Entry Mode Strategy
Entry Mode Strategy refers to the methods and approaches that firms use to enter foreign markets as part of their internationalization efforts. This process is crucial for businesses looking to expand beyond domestic borders, driven by opportunities such as accessing new customer bases and resources, as well as facing increasing global competition. The primary modes of entry include exports (either direct or indirect), cooperation agreements (like licensing and franchising), and foreign direct investment (FDI), which may involve joint ventures or establishing subsidiaries.
The choice of entry mode is influenced by various factors, including the level of control a firm desires, the resources it is willing to commit, and the associated risks. For example, exporting can be a less risky initial step, while FDI could provide greater control but also involves higher resource commitments and potential uncertainty. Additionally, firms must consider external factors such as cultural differences, legal regulations, and the competitive landscape of the target market, as these can significantly impact their strategy and success.
As globalization evolves, understanding the dynamics between location, industry specifics, and firm characteristics becomes vital for effective entry mode selection. The rise of new markets and changing geopolitical landscapes also plays a role in shaping how firms approach international expansion. Ultimately, selecting the appropriate entry mode is a complex decision that can affect a firm's long-term viability and profitability in a foreign market.
Entry Mode Strategy
Abstract
"Internationalization" is a term that refers to the international expansion of firms. The success of internationalization depends on the foreign market entry modes and strategies adopted by the firm, most of which involve cooperative and acquisition strategies. With globalization, internationalization opens the doors to great opportunities for firms, as well as great challenges. As globalization expands and morphs, theories of entry mode strategy have evolved accordingly.
Overview
The process of globalization includes the globalization of markets; what happens in one market affects the businesses and economy of other countries. In consequence, firms trying to break into foreign markets abroad must adapt their strategies to global dynamics as well as to the realities (e.g., competition, culture) of the target foreign market it wishes to penetrate. Globalization influences businesses in many ways: by creating expansion and diversification opportunities; by forcing firms to face competition from the growing presence of foreign markets and firms; by impacting the levels of competition worldwide. Globalization also creates events that seem contradictory, such as the proliferation of a higher number of manufacturing and commercial enterprises and the growing consolidation of businesses into multinational and transnational corporations.
The internationalization of firms, then, refers to the expansion of firms into foreign markets. It is more than territorial expansion into new markets. Upon designing their expansion strategy, firms must consider all the costs and risks included in international expansion, and taking action to transcend local markets into new foreign markets always implies great uncertainty. Firms, then, seek to reduce the risks and uncertainty. To do so, a company must weight the costs against the possible benefits. There are many reasons why a firm may want to expand into a new foreign market, including the opportunity to exploit the commercial opportunities or the resources available in a foreign market. Comparative advantages of a location may include cost reductions, an expanded customer base, and strategic opportunities to better compete in a specific globalized industry.
Entry mode strategy refers to the type of strategy selected by an enterprise or firm in order to penetrate a foreign market. There are several paths, or modes, a firm can undertake on the path to internationalization. The main three modes are exports, cooperation agreements, and foreign direct investment. Exports may be direct or indirect; cooperation agreements refer to agreements such as licensing, concessions, or franchises. Foreign direct investment usually takes place through joint ventures, affiliates, or subsidiaries. These modes are characterized by interrelated factors, such as the level of control the firm is going to have, resource commitment, costs, and potential to gain knowledge.
Two main kinds of export endeavors exist: indirect or passive and direct or active. In the first scenario, the firm exports by way of intermediaries, who take care of the logistics that move the product from its point of manufacture to the point of sales, including taking care of the related paperwork, customs duties, and so forth. The firm in this case is limited to producing or selling just the same as it does with its local customers at home. Intermediary companies often contribute local know-how in the foreign market, besides taking care of the logistics and bureaucratic matters. In cases of direct or active export, a business deals directly with intermediaries and final buyers in the target foreign country, and takes care directly of all logistic, financial, and bureaucratic matters related to the export activity. When the level of export becomes big enough, firms often open an export department and perhaps even subsidiaries in the foreign market.
A joint venture is an agreement between two (or more) firms, both of which contribute something in order to create a third entity or firm in the target foreign market. One of these firms is usually a local firm in the foreign market. For example, the entering firm may contribute capital and technology, while the other may contribute capital, local knowledge and market access. Many countries, such as India, require that foreign companies enter into a contractual agreement with a local firm in which the local firm will own at least 50 percent of the new business. On the other hand, if the local laws allow it, firms may also open their own affiliates or subsidiaries in a foreign market. This process is known as foreign direct investment (FDI).
Firms base their FDI strategy on a wide array of variables, among the most important of which is level of risk or uncertainty as well as the level of control it will have upon the firm’s operations and the resource commitment that will be required. The selection of the most appropriate entry mode is crucial to ensure a successful international expansion. Changing an entry mode strategy implies significant losses of time and capital, which is why firms need to consider very carefully their entry mode.
