International Strategy

Studying this chapter should provide you with the knowledge to:

1. Discuss the globalization of business.
2. Explain why firms choose to expand internationally.
3. Describe different kinds of distance, how they affect successful international expansion, and how
   this affects the choice of where firms should go when they expand.
4. Explain the three primary types of international strategy and be able to use the international strategy triangle
   to determine which international strategy is right for a specific firm.
5. Explain when a firm should use each of four major ways to enter a foreign market.

“A Chinese-telecommunications giant founded by a former engineer of the People’s Liberation Army is about to take a shot at challeng- ing Apple Inc. and Samsung Electronics Co. in the global smartphone market.” —Wall Street Journal, April 5, 20161
The headline above from a Wall Street Journal article sig- naled the emergence of the world’s third largest maker of smart- phones. By the end of 2018, most US users of smartphones were well aware of the two largest, and most popular, smartphone

makers in the United States: Apple and Samsung. Indeed, the two firms accounted for roughly 36.9 percent of the shipments of US smartphones in Q4 2018.2 But most smartphone users hadn’t even heard of Huawei, the company referenced in the Wall Street Journal article (or if they had, it was probably because the com- pany was being investigated for allegedly making 4G telecommu- nication equipment that allowed the Chinese government to spy on foreign firms).
Headquartered in Shenzhen, China, Huawei had become a technology giant by providing telecom carriers, enterprises, and consumers with products and services including ICT (information and communication technology) solutions, fixed and mobile net- works, routers, smartphones, and other mobile devices. Huawei served customers in more than 170 countries and had emerged as the world’s largest player in the global telecom equipment market (replacing Ericsson in 2013) and number three behind Samsung and Apple in the global smartphone market.3 Huawei began selling private branch exchange (PBX) switches and developed relationships with the largest telecommunications companies around the globe, eventually selling equipment that allowed them to run their 3G and 4G (LTE) networks. By 2018, Huawei derived 57.5 percent of its total revenues of US$109 bil- lion from overseas.4
Smartphones with Google’s Android OS launched in 2008 with HTC, Samsung, and Motorola being the first to launch phones based

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on Android OS. Huawei decided to leverage its expertise making tel- ecommunications equipment and its relationships with telecommu- nication carriers around the globe to launch its own smartphone in 2010. Huawei initially offered low-end phones (below US$150); the high-end market was seen as being the exclusive domain of Apple and Samsung. Indeed, initially over 80 percent of Huawei phones were made for telecom carriers (with their brand on it) and targeted to the low-end mass market in emerging economies and the price- sensitive segment in developed economies. As a result, these smart- phones did not help Huawei build any brand awareness.
Once Huawei had gained experience and volume making low- end smartphones, it decided it was time to move up-market and compete in the premium segment of the market. In April 2016, Huawei released three variants of its latest P9 series smartphone in London, with a price tag from US$699 to $849, matching that of Apple’s iPhone 6 in the United Kingdom. With Leica’s dual-lens cam- era and Huawei’s own Kirin 955 chip, the P9 was a powerful smart- phone with a top-quality camera. The release of the P9 sent a strong signal of the company’s ambitions in the global smartphone market. In the fourth quarter of 2018, Huawei’s global shipments of smart- phones topped 59.7 million units, boosting its market share to 16.1 percent from 10.7 percent in 2017. Huawei even sold more units than Apple in quarters two and three in 2018. In fact, by 2018 Chinese brands, led by Huawei and Xiaomi, accounted for 42 percent (656 mil- lion of 1,561 million) of global shipments in 2018. Indeed, 7 of the top 10 smartphone brands that year were made by Chinese companies.5

The global smartphone market saw significant growth from 2009 to 2015, with units increasing from 174 million units in 2009 to 1,433 million units in 2016, an average annual growth rate of
43.8 percent. The growth rate from 2015 to 2018 had slowed to roughly 10 percent per year. But growth in emerging markets in Asia (e.g., China, Vietnam), Asia-Pacific (Philippines, Indonesia), the Middle East, and Africa had continued strong at greater than 35 percent. The shift in demand from developed markets to emerg- ing markets triggered growth in demand for low-end smart- phones, driving down the average sale price from US$440 in 2010 to US$305 in 2015.6 Huawei was well positioned to compete in the low end of the market but hoped that it would be able to com- pete in the high end of the market by leveraging its technological capabilities as a telecom equipment provider. For example, bat- tery life was a problem for smartphone users, so Huawei devel- oped the Kirin 950 SoC to address this problem by leveraging its deep understanding of 3G and 4G wireless modem technologies to provide two days of continual battery life. But despite syner- gies with other businesses and deep technical expertise, many questioned whether Huawei could truly challenge Apple and Samsung at the high end of the market. Nonetheless, in Febru- ary 2016, CEO Chengdong Yu announced that Huawei’s strate- gic goal for its smartphone business was to overtake Apple in three years and Samsung in five years. Can Huawei realistically challenge Apple and Samsung for world dominance in high-end smartphones?

This chapter will help you to answer three critical questions about strategy, specifically concerning international expansion: Why, Where, and How. Carefully researched and thought- ful responses to those three questions can make the difference between a successful expansion effort and failure. Huawei is hoping to successfully challenge Apple and Samsung in smart- phones in the United States, but this will only be possible if it can leverage its global scale and synergies across multiple businesses in multiple countries.

The Globalization of Business

During the last 50 years, the scope of business has changed for most organizations. Com- panies used to compete primarily within their own country. Technological advancements in communications and transportation, along with falling trade barriers, have changed that for most firms. The average tariff, the tax on goods imported into a country, has dropped from more than 40 percent to an average of 4 percent in developed nations. At the same time, countries across the globe repealed regulations that kept foreign firms from buying local companies and building plants and stores in their markets. As a consequence, the volume of international trade and companies selling across national borders, has increased more than 28-fold since 1970.
International trade in merchandise alone topped $12 trillion in 2016.7 During the same period foreign direct investment (FDI), companies building factories and stores in foreign countries, increased more than 500 percent (see Figure 9.1).8 Although there is no consensus on why FDI flows to some countries and not others, common factors include low labor and tax costs, low trade barriers, and favorable exchange rates.9

foreign direct investment Direct investment in production or business in one country by a business from another country.

2500000

2000000

1500000

1000000

500000

0

FIGURE 9.1 Global Foreign Direct Investments, 1970–2016 (in 2016 US. dollars)
Source: UNCTAD, Inward and outward foreign direct investment flows, annual, 1970–2016, and OECD FDI in Figures, February 2017.

multinational firms Firms that sell or produce in multiple countries.

