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9.1
Contents
9.1 Introduction
9.2 The transaction cost approach
9.3 Factors influencing the choice of entry mode
9.4 Summary
Case studies
9.1 Jarlsberg
9.2 Ansell condoms
9.3 Video case study: Understanding entry modes into the Chinese market
Learning objectives
After studying this chapter you should be able to do the following:
l Identify and classify different market entry modes.
l Explore different approaches to the choice of entry mode.
l Explain how opportunistic behaviour affects the manufacture
intermediary
elationship.
l Identify the factors to consider when choosing a market entry strategy.
Some approaches to the choice of
entry mode
99
Introduction
We have seen the main groupings of entry modes which are available to companies
that wish to take advantage of foreign market opportunities. At this point we are con-
cerned with the question: what kind of strategy should be used for the entry mode
selection?
According to Root XXXXXXXXXXthere are three different rules:
1 Naive rule. The decision maker uses the same entry mode for all foreign markets.
This rule ignores the heterogeneity of the individual foreign markets.
2 Pragmatic rule. The decision maker uses a workable entry mode for each foreign
market. In the early stages of exporting the firm typically starts doing business with
a low-risk entry mode. Only if the particular initial mode is not feasible or profitable
will the firm look for another workable entry mode. In this case not all potential
alternatives are investigated, and the workable entry may not be the ‘best’ entry
mode.
Entry mode
An institutional
a
angement necessary
for the entry of a
company’s products and
services into a new
foreign market. The main
types are: export,
intermediate and
hierarchical modes.
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3 Strategy rules. This approach requires that all alternative entry modes are systemat-
ically compared and evaluated before any choice is made. An application of this
decision rule would be to choose the entry mode that maximizes the profit contri-
ution over the strategic planning period subject to (a) the availability of company
esources, (b) risk and (c) non-profit objectives.
Although many SMEs probably use the pragmatic or even the naive rule, this
chapter is mainly inspired by an analytical approach, which is the main principle
ehind the strategy rule.
The transaction cost approach
The principles of transaction cost analysis have already been presented in Chapter 3
(section 3.3). This chapter will go into further details about ‘friction’ and opportunism.
The unit of analysis is the transaction rather than the firm. The basic idea behind
this approach is that in the real world there is always some friction between the
uyer and seller in connection with market transactions. This friction is mainly
caused by opportunistic behaviour in the relation between a producer and an export
intermediary.
In the case of an agent, the producer specifies sales-promoting tasks that the export
intermediary is to solve in order to receive a reward in the shape of commission.
In the case of an importer, the export intermediary has a higher degree of freedom
as the intermediary itself, to a certain extent, can fix sales prices and thus base its earn-
ings on the profit between the producer’s sales price (the importer’s buying price) and
the importer’s sales price.
No matter who the export intermediary may be, there will be some recu
ent ele-
ments that may result in conflicts and opportunistic actions:
l stock size of the export intermediary;
l extent of technical and commercial service that the export intermediary is to ca
y
out for its customers;
l division of marketing costs (advertising, exhibition activities, etc.) between produce
and export intermediary;
l fixing of prices: from producer to export intermediary, and from the export inter-
mediary to its customers;
l fixing of commission to agents.
Opportunistic behaviour from the export intermediary
In this connection the export intermediary’s opportunistic behaviour may be reflected
in two activities:
1 In most producer–export intermediary relations a split of the sales promoting
costs has been fixed. Thus statements by the export intermediary of too high sales
promotion activities (e.g. by manipulating invoices) may form the basis of a highe
payment from producer to export intermediary.
2 The export intermediary may manipulate information on market size and com-
petitor prices in order to obtain lower ex-works prices from the producer. Of
course, this kind of opportunism can be avoided if the export intermediary is paid
a commission of realized turnover (the agency case).
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Chapter 9 Some approaches to the choice of entry mode
Opportunistic behaviour from the produce
In this chapter we have so far presumed that the export intermediary is the one who
has behaved opportunistically. The producer may, however, also behave in an oppor-
tunistic way, as the export intermediary must also use resources (time and money) on
uilding up the market for the producer’s product programme. This is especially the
case if the producer wants to sell expensive and technically complicated products.
Thus the export intermediary ca
ies a great part of the economic risk, and will
always have the threat of the producer’s change of entry mode hanging over its head.
If the export intermediary does not live up to the producer’s expectations it risks being
eplaced by another export intermediary, or the producer may change to its own
export organization (sales subsidiary), as the increased transaction frequency (market
size) can obviously bear the increased costs.