Further Insights
For many large firms or multinationals, an expansion into foreign markets—or a global integration of markets—depends on balancing various factors, such as the rules that regulate international trade, the adjustments the firm will need to make in order to remain competitive, as well as the new market risks and opportunities. Competition is growing from emerging markets, such as Brazil, Russia, India and China, collectively known as BRIC, as well as emerging economies in Asia, Eastern Europe, and Latin America. Many of these foreign economies are represented by smaller firms immersed in the target market. In consequence, they tend to have greater knowledge of the market and culture, as well as important local connections.
The process that firms undergo in order to penetrate foreign markets includes research in order to identify a convenient target market and an analysis of possible barriers to entering that market. There are many possible entry modes, with different pros and cons, and firms select the most appropriate for them. As firms become more experienced, they may seek to make further FDIs. Any of the variables involved in expanding the market may imply changes of entry mode. Some experts, however, argue that it is difficult for a firm to change entry mode, especially if a high level of risk or uncertainty is involved.
On the other hand, the process of globalization has deepened and widened enough that companies perceive less uncertainty than before. This correlates with greater liberalization of international trade. Most foreign markets no longer seem inaccessible and ever more firms seek to become involved in foreign trade. In fact, internationalization at some point in time is a benchmark for a many incipient companies. Experts say that for many new firms, internationalization is not a question of if to expand as much as when to do it. Moreover, foreign trade can be an important source of income when a home market suffers economic recession. Firms usually begin with exports and end with FDI, but in order to do so, they can choose from an ample diversity of modes (Mroczek, 2014).
There are many theories and approaches that experts select in order to study how, when and which types of entry modes are selected by firms expanding into international markets. Most find that there are three main categories that serve to determine a firm’s internationalization process: Location, industry-specific factors, and firm-specific factors. Location refers to external macroeconomic factors, such as social conditions. Industry-specific factors refers to looking at business at the industrial level versus firm-specific factors, which looks at characteristics specific to the firm. It is also important to note that entry mode factors may be interdependent or interact with each other. (Mroczek, 2014)
An entry mode decision is also influenced by uncertainty. There are many types of uncertainty, such external uncertainties, which include, for example, unstable or changeable political, legal, or economic factors in the target market country. Different companies have different ways of determining the level of uncertainty they can cope with and this level may vary across firms. Other uncertainties may relate to behavior and culture, such as host country culture or organizational culture. In general, however, entry mode selection is not limited to a single issue such as risk, cost, culture, or logistics. Rather, it includes the articulations or junctures between various or all of these factors and variables. When a firm is planning to expand, it usually takes all of these elements into consideration when selecting a likely entry mode.
Viewpoints
A firm may develop an export department and enter a foreign market in this way; however, it can also acquire a firm that is already established in the target market or host country. These are different strategies, which require different modes of entry. Some experts have argued that firms will acquire a local firm if it desires to enter a market whose resource base or capabilities are far or outside of the current resource base of the firm.
Other researchers argue that when there is a high degree of relatedness between a firm’s new product in the foreign market and its existing products, its costs are reduced and it might make more sense for a firm to enter the new market by selecting internal development. On the other hand, a firm is more likely to enter unrelated markets—those in which they do not have much prior experience—by way of acquisition. Moreover, there are organizational experts who argue that the issue is more complex. Location, for instance, plays a central role and the connection between entry mode and degree of relatedness to the market is influenced by the location of the new market; that is, whereas the new market is within or outside the firm’s principal market domain. Firms may also acquire local firms to increase market power and efficiency and to decrease competition. For example, a firm may acquire a rival firm that competes in the same field, which might increase its market power and income, while ideally reducing costs. These acquisitions, for example, tend to occur within a firm’s primary business domain (Lee and Lieberman, 2010).
Thus, a firm considers many variables when choosing between entry modes, and all of its attendant advantages and disadvantages. Entry modes will differ in related costs, risks, efficiency, time (speed of entry), finances, and other factors. For established firms with strong research and development capabilities, for example, internal development might be the most cost-efficient option. Internal development tends to be funded by established cash flows and gradual increments, whereas acquisitions require a lump sum payment for a purchase transaction. The risks linked to acquiring an established firm, then, might be greater than those associated with developing gradually an internal expansion.
On the other hand, acquiring a local business in the host country presents the advantage of certainty, for it is usually an established firm with—ideally—a solid foothold in the market. Moreover, acquiring a firm reduces the number of competitors in the market. In other words, when a firm purchases a business, a competitor is eliminated. Thus, it raises the prospect of higher profitability. Moreover, it is also a good selection in order to increase speed of entry into the market. Purchasing local businesses, then, is a popular entry mode strategy for many firms expanding into a foreign market (Lee and Lieberman, 2010).
Developing a market from scratch has strong advantages, but it may take time to develop a solid market share and revenues. That is why some experts argue that firms tend to use internal development as their entry mode when the foreign market they seek to enter is related to its existing products. This would make the process of internal development less costly. On the other hand, experts have also argued that relatedness may also be convenient for acquisitions, for it reduces the risk of acquisition failure and the firm may use its knowledge about the product strategically when acquiring a new firm in the foreign market.