This trend toward increased international trade has allowed organizations to place parts of their value chains in different countries, depending on where each part can generate the most value. Manufacturing, as well as service industries, has become global. Trade in commercial services, such as licensing and franchise fees, as well as other types of services such as finan- cial, information, computing, insurance, and consulting services has increased 272 percent just in the last decade, totaling more than $4.8 trillion in 2015.10
What this means for strategy is that both production and the market for many products and services aren’t national anymore—they’re regional (multiple countries) or global.11 For most industries, the competition isn’t just local or national anymore, either—it’s also global, and key competitors may be located in another country. Indeed, the World Trade Organization says that half of all the productive wealth in the world is generated by multinational firms that compete with an international strategy.
Even for small companies, international strategy is often key to success. Of the more than 408,000 US firms that competed across borders in 2014, 98 percent were small to medium-sized firms.12 Companies with effective international strategies tend to dominate both at home and throughout the world. Most organizations that hope to be leaders in their industry realize that they have to compete on a global scale.13 Indeed, for many companies, even basic survival is predicated on a clear understanding of international strategy.
Of course, competing on a global stage isn’t just about protecting oneself from foreign com- petition. It also opens up tremendous new opportunities,14 but these new opportunities come with an exponential increase in complexity. Just ask the top management team at Huawei as it looks to successfully compete in the United States. Some of the differences between countries that increase complexity and affect the success of international strategies include variations in:
• Customer tastes, needs, and income levels
• Government regulations
• Legal systems
• Public tolerance for foreign firms
• Reliability, and even existence, of basic infrastructure, such as roads and electricity
• Strength of supporting industries, including distribution channels to customers
This chapter addresses the complexity of international strategy by answering three ques- tions strategists ask when thinking about going international:

1. Why should we go international? What specific cost or revenue advantages might we gain?
2. Where should we expand? Of all the countries we could enter, which are the right ones?
3. How should we expand? What international strategy should we employ? How can we tell if we have the right one? And, what strategic options do we have for entering a foreign country?
   One thing to keep in mind as you read this chapter is that many of the concepts actually apply to geographic expansion within a country as well as international expansion. We focus the chapter on international expansion because the complex issues behind a successful expan- sion strategy are magnified exponentially when you cross international borders.

Why Firms Expand Internationally

There are a number of reasons why firms choose to compete in international markets. These include increasing sales to grow the company beyond what the home market can offer, becom- ing more efficient (raising profits by lowering costs), managing risks better, learning from con- sumers in other markets, and responding to the globalization moves of other firms.

Growth
The need to grow sales is one of the biggest reasons that firms expand internationally.15 Some firms have saturated their home markets, and entering foreign markets is the only way for them to sustain growth. This is one of the primary reasons that Harley-Davidson started selling in foreign markets. It now sells in Europe as well as Asia and the Middle East. Figure 9.2 shows

globalization The spread of businesses across national borders.

Harley-Davidson Unit Sales: 2008—2016 US vs. Foreign Sales
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200000

150000

100000

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2008 2009 2010 2011 2012 2013 2014 2015 2016 est.
US Sales Foreign Sales

20
15
10
5
0
–5
–10
–15
–20
–25
–30
–35

Harley-Davidson % Change in Unit Sales: 2008—2016 US vs. Foreign Sales

US Change Foreign Change

FIGURE 9.2 Harley-Davidson US and Foreign Sales, 2008–2016
Source: (1) Anonymous, “Harley-Davidson Is Taking Steps to Reverse Its Declining Sales Trends,” Forbes
(December 9, 2015).
(2) Anonymous, “Harley-Davidson Reports Fourth Quarter and Full-Year 2015 Results,” PRNewswire (January 28, 2016).
(3) Anonymous, “Tough Times Ahead in the Domestic Market,” Forbes (September 13, 2016).

just how important that foreign expansion has been. When unit sales in the US market have softened, sales overseas have continued to grow, mitigating Harley-Davidson’s flat to declining sales in the US market.

Efficiency
Many firms enter additional markets in order to become more efficient. Efficiency takes a num- ber of forms, including obtaining lower-cost resources, extending the lifespan of products, and achieving economies of scale and scope.

Lower-Cost Resources In many cases, key resources may be cheaper in foreign countries. One of the most common resources firms seek abroad is low-cost labor, which is often referred to by the buzzwords offshoring or outsourcing. Firms may also expand abroad in search of lower-cost sources of raw materials.16 For example, the United States is seeing an increase in foreign companies opening new plants in the United States to take advantage of cheap natural gas made available through hydraulic fracturing technology, known as fracking.
Beyond looking at the price of a particular resource, though, companies also have to take into account factors that might increase the cost to use the resource, including labor productivity, and the transportation and communication costs needed to acquire the resource. Moreover, companies must also consider a variety of other costs of doing business in a particular country, such as regulations and the challenges of managing in a different culture. Companies tend to seek an optimal location for expansion, not just the one with the lowest cost resources. For instance, although sub-Saharan Africa has the cheapest labor in the world, China’s abundance of relatively skilled and productive cheap labor, coupled with excellent communications and transportation infrastructure and a relatively stable political climate, made it the country of choice for many firms for decades. Then China’s labor costs began to rise, and countries in Southeast Asia began to develop sufficient infra- structure with labor cheaper than China’s, making that region more attractive as a place to do business.

product life cycle The stages a product or service goes through during its lifespan.

Longer Product Life Sometimes firms enter foreign countries to extend a product’s life cycle, leveraging their investment in assets and equipment.17 For example, in Chapter 2 we introduced the plight of Nokia, a one-time world leader in the cell phone industry. Although Nokia’s cell phone business, now a subsidiary of Microsoft, is no longer the world’s leading manufacturer of cell phones and smartphones, the company continues to generate substantial revenue by selling its older-model phones in Africa, the Middle East, and Southeast Asia.
In addition to leveraging prior investments in their products, firms can also leverage their capabilities. As discussed in Chapter 3, capabilities that generate competitive advantage for firms typically are difficult and costly to build. Some firms try to leverage their investments in building capabilities by using those capabilities in multiple countries.18 Fast-food restau- rants such as McDonald’s are masters of this technique.19 Manufacturing firms can also gain efficiencies from leveraging their capabilities. Toyota, for instance, has been quite successful in implementing the Toyota Production System in its US auto plants, helping to keep its costs lower than those of rivals GM and Ford.

Economies of Scale and Scope Another critical source of efficiency that firms seek to gain by going international is economies of scale, whether they come in manufacturing, R&D, or sourcing.20 Recall from Chapter 4 that economies of scale occur when firms are able to

spread the costs of investments in plant, equipment, or knowledge across many sales. As firms compete in foreign markets, they increase the number of units sold, sometimes radically, pos- sibly reaping greater economies of scale.
Related to efficiencies gained through economies of scale are economies of scope. Com- peting in multiple markets allows firms to spread their costs across more units in multiple prod- uct categories. For example, Unilever, a Dutch company, takes advantage of economies of scope by globally selling and distributing, products as diverse as food products, such as ketchup, noo- dles, salt, flour, and tea, and personal products, such as soap and shampoo—all things one can buy at a supermarket. Economies of scale and economies of scope, indeed. Unilever lowers its costs of distributing these products because they can be stored and shipped from the same warehouses using the same logistics systems.

Managing Risk
Operating in more than one country can also provide firms with a measure of protection against disaster, both economic and natural.21 Even when there are worldwide economic downturns, such as during the period from 2007 to 2012, problems are not usually spread evenly across all countries. During that period, the United States and the European Union fell into recession, while China continued to grow at a fairly rapid pace. When firms have sales in multiple coun- tries, a slowdown in one country may be offset by continued sales in another. For instance, many observers thought that General Motors would lose a good portion of its market share in 2007, when the US market for automobiles collapsed. However, within a short time, GM had actually increased its worldwide market share, regaining the title of the largest auto company based mostly on sales growth in China.
The same principle works for other types of disasters, such as natural disasters or social upheaval. If firms have operations in multiple locations they may be able to relocate produc- tion or increase sales in another country to make up for the shortfall in the area where the disaster occurred.

