International Business

Chapter Twelve
Country Evaluation and
Selection
Chapter Objectives
• To grasp company strategies for sequencing the penetration
of countries
• To see how scanning techniques can help managers both limit
geographic alternatives and consider otherwise overlooked
areas
• To discern the major opportunity and risk variables a com-
pany should consider when deciding whether and where to
expand abroad
• To know the methods and problems when collecting and
comparing information internationally
• To understand some simplifying tools for helping to decide
where to operate
• To consider how companies allocate emphasis among the
countries where they operate
• To comprehend why location decisions do not necessarily
compare different countries’ possibilities
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The Basics of Country Selection
Because firms lack sufficient resources to pursue
all potential (international) opportunities, they
must:
• determine the order of country entry
• establish the rates of resource allocation across
countries
In selecting geographic sites, firms must decide:
• where to market their products
• where to produce their products
If transportation costs are high and/or government
regulations require local production, a firm may be forced
to produce a product in the same country in which it sells it.

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Fig. 12.2: Place of Location Decisions
in International Business Operations

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Scanning vs. Detailed Examination
• Scanning techniques are based on broad vari- ables
that identify both opportunities and risks.
• Scanning techniques help to assure that firms consider
neither too many nor two few alternative countries.
[For the most part, scanning requires information that is
readily available, inexpensive, and fairly comparable.]
• Detailed examination generally requires on-site visits to
collect and analyze specific information that increasingly
contributes to the final location decision process.
• A feasibility study should have clear-cut decision points to
guide managers in the decision-making process.
Escalation of commitment: the more time and money
a firm invests in examining an alternative, the
more likely it is to accept it—regardless of its
merits.

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Fig. 12.3: Flowchart for Choosing
Where to Operate

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The Environmental Climate:
Country Opportunities
• Country opportunities are determined by
competitiveness and profitability factors.
• Factors that have the greatest influence
on country selection are:
– market size [sales potential]
– ease and compatibility of operations
– costs and resource availability
– red tape and corruption
Some factors are more important for the market location
decision, others for the production location decision.
Some factors affect both decisions.

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Country Opportunities:
Market Attractiveness
Market size, i.e., sales potential, is probably the most
important market selection variable.
• Market size predictors include:
– past and present sales data
– socioeconomic data [GDP, per capita income,
population size, population growth rates, etc.]
• Other factors to be considered include:
– the obsolescence and leapfrogging of products
– price levels and elasticity
– income levels and elasticity
– income inequalities
– substitutability of products
– existence of trading blocs
– taste and other cultural factors
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Fig. 12.4: Aluminum Consumption
and GDP per Capita

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Country Opportunities: Ease
and Compatibility of Operations
Firms are attracted to countries that:
• are located nearby
• share a common language
• have market conditions similar to those in their home
countries
• present few market restrictions
Firms’ decision points regarding country selection
may include:
• the ability to operate with product types, technologies, and
plant sizes familiar to their managers
• permissible levels of ownership and profit repatriation
• the availability of local resources [capital, viable partners, etc.]
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Country Opportunities: Costs
and Resource Availability
• Firms go abroad to secure resources that are either
unavailable or too expensive at home.
• Increasingly, firms need to be near customers and
suppliers in locations where (i) the infrastructure
permits the efficient movement of people, materials,
and products and (ii) trade restrictions are minimal.
• Productivity-related decision factors include:
– the cost of labor ̶ utility costs
– tax rates ̶ real estate costs
– available capital costs ̶ transportation costs
– the cost of other inputs and supplies
[continued]

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• Labor costs are a particularly important factor in
production location decisions. However,
̶ labor is not homogeneous
̶ capital intensity may reduce the differences in production
costs from one location to another
̶ there may be sector and/or geographic differences in wage
rates within countries
When companies move to emerging economies because
of labor cost savings, their advantages may be short-
lived because:
• competitors follow leaders to low-wage locations
• there is little first-in advantage for this type of production
migration
• costs in emerging economies may rise quickly as a result of
pressures on wages and/or exchange rates

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Country Opportunities:
Red Tape and Corruption
Red tape: obstructive bureaucracy, i.e.,
disincentives related to the clarity of laws
and whether and how they are enforced
• Red tape includes government obstacles with
respect to:
– beginning and continuing operations
– hiring and/or firing workers
– the use of expatriate personnel
– producing and marketing goods
– satisfying local agencies on matters such as taxes,
labor conditions, and environmental compliance
[continued]

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Corruption: the illegal sale of rights by govern-
ment officials for their personal gain
• Corruption, i.e., the extortion of
income or resources, may include:
– requirements of illegal payments to win a contract
– requirements of illegal payments to receive govern-
ment services
– requirements of illegal payments to operate in a
particular location or industry
Firms are likely to avoid operating countries in which
legal transparency is low and corruption is high.

