an organisation’s international operation is structured and delivered is very much

determined by its entry mode/strategy. Hence, the entry mode is a key strategic decision that
defines subsequent decisions and actions of the organisation and its performance in the target
market (Kumar, Stam & Joachimsthaler, 1994; Kumar & Subramaniam, 1997).

Foreign Market Entry Modes

The international business and marketing literature classify entry modes for international
business operations into the following categories based on the risk-return trade-off, degree of
control, and resource commitment: exporting, contractual agreements, wholly owned
subsidiaries and strategic alliances. These modes can be segmented into non-equity (export
and contractual agreements) and equity (strategic alliances and wholly-owned subsidiaries)
modes (Mpofu & Chigwende, 2013).

The decision about whether an organisation implements an equity or non-equity foreign

market entry strategy is best determined by the organisation’s objectives and circumstance.
Within that decision, and depending on the organisation’s capability and level of international
experience, there are also choices to be made regarding specific equity or non-equity entry
modes to be implemented (Hibbert, 1997; Kumar & Subramaniam, 1997).
Non-equity foreign market entry modes
Exporting:
Exporting is the direct or indirect sale of goods and services produced in one country to other
countries. Exporting offers the lowest level of risk and the least market control.  It is a non-
equity method of international business operations and can be broadly classified into direct
exporting, indirect exporting and cooperative exporting (Wach, 2014).

With direct exporting, the exporter makes direct contact with customers in the foreign market
and has control over its product and distribution. Types of direct exporting include: own sales
subsidiary/distribution network, own representative office for marketing, sales, and
consultation in the foreign market, foreign agents acting on behalf of the exporter and foreign
distributors (Wach, 2014).

Indirect exporting involves the use of local intermediaries in foreign markets to facilitate the
supply/distribution process and the exporter has no control over its products and distribution.
Forms of indirect exports include: export trading companies, export management companies,
export merchants, confirming houses, and nonconforming purchasing agents (Wach, 2014).

Direct exporting and indirect exporting share similar characteristics as both offer relatively
low cost and low risk entry modes (Arnold, 2003). However, direct exporting may incur
additional costs, for example, in the set up and operation of representative offices. There is
also the risk of low profitability and barriers to developing in-house local knowledge in
indirect exports or when foreign agents are used in direct exporting (Wach, 2014).

The third form of exporting, cooperative exporting, is one in which organisations enter into
an agreement with a foreign/local organisation to use its distribution network, hence
bypassing barriers and risks associated with other market entry modes.  Cooperative
exporting is particularly favourable to small- and medium-sized firms because of the resource
advantages and the accelerated access to markets it offers (Wach, 2014).

Export grouping/consortium and piggybacking are the two main forms of cooperative
exporting.  With an export consortium, members benefit from joint promotion of products
and services and the cost of exporting is spread (Wach, 2014). Piggybacking is an
arrangement between a rider (a small/micro business) and a carrier (a larger organisation) in
which the carrier is an international business operator offering the rider access to its foreign
distribution network for a commission/charge (Terpstra & Chwo‐Ming 1990). The carrier
often benefits from the complementary product lines and reduction of the costs of its
distribution network; however it runs the risk of dilution or damage to its reputation if the
rider’s products are of lesser quality. The rider enjoys the benefits of access to the carrier’s
foreign distribution network but loses control over the distribution of its product (Wach,
2014).

Contractual Agreements:
Contractual agreements are cooperative modes in which an organisation enters into a contract
with foreign partners to deliver its operations abroad. Examples include international
licencing, franchising, subcontracting and assembly operations.

In international licensing, the licensor enters into a contractual agreement with a foreign
entity (the licensee) that gives the licensee rights to use the assets of the licensor (Wach,
2014). The licensor typically possesses intangible assets such as technology, trademark,
know-how, patents or other intellectual property that it makes available to the licensee. The
licensee would typically pay an initial fee and/or percentage of sales to the licensor. The
effectiveness of this form of contractual agreement is affected by the host government’s
commitment to intellectual property rights and the ability of the licensor to choose the right
licensing partners (Wach, 2014). Licensing is attractive to companies that are new to
international business because it can be easily tailored to the needs of both parties. It also
provides entrance into new markets that are not accessible through exporting and it involves
relatively low risk and low capital requirement (Friesner, 2014).

Disadvantages associated with international licensing as an entry mode include loss of

intellectual property/dilution of firm specific advantages through transfer of know-how, risk
of poor choice of licensee leading to damaged reputation or loss of brand quality, and risk of
the licensee becoming a future competitor to the licensor (Brouthers, 2013; Friesner, 2014;
Wach, 2014).