Knowledge
Another reason for expanding into other countries is to acquire valuable knowledge, the basis for innovation. When a firm sells in different countries, to people with differ- ent tastes and needs, it often gains new insights about its products and services. Serving multiple types of customers can help a firm to identify unmet needs in multiple markets. Those insights can be valuable for increasing sales in many locations. Gathering informa- tion from customers in multiple countries can also help organizations more easily identify changes in customer needs, making it more likely that they will be at the forefront of the next big innovation in their industry. Research suggests that generating more knowledge may be the greatest advantage a multinational organization has over purely domestic companies.22
As an example, GE’s Healthcare division developed an inexpensive, portable ultrasound machine to serve the rural Chinese market, where health-care providers couldn’t afford GE’s large, expensive ones. GE realized that there were also markets for an inexpensive, portable ultrasound machine in Europe and the United States, specifically with first responders who don’t have space in ambulances and fire trucks for large ultrasound machines. GE now sells the product in all of its markets.
Companies can generate knowledge not only from diverse customers but also from their own units in different locations. For instance, Europe has higher energy costs than the United States does. US firms that operate in Europe have been learning how to save energy costs more rapidly than those that aren’t in Europe.

Responding to Customers or Competitors
Last, but not least, firms may expand internationally in response to either customers or com- petitors. This is particularly true of business-to-business (B2B) firms that perform intermediate steps of the value chain for large customers.23 For example, the “Big 4” accounting firms— Deloitte Touche Tohmatsu, Ernst & Young, KPMG, and PricewaterhouseCoopers—have all expanded globally to better serve their largest clients, who are multinationals with operations around the globe. Indeed, sometimes customers demand that their suppliers go international when they do.
Sometimes firms feel compelled to go global because their rivals do. If the rivals gain any of the advantages previously discussed, they may use those advantages to subsidize aggressive sales and marketing campaigns in the home markets of their competitors.24 If a firm doesn’t expand to replicate those advantages, it may be at a distinct disadvantage. This is one of the primary reasons that Lincoln Electric, a manufacturer of arc-welding products, expanded abroad—to respond to ESAB, a Swedish welding company, that had just entered the United States. That is also true of Harley-Davidson. It had to aggressively pursue interna- tional expansion because part of its decline in domestic sales came at the hands of foreign competitors like Honda. Better to force your competition to compete in its home market as well than to let it gain international economies of scale and beat you without having to fight on multiple fronts.

Where Firms Should Expand
After a firm has decided to go international, the next question it must answer is where to expand. The easiest answer is to enter the country with the largest number of potential customers— often, a country with a huge population, such as China or India. However, wise managers also think about how likely they are to succeed in a particular foreign market. After all, the word foreign means different, and different can be difficult to get right. Research on the risks of inter- national expansion refers to this as the liability of foreignness.
Successful international expansion requires a clear understanding of the possible risks. Some risks are market driven—will foreign customers buy your products at the same rate as your home country customers? Will distribution work the same way, or will it cost more to get products to the end customer?
Other risks are political. Sometimes foreign governments enact policies that place addi- tional burdens on foreign firms, such as tariffs that increase the cost of foreign products, laws requiring a certain percentage of each product be made in the foreign country or a certain percentage of managers be locals, or laws prohibiting foreign ownership of local firms. Other burdens come from the uneven application of local laws. For instance, in some countries it is difficult for foreign firms to protect their intellectual property as local courts may side pri- marily with local firms. And sometimes nationalistic sentiment leads governments to threaten foreign firms with additional tariffs, lawsuits in both local and world courts (such as the World Trade Organization), inspections and fines not levied against local firms, and even seizure of plants and equipment. Companies entering foreign markets need to be well aware of the pos- sibility of government action.
Finally, other risks are economic in nature. Not all markets are equally stable. Some coun- tries are more susceptible to economic recessions, directly affecting the bottom line of the firms selling in those markets. Foreign countries may also be susceptible to monetary crises, where the value of the local currency fluctuates wildly as shown in Figure 9.3. The currencies of some countries, even when not in crisis, may fluctuate significantly compared to the US dollar. This can create an adverse exchange rate. This matters because a firm selling in a foreign market earns profit in that market’s currency, and those producing in a foreign country buy goods and

Exchange Rate of US Dollar vs. European Euro 2012-March 2017

1.00

0.90

0.80

0.70

0.60

2013

2014

2015

2016

2017

FIGURE 9.3 Exchange Rate of US Dollar vs. European Euro, 2012–2017
Source: XE Corporation, https://www.xe.com/currencycharts/?from=USD&to=EUR&view=5Y, accessed March 20, 2017.

pay labor in the local currency. If that currency fluctuates, the costs and profits, when trans- ferred back into the home currency, fluctuate as well. This can make a significant difference in how competitive a firm is. If the exchange rate is favorable, they can lower their prices and steal market share from other firms. If the exchange rate is not favorable, the opposite can happen. In fact, this is one of the reasons that Harley-Davidson’s domestic sales started to slump in late 2014 through 2017. As Figure 9.3 shows, the dollar strengthened considerably against the euro during that time. That means that European companies wanting to sell in the United States could suddenly do it much more cheaply than they could before, increasing the competition for Harley-Davidson products in its home market.
Organizations considering international expansion need to carefully consider the market, political, and economic risks of each country they are thinking about entering. Since com- panies want to do business in the countries where they are most likely to succeed, that means choosing locations that have the lowest risks. Another way to think about managing the risk of expansion is to consider the distance between countries. Even though transportation and communication have advanced to the point where firms can realistically do business in nearly every country on the planet, the distance between countries still matters. In addition to geo- graphic distance, there are three other kinds of distance that managers should consider when undertaking international expansion: cultural, administrative, and economic distances.25 A useful mnemonic for remembering the four types of distance is CAGE—cultural, administrative, geographic, and economic.26
Even if there are a lot of potential customers, a country might not be the right one to enter if the likelihood of success is low because of greater distance. The lower the distance deter- mined by a CAGE analysis, with an emphasis on the distance that most affects your specific industry, the greater the likelihood of a successful expansion.

Cultural Distance
Cultural distance refers to differences in language and culture, the way people live and think about the world. People in another country might hold different beliefs about a host of signifi- cant issues, including how people should interact and how business should be conducted.

cultural distance The degree of difference between the cultures of two nations.

They might have very different worldviews about human nature and the role of individuals and companies in society. All of these can add up to a very foreign environment that makes it diffi- cult for firms to understand their customers and local employees.27
Although it’s only one aspect of culture, the issue of language is influential. Firms are 42 percent less likely to do business in a country with a different language.28 Language differences are relatively easy to fix, but potential problems increase rapidly when companies move into countries with deeper, more difficult to overcome types of cultural distance. These may include differences in:
• Religion
• Ethnicity
• Trust for outsiders29
• How genders are expected to behave
• The degree to which the culture is focused on individuality or collective action
• How people accept ambiguity or follow rules and laws
• The degree to which people allow abuses of political or market power30
Many of these types of cultural differences can be subtle but still have a significant impact on consumer behavior and shape the market demand for foreign products.
Not all industries are affected the same way by cultural distance. Firms that sell com- modity products, such as corn, wheat, oil, or cement, don’t tend to have difficulty with cultural distance. However, firms with products that have high linguistic content, such as TV shows, movies, music, and even textbooks, have to be careful. Likewise, products that affect how people see themselves, such as food and clothing, are affected by cultural distance. This is particularly true if those products clash with religious or national identities. It is difficult to sell pork products in the Middle East, as pork is forbidden in both Judaism and Islam. Other products might not directly clash with religion, but they might not match cultural norms. For instance, in Germany parents have a tendency to prefer well-crafted, wooden toys for their children. Firms that focus on less-expensive plastic toys do much better in markets such as the United States.
Sometimes, however, cultural distance can be a selling point for multinationals. For instance, in Russia, foreign products are often seen as superior to local ones. Likewise, being associated with a particular country can sometimes increase sales of a product worldwide, as is the case for German luxury automobiles, Italian fashion, and US fast food.

administrative distance The degree of differences between the legal and regulatory frameworks of two nations.