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The Environmental Climate:
Country Risks
Risk: the possibility of suffering harm or loss, or a
course involving uncertain danger or hazard
• Returns tend to be higher in countries where operating
risks are higher.
• Firms may balance operations in low-return, low-risk
countries with operations in high-return, high-risk
countries.
• Firms may guard against currency fluctuations by
locating operations in countries whose exchange rates
are not closely correlated.
• Adverse situations may heighten the perceived needs
for certain products.

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Country Risks:
Risk and Uncertainty
• Companies use a variety of financial techniques to
compare potential projects, including:
– discounted cash flow ̶ return on assets employed
– economic value added ̶ internal rate of return
– payback period ̶ accounting rate of return
– net present value ̶ return on equity
– return on sales
• Given the same expected return, most decision
makers prefer a more certain outcome to a less
certain one.
Firms may acquire insurance to reduce risk and uncertainty.

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Comparison of ROI Certainty
INVESTMENT A INVESTMENT B
WEIGHTED WEIGHTED
ROI PROBABILITY VALUE PROBABILITY VALUE
0% .15 0.0 0 0.0
5% .20 1.0 .30 1.5
10% .30 3.0 .40 4.0
15% .20 3.0 .30 4.5
20% .15 3.0 0 0.0
Est. ROI 10.0% 10.0%
During the initial scanning stage a firm should weight the elements
of risk and uncertainty; during a later feasibility study, the firm
must determine whether the degree of risk is acceptable.

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Country Risks:
Liability of Foreignness
• Liability of foreignness: the lower survival rate of
foreign firms in their initial years of operation
• Firms may reduce the associated risks by:
– first entering countries similar to their home countries
– enlisting experienced intermediaries to handle operations
for them
– using operational forms that require a lower commitment
of foreign resources
– initially moving to fewer, rather than more, foreign
countries
Foreign firms that manage to survive their early years
of operation actually have long-term survival rates
comparable to those of local competitors.

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Fig. 12.5: The Usual Pattern of
Internationalization

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Country Risks: Competitive Risk

Strategies designed to deal with the risks posed by

competition include:
• the imitation lag: exploiting temporary innovative advantages
by moving first into those countries most likely to catch up
• the first mover advantage: becoming the first major com-
petitor to enter a country in order to gain the best partners,
the best locations, and the best suppliers
• the oligopolistic reaction: purposely crowding a market to
prevent competitors from gaining advantages they might use
to improve their competitive positions elsewhere
• clustering: locating in places where competitors are present
to gain access to multiple suppliers, skilled personnel, an
existing customer base, and information regarding innovations

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Country Risks: Monetary Risk

Liquidity preference: the theory that presumes that

investors generally want some of their holdings in
highly liquid assets
• When considering monetary risk, firms must
carefully evaluate a country’s:
– present capital controls
– exchange rate stability
– balance-of-payments accounts
– inflation rates
– levels of government spending
Investors are willing to accept a lower rate of return on
liquid assets in order to be able to move them easily.

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Country Risks: Political Risk

Political risk: the expectation that the political climate

in a given country will change in such a way that a
firm’s operating position will deteriorate
• Firms can evaluate the potential political risk of a given
country by:
– examining the country’s past patterns of political risk
– evaluating the direction of change in the views of
government decision makers
– employing expert analysts
– tracking economic and social conditions
Political risk may arise from war, the expropriation of property,
changes in political leaders’ opinions and policies, civil disorder,
and/or animosity between a home and host country.

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Data Collection and Analysis
• Firms conduct research to:
– reduce uncertainties at all levels in their decision processes
– expand or narrow the alternatives they consider
– assess the merits of their existing programs
• The cost of data collection must be weighed
against the probable payoff in terms of:
– revenue gains
– cost savings
When firms conduct original studies in foreign countries,
they may have to be extremely imaginative and observant
and analyze indirect and/or complementary indicators.

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Problems with International Data
and Research Results
• The lack, obsolescence, and/or inaccuracy of
data regarding many countries make much
research difficult and expensive to undertake.
• Reasons for data inaccuracies include:
– the inability of governments to collect the needed
information
– the publication of false or purposely inaccurate
information designed to mislead constituencies
– the publication of conclusions based on too few
observations, non-representative samples, and/or
poorly designed research instruments
[continued]

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• Data comparability problems are rooted in:
– definitional differences across countries [e.g., family
categories, literacy levels, accounting rules]
– differences in base years and time periods
– distortions in foreign currency conversions
– differences in the measurement of investment flows
– the presence of black market activities
Many countries have agreed to similar standards for
collecting and publishing various categories of national
data in response to a recommendation of the IMF.