In short, relatedness or proximity of the market products may work in favor of both internal development or acquisition, by reducing the risk and other costs associated with entering a foreign market. Nevertheless, according to recent studies, acquisition tends to be the likelier entry mode strategy the closer a new product is to the firm’s existing products. Other issues may influence the entry mode strategy selected by a firm, such as patent or tariff barriers and technology gaps. In cases such as these, acquiring a firm that is already established in the market may seem the best option (Lee and Lieberman, 2010).
Businesses increasingly resort to strategic alliances with already established businesses, or with corporations who may already have made inroads into a target foreign market. Such alliances represent an important entry mode. They usually involve a collaboration agreement between firms for a specific market project or goal; however, the firms involved both maintain their autonomy. A more permanent form of alliance would be a joint venture. In a joint venture, as explained above, two firms join efforts and contribute resources in order to create a third company, which becomes a separate business unit. A firm would take into consideration which of these entry modes would serve its expansion needs best, depending upon such factors as a preference for more effectiveness and speed, the need to gain advantage over another competitor, the need to solidify in order to withstand rapid global changes, and the legal requirements of the host country.
There are other important factors that have created great changes in contemporary international trade and, in consequence, entry mode selection for international firms: technology and geopolitics. Hyper-connectivity has been made possible by advances in information and communication technology, so that multinationals are increasingly coordinators of myriad activities and facilities (e.g., global factories, rapid multibillion dollar financial transactions, supply chain operations), which can be managed from the home country headquarters or, through the Internet, from anywhere in the world. In other words, important firm transactions can be headquartered anywhere at any given time, operating both local and transnational systems. Some organizational experts argue, however, that the more business activities become dispersed around the world, the less control a firm will have over operations, logistics, and any possible externality (Buckley, 2015).
Other important changes include the national operators of international trade. The strongest firms of the twentieth century used to be based in the United States, Europe, and Japan. In the twenty-first century, however, firms from around the world have gained significant importance, especially in the emerging BRIC countries. Some experts express concern that the globalized economy does present emerging economies with opportunities to become important international game players, but a reliance on factory economies may also prove to be a deterrent to developing higher value-added activities (Buckley, 2015). For example, an emerging country might develop a prospering market economy based on the assembly of computers, but not focus on developing the necessary resources for a high-tech innovative design industry. On the other hand, for emerging economies in the transnational market, diversification may only be a matter of time.
Terms & Concepts
Acquisition: An asset that is gained, usually by purchasing or buying it.
Emerging Market Economy: A national economy in the process of transforming rapidly into a more advanced economy. They usually take place in industrializing countries.
Foreign Direct Investment (FDI): An investment or purchase made by a firm based in one country (the home country) of another firm or unit established in another country (host country). It tends to give the investing firm a high level of control upon the company in which it has invested.
Internationalization: A strategy which corporations engage in to expand and operate transnationally.
Multinational Firm: A corporate firm that operates in more than one country, but it is headquartered in one country (home country).
Relatedness: Sharing characteristics across items. Degree of proximity.
Uncertainty: The quality of being unstable, unpredictable, or changeable. In reference to international trade, for example, economic and political uncertainty are almost always factored into calculations and analysis.
Bibliography
Buckley, P. J., & Pervez, N. G. (Eds.) (2015). International business strategy: Theory and practice. London, UK: Routledge.
Cullen, J. B., & Parboteeah, K. P. (2013). Multinational management: A strategic approach. Cincinnati, OH: South Western College Publishing.
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Gollnhofer, J. F., & Turkina, E. (2015). Cultural distance and entry modes: implications for global expansion strategy. Cross Cultural Management, 22(1), 21–41. Retrieved January 3, 2016, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=100607149&site=ehost-live
Lee, G. K., & Lieberman, M. B. (2010). Acquisition vs internal development as modes of market entry. Strategic Management Journal, 31(2), 140–158. Retrieved January 3, 2016, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=46769858&site=ehost-live
Mroczek, K. (2014). Transaction cost theory – explaining entry mode choices. Pozman University of Economics Review, 14(1), 48–62. Retrieved January 3, 2016, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=95422815&site=ehost-live
Plante, J., & Nordhill, K. (2002). Beyond the choice of entry mode.Aa case study in micropower. Grin Verlag Gmbh.
Sachse, U. (2012). Internationalisation and mode switching: Performance, strategy, timing. Berlin, Germany: Gabler Verlag.
Suggested Reading
Anil, I., Tatoglu, E., & Ozkasap, G. (2014). Ownership and market entry mode choices of emerging country multinationals in a transition country: Evidence from Turkish multinational in Romania. Journal for East European Management Studies, 19(4), 413–452. Retrieved January 3, 2016, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=99537902&site=ehost-live
De Ville, M. A., Rajwan, T., & Lawton, T. (2015). Market entry modes in a multipolar world: Untangling the moderating effect of the political environment. International Business Review, 23(3), 419–429. Retrieved January 3, 2016, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=102000686&site=ehost-live
Fong, C.-M., Lee, C.-L., & Du, Y. (2014). Consumer animosity, country of origin, and foreign entry-mode choice: A cross-country investigation. Journal of International Marketing, 22(1), 62–76. Retrieved January 3, 2016, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=97479322&site=ehost-live