Administrative Distance
Administrative distance refers to differences in the legal, political, and regulatory institutions between countries. For example, are laws and government policies similar or different between two countries? This is important for firms because understanding the political and legal envi- ronment is often a key to success in a foreign country.31
You can have the best product or service at the cheapest price, but if you don’t understand how contracts will be enforced or how local and national policies apply to foreign firms, you may fail. Administrative distance often causes challenges for US firms in industrialized nations such as France (which relies on a different legal system than the United States and the United Kingdom), but it can become bewildering in many emerging and Third World markets, where regulations and laws may be applied capriciously.
Low administrative distance can increase the rate of entry by foreign firms into a country by as much as 300 percent.32 Administrative distance is low among countries that (1) use the same legal system, such as the common law system used in the Anglo sphere (the United Kingdom and its former colonies, including the United States, Canada, Australia, and India);
(2) used to be part of a colonizer/colony network, such as some European countries and their former African colonies; (3) use the same currency; or (4) are part of the same trading bloc, such as NAFTA in North America or the European Union.

Industries most directly affected by administrative distance are those in which gov- ernments are most likely to have a stake. This includes industries that provide equipment or services critical to national security, such as providers of steel or telecommunications; those that employ large numbers of people; those that serve government directly, such as mass-transportation equipment manufacturers; those that extract natural resources; and those that produce staple goods that most people buy, such as rice in Thailand or corn in Mexico. A specific firm might also confront increased administrative distance if it competes head-to-head with a local champion, a local firm that government sees as important to its future, such as Airbus, the EU airplane manufacturer, or Gazprom, the Russian state-owned natural gas firm.

Geographic Distance
At its most basic, geographic distance refers to how many miles separate two countries. Companies are more likely to succeed in nearby countries, because physical proximity lowers both transportation and communication costs. That’s one reason most US companies expand first to Canada and Mexico. Even with fast air travel and consistent, reliable container ship- ping, research suggests that for each 1 percent increase in the distance between countries there is a 1 percent decrease in the number of foreign firms selling in those countries.33 Clearly, miles still matter.
In addition to the actual physical distance between countries, however, geographic dis- tance is also influenced by how easy it is to travel between countries. For instance, firms enter countries with seaports much more frequently than they expand to landlocked nations. Com- panies are also more likely to enter countries with good transportation infrastructure. For most firms, geographic distance increases the cost of managing daily operations and coordinating activities. Despite the availability of instant communications and video conferencing, many overseas operations require hands-on help from headquarters. When those operations are many hours away from headquarters by plane, the communication and transportation costs start to add up.
Not all industries are affected the same way by geographic distance. Firms, such as Google, that sell electronic products that can be transmitted to the other side of the world in fractions of a second at almost no cost don’t have to worry as much about geographic distance as firms that sell heavy, bulky products such as finished computers. That is one reason that companies such as Dell buy their parts from all over the world but then put them together near their target markets. Other industries that are heavily affected by geographic distance are those that sell fragile products that might be damaged in transport, or perishable products, such as fresh-cut flowers, that must be transported rapidly. Even for Google, however, the need to oversee oper- ations means that the company must set up local offices in some countries, such as Russia, because the product still needs to be localized (if only for language and currency reasons) and constant travel from California is too unwieldy.

Economic Distance
Economic distance refers primarily to differences in the average income of customers in two countries, usually measured as per capita GDP (gross domestic product). Firms from wealthy nations tend to expand to other wealthy nations because the customers there earn enough income to buy similar products. This is clearly true for expensive products such as cars or home appliances but is also true of a wide variety of products that wealthier customers tend to think of as inexpensive, such as laundry detergent or snack food (see the Strategy in Practice for an example).
The industries most affected by economic distance are those for which the demand for products is very elastic—meaning demand changes dramatically as prices go up or down. In these types of industries, demand is significantly affected by customers’ purchasing power and the ability of producers to lower prices.

geographic distance The distance in miles, or kilometers, between two countries.

economic distance The degree of difference between the average income of people in two different countries.

Strategy in Practice
How Unilever Manages Economic Distance more than 1.5 million small retail outlets that Hindustan Unilever
in Rural India operates, the vast majority live in rural villages, with little to no infrastructure connecting them.35
Laundry soap isn’t something that most of us give much thought to. Hindustan Unilever’s response to the distribution problem We can buy it in small boxes or giant packages, but no matter how was to create Shakti Ammas in the rural villages. Many of these we buy it, the cost per use is small enough that few in Organization villages had developed women’s self-help groups where women for Economic Co-operation and Development (OECD) countries give counseled each other and pooled their money to help each other it much thought. The same is not true in other places around the financially. Combined with micro-loans, Hindustan Unilever world. While India has been making great strides, it still has mil- created a direct sales force of women in thousands of rural lions of people who live on less than $2 a day. At that wage no one villages. Each woman sold to her own village, as well as smaller can afford to buy a box of laundry detergent, not even the generic ones nearby. Most of these women have been successful enough brand. So if you are a manufacturer of laundry soap, how do you that they have been able to double their family’s income. To date reach these customers? After all, they represent nearly 750 million Hindustan Unilever has nearly 70,000 Shakti Ammas reaching people worldwide.34 That is not a customer segment you want more than 162,000 rural villages and 4 million rural households to ignore. with a variety of household products beyond laundry soap that Unilever, in a joint venture with an Indian firm called Hindustan have been manufactured to meet the budget of the poorest of Unilever Limited, has figured out how to bridge that economic the poor. It has been successful enough that Hindustan Unilever distance and sell to the poorest of the poor in India. They call the has expanded the project to include husbands of Shakti Ammas, approach Project Shakti, which means Project Strength. They first called Shaktimaans, who can reach villages farther away than had to learn how to break their product down into the smallest their wives. There are now 48,000 Shaktimaans.36 The impact of possible packages and figure out how to reduce manufacturing this program on the poorest in India is striking. The head of the costs. The big problem, however, was how to deal with distribution. Project Shakti, Sharat Dhall, called it “the biggest rural operation
While many poor live in the big cities and can be serviced by the in the history of India.”37

How Firms Compete Internationally

local responsiveness A firm’s adjustments to products, services, and processes in order to account for local culture and needs.

standardization Making products and/or processes consistent across different units within a firm and/or across different countries the firm operates in.
global integration The standardization of processes within a single business in different locations around the world.