International franchising is another form of contractual agreement similar to licensing, in

which the franchisor makes its business model or trademark available to the franchisee for the
sale of its products or services. In return, the franchisee pays a fee or royalty to the franchisor
(Malhotra et al., 2003). The low start-up cost associated with this entry mode highly favours
SMEs, and is particularly attractive to small and micro enterprises (Wach, 2014). A franchise
agreement may provide the franchisee with access to the franchisor’s equipment, business
model, training, trademark/brand name, operations and management. It may also impose
restrictions/guidelines on how the franchisee may use the franchise (Mpofu & Chigwende,
2013). Franchising is a less risky and accelerated form of foreign market entry mode because
it is based on an already successful business model, the franchisee typically has local
knowledge and it allows simultaneous access to multiple foreign markets. Hence, the
franchisor is protected from typical risks associated with foreign market operations (Mpofu &
Chigwende, 2013). However, there are other problems that the franchisor may have to
contend with, such as: legal disputes with the franchisee, monitoring and managing the
performance of the franchisee, preserving the franchisor’s image/brand quality, and the risk
of the franchisee becoming a future competitor (Wach, 2014). Overall, the benefits associated
with franchising are seen to outweigh the associated risks and hence it is a popular foreign
market entry and expansion mode (Hoy & Stanworth, 2003; Cavusgil et al., 2008; Decker,
2013). Well known examples of successful franchises include KFC, McDonalds, Subway,
and Dominoes. These brands were able to rapidly expand their operations globally using the
franchise platform in a way that would not have been possible through any other foreign
market entry strategy.

Subcontracting − turnkey operations: turnkey operations refer to projects in which the

exporter (seller) is paid by a contractor (buyer) to design and build complete, ready-to-
operate facilities. Turnkey is a way by which a foreign company can export its processes and
technology to other countries, especially industrial companies who need to export their entire
system to a foreign country, such as those in the chemical, mining or petroleum industries 
(Evans, 2005; Wach, 2014). With turnkey, there is the potential risk of company secrets
leaking to competitors and of the plant being taken over by the government. Large turnkey
projects could also suffer costly delays due to restrictive regulations. However, this entry
mode is particularly advantageous for industrial companies that specialize in complex
production technologies as it offers access to establishing a plant in a foreign country where
direct investment is restricted (Evans, 2005).

Equity based foreign market entry modes

Equity-based market entry modes are investment models whereby a company either
establishes a wholly-owned subsidiary, with 100 per cent ownership or a joint venture
subsidiary, with less than 100 per cent ownership. A subsidiary is a separate legal entity
operating under the laws of its country of foreign location. However, in legal terms,
subsidiaries are created in one of the legal forms of economic activities occurring in the law
of the host country (Buckley & Casson, 1998; Wach, 2014).

Wholly-owned subsidiaries are established either through acquisitions, whereby the

organisation acquires a foreign company to enter a foreign market or through greenfield
operations, which involves building a new organisation from start.  With acquisition, the
organisation is able to limit its risk and maximise its access to the foreign market because of
the already established brand name and customer-base of the acquired company, which
provides it with accelerated access to, and a foothold in the foreign market. Hence,
acquisition can potentially be the quickest route to entering and expanding in foreign markets
through equity (Buckley & Casson, 1998; Wach, 2014).

Greenfield operations offer a more expensive equity mode of foreign market entry due to the
costs of establishing a new business in a new country and the time consuming process it
entails; however, it is gives full control to the parent company and has the potential to
produce above average returns (Wach, 2014).

Both modes are based on foreign direct investment and provide relatively lower production
costs and a direct presence in the foreign market. However, from a strategic perspective,
acquisition strategy is likely the more effective choice in service industries where customer
relationships, specialised know-how and customisation are critical. Greenfield investment, on
the other hand, is likely to be more suited to projects involving capital intensive plants, where
there are no suitable platforms to acquire already established competitive advantages such as
skills and embedded capabilities (Buckley & Casson, 1998; Wach, 2014).

The final form of equity-based market entry mode discussed is the joint venture subsidiary.
An international joint venture (JV) is a collaborative equity strategy in which the organisation
has joint control, with minority shares or majority shares in a foreign company. In JVs,
investors share ownership, control, risk, reward and proprietary rights (Durmaz & Tasdemir,
2014). Primary reasons for forming a JV include sharing resources and leveraging on the
combined strengths of the partners to achieve common objectives such as government
requirements and access to new markets that the partners cannot achieve alone (Wach, 2014).
The shared risk and the combined assets and resources of the partners help to reduce
investment costs, hence making JVs an attractive entry mode for risky markets (Durmaz and
Tasdemir, 2014). Potential problems that could arise with JVs include: how to manage
proprietary rights, disagreement over reward formula, cultural clashes and how to exit (Chang
et al., 2012). Environmental factors also play a significant role in this entry mode. Studies
indicate that the greater the perceived distance between the home and host country in terms of
culture, economic systems, and business practices, the more likely it is that an international
organisation will adopt a joint venture as an entry mode (Koch, 2001).

To summarise, it is clear from the entry modes discussed that there are a variety of reasons
why organisations engage in international business and that the entry modes adopted differ
for various reasons. Likewise, entry modes vary in the degree of risk, control, resource
commitment and reward.  When an organisation enters a foreign market, it is important to
understand where they are positioned in relation to these variables in order to enable the right
decisions about which markets to enter, the segments to focus on, the structural form to take,
the level of investment and how to manufacture, market and sell its product/service. Hence,
organisations have to determine which entry mode will give them the best chance of
succeeding in their target market based on their goals and weighing their strengths and
limitations.

Conclusion
Based on the argument presented above, the author is of the opinion that there is no one
market entry mode that is to be preferred above all others. Organisations wanting to
internationalize their operations must perform prior due diligence including political,
economic, financial, internal, environmental and cultural analyses, in order to determine
which of the foreign market entry modes would be appropriate for its objectives, risk-return
profile and control requirements as well as any other vital requirements peculiar to the
organisation’s circumstance.