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External Sources of Information
• The major types of external, secondary information
sources include:
– individualized reports from market research and business
consulting firms [commissioned for a fee]
– specialized studies from research organizations regarding
countries, regions, industries, issues, etc.
– service firm reports regarding relevant business topics
– government agency socioeconomic and other reports
– international organization and agency reports
[e.g., the UN, the IMF, the World Bank, and the OECD]
– trade association reports
– information service company reports [fee-based databases]
Both the specificity and the cost of information will vary by source.

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Country Comparison Tools
• Grids can be used to:
– depict acceptable or unacceptable conditions [e.g.,
ownership rights]
– rank countries according to selected, weighted variables
[e.g., return or risk]

• Matrices can be used to:

– incorporate weighted indicators of a firm’s risks and
opportunities in specific countries
– plot the scores to more clearly reveal respective positions
for comparative purposes
It is useful to develop both present and future scores for countries;
a significant shift in a future score could have serious implications
with respect to the country selection process.

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Simplified Country Comparison Grid:
Three Types of Information
COUNTRY
VARIABLE WEIGHT I II III IV V
1. Ownership
a. Sole — No Yes Yes Yes Yes
b. Jt. venture — Yes Yes Yes Yes Yes
2. Return [higher number preferred]
a. Investment 0-5 — 4 3 3 3
b. Direct costs 0-3 — 3 1 3 2
Total 7 4 6 5
3. Risk [lower number preferred]
a. Exchange risk 0-3 — 0 0 3 3
b. Political risk 0-3 — 0 1 2 3
Total 0 1 5 6
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Fig. 12.7: Opportunity-Risk Matrix

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Country Resource Allocation:
Reinvestment vs. Harvesting
Reinvestment: the use of retained earnings to replace
depreciated assets or to add to a firm’s existing
stock of capital
• Over time, most of the value of a firm’s FDI comes from
reinvestment; it may take several years and even the
allocation of additional funds to meet stated objectives.
Harvesting: the reduction in the amount of an invest-
ment, either by simply harvesting earnings or by
divesting assets as well
• If an operation no longer fits a firm’s overall strategy, or if
better opportunities exist elsewhere, a firm must determine
how to exit that operation.
Managers are more likely to propose investments than divestments.

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Country Resource Allocation:
Diversification vs. Concentration
Geographic diversification: moving rapidly into
numerous foreign countries and then gradually
building a presence in each
Geographic concentration: moving into a limited
number of countries and developing a strong
competitive position in each
• Factors to be considered when selecting a strategy
(or perhaps a hybrid of the two) include:
̶ market growth rates ̶ the need for adaptation
̶ market sales stability ̶ program control
̶ competitive lead time requirements
̶ spillover effects ̶ constraints

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Diversification vs. Concentration
Strategies: Product and Market Factors
Prefer Prefer
Factor Diversification Concentration
if: if:
1. Market growth rate low high
2. Market sales stability low high
3. Competitive lead time short long
4. Spillover effects high high
5. Need for product adaptation low high
6. Need for promotion low high
and distribution adaptation
7. Program control requirements low high
8. Constraints low high
Source: “Marketing Expansion Strategies in International Marketing,” Journal of Marketing, Spring 1979, p.89.

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Final Country Selection Details and
Non-comparative Decision
Making
• For new investments, firms must:
– make on-site visits
– generate detailed estimates of all costs
– consider different locations within a given country
– evaluate partnership prospects
• For acquisitions firms must examine financial
statements and operations in detail.
• For expansion within countries, decisions will
most likely be made on the basis of capital
budget requests.
[continued]

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Major factors restricting companies from compar-
ing country investment opportunities in great
detail are:
• costs—the additional time and resources
required may increase costs to unacceptable
levels
• time—firms may need to react quickly in order to
capture first-mover advantages or respond to
competitive threats
Many firms consider proposals one at a time and accept
them if they meet minimum threshold criteria.

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Implications/Conclusions

• Firms use both qualitative and quantitative

information to determine which markets to
serve and where to locate production.
• Because each firm has unique competitive
capabilities and objectives, the factors
affecting the country selection decision will
differ for each.

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• When allocating resources across countries,
a company must consider its need for
reinvestment vs. divestment, its preference
for diversification vs. concentration, as well
as the interdependence of its operations.
• The interdependence of a firm’s operations
may obscure the real impact of a given
operation on overall corporate activity and
profitability.

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