As companies expand internationally, they often find themselves torn by two competing pressures.38 The first pressure is toward local responsiveness, the need to tailor their prod- ucts, marketing, and distribution strategies to the local customers in a foreign country. For instance, Coca-Cola isn’t the same in every country. In fact, Coca-Cola demonstrates its responsiveness by manufacturing more than 48 different flavors of Coke alone (not to men- tion the more than 100 non-cola beverages sold worldwide by Coca-Cola) to suit local tastes. Coca-Cola also changes its distribution method to fit local markets.
However, adapting products and operations to fit local circumstances isn’t cheap. In gen- eral, the more a company tailors a product or service to a local market, the higher the cost. Higher costs are risky, because companies with lower costs can beat their competition through lower prices. When firms begin to compete on a global stage, the number of rivals can increase dramatically, putting intense pressure on firms to cut costs. Furthermore, many firms expand internationally in order to increase efficiency and to lower costs. Firms achieve economies of scale by standardizing their products, producing them without variations, or integrating their processes on a global scale, called global integration. Thus, firms have two competing pressures they must address: local responsiveness and cost reduction.
There are three primary strategies firms can use to manage this strategic tension:

1. Multidomestic strategy—emphasizes local responsiveness over standardization
2. Global strategy—emphasizes global standardization and economies of scale over local responsiveness
3. Arbitrage strategy—takes advantage of country-comparative advantages—sources of low cost (e.g., cheap labor) or unique resources (e.g., skilled workers) FIGURE 9.4 International Strategies and Local Responsiveness Versus Standardization

The first two strategies deal directly with the tug-of-war between local responsiveness and cost-reducing standardization differently as illustrated in Figure 9.4. The third strategy, arbitrage, can focus on either local responsiveness or standardization, but does so from a posi- tion of taking advantage of country differences rather than trying to overcome them.
Each strategy is appropriate for a different set of industry dynamics and firm capabilities. We’ll discuss each in turn as well as discussing combining strategies. The three primary strat- egies are not mutually exclusive. Some firms are successful at pursuing two at the same time, although it becomes increasingly complicated to manage operations and maintain strategic focus when doing so. At the end of the chapter we’ll introduce a tool for determining which strategy is best for any given firm.

Multidomestic Strategy—Adapt to Fit the Local Market
The multidomestic strategy centers on tailoring products and operations to individual mar- kets.39 Firms in industries where customer needs and preferences vary widely from country to country, such as food or media, often use this strategy. By tailoring their products and services to better meet the needs of local customers, firms can maximize their responsiveness, increas- ing their sales and market share in each country. They usually succeed through a differentiation strategy rather than a cost leadership strategy. Unilever uses this strategy. It sells more than 1000 brands worldwide. In most of the countries it enters it uses different brand names (i.e., in the case of bar soap—Dove in the United States, Block & White in the Philippines, and Gessy in Brazil).
As firms enter more countries and the differences between the home country and each foreign country increase, firms must expand the degree of tailoring, or adaptation. Conse- quently, many firms that pursue a multidomestic strategy put autonomous decision-making authority into the hands of managers in charge of individual regions or countries.40
To enable such autonomous decisions, significant parts of the value chain have to be repli- cated in each country. For instance, each country may have a product development and design lab, manufacturing plants, and sales and distribution personnel. Replicating these different functions in each country comes at a significant cost. Not surprisingly, firms find it hard to tap into economies of scale if they are designing and producing something different in each country. As companies decentralize their operations to be locally responsive, it also makes it diffi-
cult to share valuable knowledge across the firm globally. As a consequence, firms that pursue a multidomestic strategy often find it difficult to develop a worldwide competitive advantage. At best, they produce a series of local competitive advantages.

multidomestic strategy A strategy involving tailoring products or services to local markets.

Strategy in Practice
National Competitive Advantage
Have you ever wondered how firms from the same country domi- nate their industries worldwide? For example US companies Apple, Google, and Microsoft control the worldwide industry for computer operating systems; German organizations dominate in machine tools; and Italian firms lead in the sale of leather goods. Michael Porter developed a tool, the Porter’s Diamond of National Competi- tive Advantage, that explains how this happens.
Four factors help push organizations toward greater inno- vation, with those companies that innovate the most having an advantage in international competition:

1. Factor conditions. An abundance of critical resources includ- ing skilled labor, a technologically advanced knowledge base, easy access to capital, and solid infrastructure provide firms with the tools they need to innovate. Germany is known for an educated, manufacturing-oriented workforce, giving it an advantage in the machine tool industry.
2. Demand conditions. The more a country’s customers demand innovation, the more likely domestic firms are going to be at the forefront of innovation. Japanese consumers tend to be

ahead of the curve in demanding the latest consumer elec- tronics products, giving Japanese consumer electronics firms direction in developing new products.

3. Related and supporting industries. If a country has mul- tiple parts of the value chain located near each other, it is easier to coordinate innovation, speeding up the pace. Italy is known not just for leatherworking but leatherwork- ing machinery, fashion, and shoes. The four industries being co-located allows for closer coordination and faster innovation.
4. Firm strategy, structure, and rivalry. Different types of firm structure are suited to particular types of industries. Laws governing how firms are started and how they interact with labor have a large impact on the international strat- egies that firms pursue. Rivalry also plays a large role. While rivalry, according to the five forces model discussed in Chapter 2 and illustrated in Figure 9.5, tends to decrease profit, it also spurs innovation. Firms that survive high levels of rivalry are usually more prepared to take on inter- national competition. FIGURE 9.5 Porter’s Diamond of National Competitive Advantage
   Source: Adapted from M. E. Porter, The Competitive Advantage of Nations
   (New York: Free Press, 1990).

factor conditions Land, natural resources, and labor that allow for production of goods and services.
demand conditions The conditions in a market that determine the degree of demand for a product or service.
related and supporting industries Industries that produce products or services that are inputs or complements to the industry you are studying.

In most industries, firms find a pure multidomestic strategy unworkable. Cost pressures are simply too intense. The key to successfully pursuing this strategy is to manage the variation that occurs across countries. Firms can manage variation in three major ways:

1. Focus adaptations. Some firms manage the variation by tightly focusing on a particular product, customer segment, or geographic area. Such highly focused firms still tailor their products, but the amount of variety they face is more manageable by maintaining a tight focus.
2. Externalize adaptations. Some firms externalize the work of adapting the product for local needs, generally by arranging for local customers to do it. Methods of externalization include franchising and alliances, which are discussed later in this chapter.
3. Design adaptability. A third method for managing the costs of localization involves designing a product so that it can be adapted while still maintaining some economies of scale. Some companies design for cheap adaptation by investing in flexible manufacturing

that reduces the costs of short manufacturing runs. Others modularize their product, creating a set of standard interfaces that allow many different types of alternatives to plug into one another. For example, appliance manufacturers such as GE and LG offer a variety of refrigerators, with different sizes, different number of doors, and other features, but all their different refrigerators are designed to share a common set of core components. This allows some economies of scale while still adapting refrigerators to local tastes.

