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11.1
Contents
11.1 Introduction
11.2 Contract manufacturing
11.3 Licensing
11.4 Franchising
11.5 Joint ventures/strategic alliances
11.6 Other intermediate entry modes
11.7 Summary
Case studies
11.1 Ka-Boo-Ki
11.2 Bayer and GlaxoSmithKline
11.3 Video case study: Mariott
Learning objectives
After studying this chapter you should be able to do the following:
l Describe and understand the main intermediate entry modes:
– contract manufacturing;
– licensing;
– franchising; and
– joint venture/strategic alliances.
l Discuss the advantages and disadvantages of the main intermediate entry
modes.
l Explain the different stages in joint-venture formation.
l Explore the reasons for the ‘divorce’ of the two parents in a joint-venture
constellation.
l Explore different ways of managing a joint venture/strategic alliance.
Intermediate entry modes
1111
Introduction
So far we have assumed that the firm entering foreign markets is supplying them from
domestic plants. This is implicit in any form of exporting. However, sometimes the
firm may find it either impossible or undesirable to supply all foreign markets from
domestic production. Intermediate entry modes are distinguished from export modes
ecause they are primarily vehicles for the transfer of knowledge and skills, although
they may also create export opportunities. They are distinguished from the hierarchical
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entry modes in the way that there is no full ownership (by the parent firm) involved,
ut ownership and control can be shared between the parent firm and a local partner.
This is the case with the (equity) joint venture.
Intermediate entry modes include a variety of a
angements, such as licensing,
franchising, management contracts, turnkey contracts, joint ventures and technical
know-how or coproduction a
angements. In Figure 11.1 the most relevant inter-
mediate modes are shown in the usual value chain perspective.
Generally speaking, contractual a
angements take place when firms possessing
some sort of competitive advantage are unable to exploit this advantage because of
esource constraints, for instance, but are able to transfer the advantage to anothe
party. The a
angements often entail long-term relationships between partner firms
and are typically designed to transfer intermediate goods such as knowledge and/o
skills between firms in different countries.
Contract manufacturing
Several factors may encourage the firm to produce in foreign markets:
l Desirability of being close to foreign customers. Local production allows bette
interaction with local customer needs concerning product design, delivery and
service.
l Foreign production costs (e.g. labour) are low.
l Transportation costs may render heavy or bulky products non-competitive.
l Tariffs or quotas can prevent entry of an exporter’s products.
l In some countries there is government preference for national suppliers.
Contract manufacturing enables the firm to have foreign sourcing (production)
without making a final commitment. Management may lack resources or be unwilling
to invest equity to establish and complete manufacturing and selling operations. Yet
contract manufacturing keeps the way open for implementing a long-term foreign
development policy when the time is right. These considerations are perhaps most
important to the company with limited resources. Contract manufacturing enables the
firm to develop and control R&D, marketing, distribution, sales and servicing of its
products in international markets, while handing over responsibility for production to
a local firm (see Figure 11.1).
Payment by the contractor to the contracted party is generally on a per unit basis,
and quality and specification requirements are extremely important. The product can
e sold by the contractor in the country of manufacture, its home country, or some
other foreign market.
This form of business organization is quite common in particular industries. Fo
example, Benetton and IKEA rely heavily on a contractual network of small overseas
manufacturers.
Contract manufacturing also offers substantial flexibility. Depending on the duration
of the contract, if the firm is dissatisfied with product quality or reliability of delivery
it can shift to another manufacturer. In addition, if management decides to exit the
market it does not have to sustain possible losses from divesting production facilities.
On the other hand, it is necessary to control product quality to meet company stand-
ards. The firm may encounter problems with delivery, product wa
anties or fulfilling
additional orders. The manufacturer may also not be as cost efficient as the contracting
firm, or may reach production capacity, or may attempt to exploit the agreement.
Contract manufacturing
Manufacturing is
outsourced to an external
partner, specialized
in production and
production technology.
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Thus, while contract manufacturing offers a number of advantages, especially to a
firm whose strength lies in marketing and distribution, care needs to be exercised in
negotiating the contract. Where the firm loses direct control over the manufacturing
function mechanisms need to be developed to ensure that the contract manufacture
meets the firm’s quality and delivery standards.
Licensing
Licensing is another way in which the firm can establish local production in foreign
markets without capital investment. It differs from contract manufacturing in that it is
usually for a longer term and involves much greater responsibilities for the national
firm, because more value chain functions have been transfe
ed to the licensee by the
licensor (see Figure 11.1).