The last case may also be part of a deliberate strategy from the producer: namely, to
tap the export intermediary for market knowledge and customer contacts in order to
establish a sales organization itself.
What can the export intermediary do to meet this situation?
Heide and John XXXXXXXXXXsuggest that the agent should make a number of further
‘offsetting’ investments in order to counte
alance the relationship between the two
parties. These investments create bonds that make it costly for the producer to leave
the relationship: that is, the agent creates ‘exit ba
iers’ for the producer (the principal).
Examples of such investments are as follows:
l Establish personal relations with the producer’s key employees.
l Create an independent identity (image) in connection with selling the producer’s
products.
l Add further value to the product, such as a BDA (before–during–after) service,
which creates bonds in the agent’s customer relations.
If it is impossible to make such offsetting investments Heide and John XXXXXXXXXXsug-
gest that the agent reduces its risk by representing more producers.
These are the conditions that the producer is up against, and when several of these
factors appear at the same time the theory recommends that the company (the pro-
ducer) internalizes rather than externalizes.
Factors influencing the choice of entry mode
A firm’s choice of its entry mode for a given product/target country is the net result of
several, often conflicting forces. The need to anticipate the strength and direction of
these forces makes the entry mode decision a complex process with numerous trade-
offs among alternative entry modes.
Generally speaking the choice of entry mode should be based on the expected con-
tribution to profit. This may be easier said than done, particularly for those foreign
markets where relevant data are lacking. Most of the selection criteria are qualitative in
nature, and quantification is very difficult.
As shown in Figure 9.1, four groups of factors are believed to influence the entry
mode decision:
1 internal factors;
2 external factors;
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3 desired mode characteristics;
4 transaction-specific behaviour.
In what follows a proposition is formulated for each factor: how is each factor supposed
to affect the choice of foreign entry mode? The direction of influence is also indicated
oth in the text and in Figure 9.1. Because of the complexity of the entry mode decision
the propositions are made under the condition of other factors being equal.
1 Internal factors
Firm size
Size is an indicator of the firm’s resource availability; increasing resource availability
provides the basis for increased international involvement over time. Although SMEs
may desire a high level of control over international operations and wish to make heavy
esource commitments to foreign markets, they are more likely to enter foreign markets
using export modes because they do not have the resources necessary to achieve a
high degree of control or to make these resource commitments. Export entry modes
(market modes), with their lower resource commitment, may therefore be more suit-
able for SMEs. As the firm grows it will increasingly use the hierarchical model.
International experience
Another firm-specific factor influencing mode choice is the international experi-
ence of managers and thus of the firm. Experience, which refers to the extent to
Figure 9.1 Factors affecting the foreign market entry mode decision
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Chapter 9 Some approaches to the choice of entry mode
which a firm has been involved in operating internationally, can be gained from
operating either in a particular country or in the general international environ-
ment. International experience reduces the cost and uncertainty of serving a market,
and in turn increases the probability of firms committing resources to foreign
markets.
In developing their theory of internationalization Johanson and Vahlne (1977)
assert that uncertainty in international markets is reduced through actual operations
in foreign markets (experiential knowledge) rather than through the acquisition of
objective knowledge. They suggest that it is direct experience with international
markets that increases the likelihood of committing extra resources to foreign
markets.
Product/service
The physical characteristics of the product or service, such as its value/weight ratio,
perishability and composition, are important in determining where production is
located. Products with high value/weight ratios, such as expensive watches, are typically
used for direct exporting, especially where there are significant production economies
of scale, or if management wishes to retain control over production. Conversely, in the
soft drinks and beer industry, companies typically establish licensing agreements, o
invest in local bottling or production facilities, because shipment costs, particularly to
distant markets, are prohibitive.
The nature of the product affects channel selection because products vary so widely
in their characteristics and use, and because the selling job may also vary markedly.
For instance, the technical nature of a product (high complexity) may require service
oth before and after sale. In many foreign market areas marketing intermediaries
may not be able to handle such work. Instead firms will use one of the hierarchical
modes.
Blomstermo et al XXXXXXXXXXdistinguish between hard and soft services. Hard services
are those where production and consumption can be decoupled. For example software
services can be transfe
ed into a CD, or some other tangible medium, which can be
mass-produced, making standardization possible. With soft services, where produc-
tion and consumption occur simultaneously, the customer acts as a co-producer,
and decoupling is not viable. The soft-service provider must