Global Strategy—Aggregate and Standardize to Gain Economies of Scale
A global strategy centers on capturing the efficiencies that can come with expanding over- seas, particularly economies of scale, learning, and leveraging firm capabilities. Most firms that pursue a global strategy standardize their products, marketing, and operational prac- tices, and aggregate, or centralize, them in only a few locations, to achieve economies of scale.41 Individual country-level units are tasked mostly with implementing decisions made at a central headquarters,42 and the firm uses the same tactics in most, if not every, country where it competes.
The most extreme versions of a global strategy might have all functions located in the same place, with country units overseeing only local sales. For example, Red Bull, the energy drink, is manufactured in a single location next to its headquarters in Fuschl am See, Austria (did you know Red Bull was an Austrian firm?). In 2016, it produced approximately
2.5 billion cans of Red Bull, all in the same factory. And while their marketing might seem like it is tailored to different locations, it actually follows the same format everywhere Red Bull is sold—sponsoring extreme sporting events. In practice, many global firms have fac- tories on multiple continents, producing the same product, in order to reduce transporta- tion costs and manage risk. Moreover, when factories in different locations are producing the same products, they are more likely to share best practices, helping firms reduce the learning curve.
A global strategy is typically a low-cost strategy, with low costs achieved through econ- omies of scale. However, it can also be used effectively as a differentiation strategy that the company applies in the same way, to the same customer segment, worldwide. Apple is a great example of a firm that standardizes its products to achieve economies of scale but differentiates them from other smartphones, computers, or tablets in order to increase the price customers are willing to pay for them. Firms that pursue a global strategy tend to enter countries that have a large, ready-made market for their products. They also tend to be in industries where cost pressures are high and standardized products can meet relatively universal needs. For instance, elevators are used the same way in Hong Kong as they are in Chicago, making elevator manufacturing firms, such as Otis Elevator, prime candidates for a global strategy.
The downside of a global strategy, however, is that standardized products may not meet the needs of customers in particular countries. As a consequence, global firms may not be able to compete in as many markets as multidomestic firms, and they may not be able to pene- trate those markets as deeply.43 Another disadvantage is that, although global firms share knowledge between units with greater ease than multidomestic firms do, a global firm gen- erates less knowledge overall, because it isn’t as actively trying to meet a wider variety of cus- tomer needs. So, in the short term, global firms may miss sales by not being responsive, and in the long term they may miss changes in local market conditions.
However, just as there are ways to manage the cost of variation in multidomestic firms, there are also methods for dealing with excessive centralization and standardization in global firms. First, a firm need not centralize all parts of the value chain. The greatest cost savings from economies of scale often occur in R&D and manufacturing. A global firm can centralize some functions while localizing others in order to penetrate local markets more fully. For instance, in the 1980s and 1990s, the household appliance manufacturer Whirlpool pursued compo- nent manufacturing and R&D primarily on a global scale, but carried out product design, final assembly, marketing, and sales at regional and local levels.

global strategy A strategy involving selling standardized products, using standardized processes, around the world.

Ethics and Strategy
Is Economic Arbitrage Ethical? Won’t It Lead • 320 workers share 24 toilets and 24 showers. No hot water.
to Worker Exploitation? Rusted pipes. No shower heads. Workers are forced to use buckets or pans to bathe.
In recent years, numerous news reports have emerged detail- • Cafeteria facilities are inadequate. Workers are fed inadequately. ing the exploitation of low-cost labor in foreign countries. China Food often has foreign matter in it.
Labor Watch, a nonprofit working to raise awareness of worker • In practice, during peak months, no leave or sick leave exploitation issues in China, found that suppliers of Disney toys is approved.
have been accused of exploiting lax enforcement of labor laws in
order to keep costs low. China Labor Watch calls it the Dark World Such abuses are common across a wide range of industries, of Disney.44 and not just in China but also in many low-wage countries. Indeed, Mistreatment of workers includes: in one case in Bangladesh, more than 1,100 workers were killed when an eight-story building housing multiple garment factories
• Workers work with toxic chemicals all day long yet are given little collapsed in 2013. The factories had not installed appropriate safety
to no training and little to no protective gear. measures. Many companies, including Nike, Apple, and Walmart,
• Workers earn only $1.38 (USD) per hour, so low that it is insuf- have been accused of exploiting workers in foreign countries.45 ficient to pay for basic living necessities without overtime pay. Economic arbitrage, in and of itself, is not necessarily uneth- Many workers live in the factory, a perk for which they pay (and ical. In many cases, foreign firms pay better than average wages and need overtime to cover the cost). bring improved safety and labor practices to their factories and their
• Workers typically work 11 to 12 hours a day, with 90 overtime supplier’s factories.46 However, when many firms in the same industry hours per month—2.5 times the upper limit set by Chinese are seeking a cost advantage by utilizing an arbitrage strategy, the labor law. pressure to decrease costs can be immense, and firms have to be vigi- lant that workers aren’t exploited. To that end, companies such as Nike
• In the dormitories, 16 workers share a 16-square-meter and Apple have developed a supplier code of conduct, which they use
(172-square-foot) room—just larger than a typical child’s to audit their overseas suppliers.47 Although this doesn’t always work, bedroom in the United States. because suppliers sometimes find ways around the audits,48 it does
decrease the incidence of unethical exploitation of workers.49

arbitrage strategy A strategy involving buying where costs are low and selling where prices are high.
economic arbitrage Capitalizing on differences in costs by buying where costs are low and selling where prices are high. This is the traditional, age-old definition of arbitrage.
capital arbitrage Capitalizing on differences in the cost of capital by acquiring capital where it is less expensive.
cultural arbitrage Capitalizing on differences in culture between countries by actively using the culture of one country as a selling point for products being marketed in another country.
administrative arbitrage Capitalizing on differences in taxes, regulations, and laws between countries by operating where they are lower or more lax.

Arbitrage Strategy
An arbitrage strategy is the third of the three primary international strategies. While the other two strategies view foreign markets as sales opportunities with the need to manage differ- ences between countries, the essence of arbitrage is taking advantage of those differences. Arbitrage, at its simplest, is defined as using differences between markets to buy low in one location and sell high in another.
It can involve economic, cultural, administrative, or capital arbitrage. One of the most common modern forms of arbitrage is also one of the basic reasons firms expand internation- ally, to find the lowest-cost source of labor or raw materials. This is called economic arbitrage, and it often involves offshoring manufacturing or R&D to countries with low labor costs. How- ever, some firms also practice capital arbitrage. For example, CEMEX, a Mexican cement man- ufacturer, operates plants in Spain so that it can raise capital in the European Union, where interest rates are often lower than they are in Mexico.
Not all arbitrage involves sourcing low-cost resources, however. Some forms of arbi- trage take advantage of differences between countries to sell products. Cultural arbitrage trades on the culture of one nation to sell in another. US-based fast-food restaurant chains are popular worldwide partly because they embody US culture. Likewise, for centuries the French were able to sell wine at a premium price because it came from France. Some firms also utilize what is known as administrative arbitrage, taking advantage of differences between countries that are created by laws and government regulations. Many companies incorporate in the Cayman Islands because of low corporate tax rates. Likewise, nearly one-third of all foreign capital flowing into China actually originates in China, but the inves- tors process their financial transactions through Hong Kong in order to avoid government regulation.

Combining International Strategies
As many industries have become increasingly global, the pressures for both local responsive- ness and the efficiency that comes from standardization have become more intense. Some companies try to use a hybrid of the multidomestic and global strategy in order to be glocal. These firms typically begin with a strong emphasis in a single strategy and then work to mini- mize the downsides associated with that strategy as much as possible as they begin to imple- ment the second strategy. As shown in Figure 9.6, competing with both a multidomestic and a global strategy, in order to achieve both local responsiveness and standardization, is often called a transnational strategy.50 Strategy combinations, of course, can also include multi- domestic and arbitrage strategies or global and arbitrage strategies as well.
Procter & Gamble is an example of a firm that started with a strong position in a multido- mestic strategy and then added a global one. When P&G first expanded internationally, it repli- cated its operations in each country where it competed. However, beginning in the 1980s, P&G began to balance adaptation with a greater focus on centralized decision making to allow for greater economies of scale across countries. It established global business units (GBUs), one for each major product category, which operated concurrently with the traditional country units using the IT systems to tie the two types of organizations together. They also required executive career paths to include both organizations. Although it took more than a decade, P&G succeeded in gaining some of the benefits of a global strategy without losing its multidomestic focus.
At the end of this chapter we present a tool, the international strategy triangle, that can help you assess the international strategies that firms currently pursue or help you determine which international strategy a firm should pursue if it is considering doing business overseas.

transnational strategy A strategy involving a combination of both local responsiveness and standardization.