A licensing agreement
A licensing agreement is an a
angement wherein the licensor gives something of value
to the licensee in exchange for certain performance and payments from the licensee.
The licensor may give the licensee the right to use one or more of the following things:
l a patent covering a product or process;
l manufacturing know-how not subject to a patent;
l technical advice and assistance, occasionally including the supply of components,
materials or plant essential to the manufacturing process;
l marketing advice and assistance;
l the use of a trade mark/trade name.
In the case of trade mark licensing the licensor should try not to undermine a
product by overlicensing it. For example, Pie
e Cardin diluted the value of his name
y allowing some 800 products to use the name under license. Overlicensing can
increase income in the short run, but in the long run it may mean killing the goose that
laid the golden egg.
In some situations the licensor may continue to sell essential components or services
to the licensee as part of the agreement. This may be extended so that the total agree-
ment may also be one of cross-licensing, wherein there is a mutual exchange of know-
ledge and/or patents. In cross-licensing there might not be a cash payment involved.
Licensing can be considered a two-way street because a license also allows the original
licensor to gain access to the licensee’s technology and product. This is important
ecause the licensee may be able to build on the information supplied by the licensor.
Some licensors are very interested in grantbacks and will even lower the royalty rate in
eturn for product improvements and potentially profitable new products. Where a
product or service is involved the licensee is responsible for production and marketing
in a defined market area. This responsibility is followed by all the profits and risks asso-
ciated with the venture. In exchange the licensee pays the licensor royalties or fees,
which are the licensor’s main source of income from its licensing operations and that
usually involve some combination of the following elements:
l A lump sum not related to output. This can include a sum paid at the beginning of
an agreement for the initial transfer of special machinery, parts, blueprints, know-
ledge and so on.
Licensing
The licensor gives a right
to the licensee against
payment, e.g. a right to
manufacture a certain
product based on a patent
against some agreed
oyalty.
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l A minimum royalty – a guarantee that at least some annual income will be received
y the licensor.
l A running royalty – normally expressed as a percentage of normal selling price or as
a fixed sum of money for units of output.
Other methods of payment include conversions of royalties into equity, manage-
ment and technical fees, and complex systems of counter purchase, typically found in
licensing a
angements with eastern European countries.
If the foreign market ca
ies high political risk then it would be wise for the licenso
to seek high initial payments and perhaps compress the timescale of the agreement.
Alternatively, if the market is relatively free of risk and the licensee is well placed to
develop a strong market share, then payment terms will be somewhat relaxed and
probably influenced by other licensors competing for the agreement.
The licensing agreement or contract should always be formalized in a written docu-
ment. The details of the contract will probably be the subject of detailed negotiation
and hard bargaining between the parties, and there can be no such thing as a standard
contract.
In the following we see licensing from the viewpoint of a licensor (licensing out) and
a licensee (licensing in). This section is written primarily from the licensor’s viewpoint,
ut licensing in may be an important element in smaller firms’ growth strategies, and
therefore some consideration is given to this issue too.
Licensing out
Generally there is a wide range of strategic reasons for using licensing. The most
important motives for licensing out are as follows:
l The licensor firm will remain technologically superior in its product development.
It wants to concentrate on its core competences (product development activities)
and then outsource production and downstream activities to other firms.
l The licensor is too small to have financial, managerial or marketing expertise fo
overseas investment (own subsidiaries).
l The product is at the end of its product life cycle in the advanced countries because
of obsolescent technology or model change. A stretching of the total product life
cycle is possible through licensing agreements in less developed countries.
l Even if direct royalty income is not high margins on key components to the licensee
(produced by the licensor) can be quite handsome.
l If government regulations restrict foreign direct investment or if political risks are
high licensing may be the only realistic entry mode.
l There may be constraints on imports into the licensee country (tariff or non-tariff
a
iers).
When setting the price for the agreement the costs of licensing should not be under-
estimated. Table 11.1 presents a
eakdown of costs of licensing out by Australian
firms.
Licensing in
Empirical evidence shows (Young et al., 1989, p. 143) that many licensing agreements
actually stem from approaches by licensees. This would suggest that the licensee is at
an immediate disadvantage in negotiations and general relations with the licensor.
In other cases licensing in is used as the easy option, with the license being renewed
egularly and the licensee becoming heavily dependent on the technology supplier (the
licensor).
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