FIGURE 9.6 International Strategies and Local Responsiveness Versus Standardization

Strategy in Your Career
Why should you develop a deep understanding of international generate a lot of goodwill from those above you if those strategy? What good might it do you in your career? Some points goals have to include transferring some company opera- to consider: tions overseas.

1. Companies are looking to hire and promote those with a 4. Companies are increasingly likely to have a diverse, interna- global outlook. tional company culture. And if they don’t, they likely deal with
2. It used to be that few employees spent time overseas. Now suppliers and/or buyers who do. Companies these days are being transferred abroad for a period of time is much more less hierarchical and accomplish a lot more with teams. If you likely to happen. have a global outlook and can work with people from different
   cultures, you will be more successful.
3. Understanding and supporting your company’s international
   goals will help you further develop your skills and may also

How a Firm Gets into a Country: Modes of Entry

modes of international market entry Methods for entering a foreign market for the purposes of either selling or producing products or services.

exporting Sending goods or services to another country for sale.

licensing Granting another business the permission to use or sell a firm’s product, technology, or process.
franchising A license that allows a person or firm access to a business’s proprietary knowledge, processes, or trademarks in order to allow them to sell a product or service under the business’s name.

In this final section, we discuss four different modes of international market entry: (1) export- ing, (2) licensing and franchising, (3) joint ventures and alliances, and (4) wholly owned sub- sidiaries. Entering foreign markets can be very risky. There are pros and cons to each entry mode. The best method for a firm is often based on which international strategy the firm has chosen: global, multidomestic, or arbitrage. We will look at each mode in turn, starting with those that involve the least risk and least control and moving to those with the most risk and most control.

Exporting
Exporting involves producing goods in a single location and selling them in foreign markets.51 Although most exporting happens from a home country, firms can also use it with an arbitrage strategy by producing in a low-cost location and exporting to other countries from there. Exporting is the first entry mode most companies choose when they decide to go interna- tional.52 Exporting allows a firm to ramp up production in a single location, thereby increasing economies of scale. As we saw earlier, exporting is how Red Bull has captured the majority market share in the energy drink business. It also is how Samsung is keeping pace with Apple in the smartphone and tablet computer industries.
Exporting works well when little adaptation of a product is required and good distribu- tion networks are in place in the foreign market. It is also the least risky of the entry modes, as it involves the least investment in the foreign country. If cultural or administrative distance is large, exporting might be the right decision, because you avoid the challenges of managing a culturally different workforce in a foreign country. It is also a good choice if speed to market is important, as products can be shipped and sold in foreign markets quickly.
Of course, exporting also has its limitations. Transportation costs and government trade tariffs can both increase the cost of selling in a foreign market. Your company and its products will likely be viewed as “foreign,” which can be a problem in some countries. Exports also may suffer if the value of the home nation’s currency rises compared to the currency of target foreign markets.53 As the exchange rate fluctuates, so does the price of a firm’s product in the foreign market. For instance, in 2007, one US dollar cost 121 Japanese yen. By 2012, the dollar was trading for only 77 yen.54 The yen had strengthened compared to the dollar. The consequences were that a product manufactured in Japan and sold in the United States for $100 brought the Japanese company 12,100 yen in 2007, but only 7,700 yen in 2012, a 36 percent drop in profit for no other reason than changes in the currency exchange rate. Although firms can try to cut costs to compensate for such involuntary price changes, exporters are often at the mercy of exchange rates.

Licensing and Franchising
Licensing and franchising both involve selling the rights to produce a firm’s products or ser- vices.54 The licensee or franchisee typically pays a negotiated fee (usually 5 percent to 10 per- cent) as a royalty, based on the number of units sold. As described in Chapter 8, Disney receives royalties from the Oriental Land Company on revenues derived from Tokyo Disneyland. This is an example of licensing. Franchising is a special form of licensing with a longer-term commit- ment, the use of the brand name, and more often involves a transfer of firm knowledge and business processes. In addition to negotiating a contract concerning royalty payments, firms that franchise usually impose strict rules on franchisees concerning how the business is oper- ated and marketed, and provide them with ongoing support and oversight.

Licensing and franchising are good entry modes for firms that have unique know-how or a solid brand that can be easily valued (so the price of the license or franchise can be negoti- ated), but do not have the capital or resources and capabilities to expand abroad themselves. Because they involve only the transfer of knowledge, rather than building operations in a foreign country, these two modes of entry require less investment and are often among the faster ways to earn a profit in foreign markets. The lower risk and speed of entry make these attractive entry choices when the risk is otherwise high because of large distances (any of the four distances) between countries.
As with each mode of entry, there are downsides to licensing and franchising. First, they offer the least amount of control of all the various modes of entry.55 Firms may try to include contractual safeguards, but the firm that buys the license or franchise is ultimately in charge of manufacturing and marketing. Sometimes the licensee or franchisee does not invest enough in the business to maintain quality and build a strong brand. Lack of control also can make it hard to tap into local knowledge and innovation. Moreover, any knowledge being generated from the foreign operations belongs to the licensee or franchisee. Extracting that knowledge for use in other locations can be problematic.
Finally, there is a risk that the firm licensing the product or service can become a com- petitor. If you let others manufacture your product or operate your business model, they are going to gain critical capabilities in your business. RCA, a US-based manufacturer of color tele- visions, met its death this way. It licensed its technology to Japanese firms in the 1970s, only to have them enter the US market soon after their licenses expired and put RCA out of the televi- sion business.

Alliances and Joint Ventures
Alliances (discussed in detail in Chapter 8) involve sharing resources, risks, and rewards.56 They are an increasingly favored way to enter markets that are distant (i.e., more risky) from the home market.57
Many companies use alliances to access complementary assets.58 For instance, a common way to enter a distant, foreign market is to create an alliance with a local company that knows what consumers want and knows how to navigate local government regulations and distri- bution channels. An alliance with a local firm also mitigates some of the foreignness of the entering firm, allowing the alliance to be perceived by both government and consumers as local. Sometimes this is the only way to enter a market. For example until recently, in many industries India did not allow foreign retailers to enter the country unless they partnered with a local firm.
A joint venture is a special form of alliance involving the joint creation of a new firm. Most joint ventures involve a 50/50 share of ownership; each company puts in 50 percent of the value and gets 50 percent of the rewards. If the venture doesn’t work, the home- country firm loses only half the overall investment in the joint venture. When General Mills wanted to enter the European Union in the early 1990s, it created a joint venture with Nestlé. The complementary asset was Nestlé’s distribution system that put Nestlé products in every big and little store in the many different countries in Europe. Indeed, between the two companies the distribution system was considered important enough that the prod- ucts are under the Nestlé brand. So, if you buy Cheerios in Hungary, you will be buying Nestlé Cheerios.
Although alliances allow faster and less risky access to new markets than wholly owned subsidiaries (discussed next), they also present significant management challenges. Over- coming cultural and linguistic barriers to bring together teams of managers from both companies increases the difficulty of operations. Each party in the alliance may also hold different strategic goals. These challenges cause many alliances to fail. Moreover, as with licensing, the lack of tight control can create serious problems by allowing the partner firm to develop resources and capabilities that enable it to become a competitor. Indeed, the Chinese government forces foreign firms in strategic industries to form joint ventures

alliances An agreement between two businesses to cooperate on
a mutually beneficial project. It usually involves the sharing of resources and/or knowledge.
complementary assets Assets owned by another company that are needed in order to successfully commercialize and market a product or service.

joint venture An alliance between firms involving the creation of a new entity where both firms provide assets and/ or knowledge, processes, or technology.

with Chinese firms for the explicit purpose of learning their technology in order to compete against them.

wholly owned subsidiary A unit in a foreign country that is wholly owned by the parent company.

greenfield investment A wholly owned subsidiary in which the firm involved builds the facility from the ground up.

Wholly Owned Subsidiaries
Wholly owned subsidiaries are local units owned outright by the entering firm. This type of entry requires the most investment and creates the most risk, as the firm has to put up all of the capital itself. Wholly owned subsidiaries can, however, overcome trade and transportation bar- riers by producing locally. They may also allow a foreign firm to appear more local to host- country governments and consumers.
In addition, this mode offers the firm the most control over what its local subsidiary does. Many high-tech firms form wholly owned subsidiaries as a way to control access to their tech- nology and avoid leaking it to a licensee or alliance partner. A wholly owned approach gives firms that use a combination of international strategies sufficient control to realize economies of scale. For example, wholly owned entry can allow a firm enough control to coordinate a worldwide value chain with key elements of the value chain located in the lowest-cost location to gain an arbitrage advantage. Such a firm might manufacture all of a certain type of compo- nent in one location in order to gain economies of scale and then ship the components from one location to another for assembly.
There are two ways of entering with wholly owned subsidiaries: (1) a greenfield investment, in which the firm builds operations from scratch; or (2) acquiring a local firm. Greenfield invest- ments give the firm the greatest amount of control, because they build the operations, marketing, and distribution from the ground up. However, they are also the slowest entry mode, as it takes time to build capabilities. Moreover, although the firm maintains tight control over its own technology and processes, it also has to learn about the local market and government regulations on its own.
Acquisitions involve buying local firms. Such a purchase allows the entering firm to acquire local resources, knowledge, and expertise while still maintaining control through 100 percent ownership. However, acquisitions typically involve paying a price premium, and they can also be notoriously difficult to integrate into the rest of the firm’s worldwide operations. Merging two firms is difficult enough within the same country. Cultural differences complicate the pro- cess considerably, often resulting in a slower integration process and a higher risk of failure.59 Table 9.1 summarizes some of the key differences among the modes of entry.

TABLE 9 . 1 Entry Modes

Exporting Licensing/ Franchising Alliance/Joint Venture Wholly Owned Subsidiary
Investment required Low Low Medium High
Level of risk Low Low Medium High
Overcome trade barriers? No Yes Yes Yes
Speed of entry Fast Fast Medium Slow (faster for acquisition than greenfield)
Acquire local resources, including knowledge? No No Yes Yes
Viewed as insider or outsider? Outsider Insider Possibly insider Possibly insider
Degree of control Low Low Medium High

Choosing a Mode of Entry
The choice of which mode to use is based on the firm’s situation, including its access to cap- ital and need for local resources or capabilities, as well as the firm’s primary international strategy. Global strategies require more control, moving firms toward exporting and wholly owned subsidiaries, whereas multidomestic strategies encourage local innovation, which could involve joint ventures, franchising, or autonomous wholly owned subsidiaries. Arbitrage strategies require ownership, suggesting that exporting and licensing/franchising will not be good choices.
The choice of which mode to use is also based on a firm’s international experience. Most firms start their international expansion by first exporting, or selling to target country whole- salers. Firms may then move to joint ventures, and finally to wholly owned subsidiaries as they become more comfortable managing operations in the foreign market. Figure 9.7 high- lights this effect of learning over time in a more nuanced fashion. It shows the typical paths followed by firms who first enter a foreign market through exporting, licensing, or franchising. The beginning points for most firms are on the left with most firms moving toward the right as they gain experience.

Length of Time to Enter

Franchising Licensing

Wholly Owned (Greenfield, Acquisition)

Joint Venture

Exporting

FIGURE 9.7 Experience and Entry Modes

Risk

Source: Adapted from F. R. Root, Entry Strategies for International Markets (San Francisco: Jossey-Bass, 1994), p. 18.

Summary
• There is a clear trend toward increased international trade. Indeed, the trend has become so prevalent that a large propor- tion of US firms, including small- and medium-sized firms, participate in international trade, and thus need an international strategy.
• Firms expand internationally for many reasons, the most impor- tant of which are growth, efficiency, managing risk, gaining access to more knowledge, and responding to customers and/or competitors.

• There are four types of distance—cultural, administrative, geo- graphic, and economic (CAGE)—that firms should keep in mind when entering a particular country. The shorter the overall distance, the greater the likelihood of success.
• There are three types of international strategy—multidomestic, global, and arbitrage.
• Exporting, licensing/franchising, alliances/joint ventures, and wholly owned subsidiaries are four different ways of entering a country.

Key Terms
administrative arbitrage 166
administrative distance 160
alliances 169
arbitrage strategy 166
capital arbitrage 166 complementary assets 169 cultural arbitrage 166
cultural distance 159
demand conditions 164
economic arbitrage 166
economic distance 161

exporting 168
factor conditions 164
foreign direct investment 153 franchising 168
geographic distance 161
global integration 162
globalization 155
global strategy 165
greenfield investment 170
joint venture 169
licensing 168

local responsiveness 162
modes of international market entry 168 multidomestic strategy 163
multinational firms 154 product life cycle 156
related and supporting industries 164 standardization 162
transnational strategy 167 wholly owned subsidiary 170

Review Questions

1. What are the five main reasons that firms expand into interna- tional markets?
2. Describe the four types of distance that firms should consider when choosing which foreign markets to enter. What factors help managers determine which type of distance is most likely to affect the success of an international expansion?
3. Describe the concepts of local responsiveness and standardization. Determine which international strategy is best suited to each pressure and explain why.
4. Describe the three primary international strategies.
5. What does a multidomestic strategy look like? What are the key ele- ments? Comparatively, what are the key elements of a global strategy? Can you name a firm that pursues each strategy?
6. What makes an arbitrage strategy different from a multidomestic or global one? Name the four types of arbitrage and explain how each one works.
7. Describe the ways that managers can help keep multidomestic strategies from becoming too costly and global strategies from failing to meet local needs.
8. Explain the international strategy triangle that follows in Figure 9.8 and list the steps to construct one.
9. Explain how you would you use the international strategy triangle to identify which international strategy a firm should use. Explain how you would use it to evaluate the strategies of firms that have already gone international.
10. What is a mode of entry? Describe the four main types of entry modes.
11. Which type of entry mode is most appropriate for each of the pri- mary international strategies? List the factors that firms using each pri- mary strategy should consider when choosing an entry mode.

Application Exercises
Exercise 1: Pick a firm of your choice or one that your professor has assigned you.

1. If the firm has already expanded internationally, using the reasons why firms go global (the first major section of this chapter), determine the primary reason that your firm went global.
2. If your firm has not yet expanded internationally, determine what forces are likely to drive it to go global.
   Exercise 2: Use the four types of distance to evaluate the likelihood of a successful foreign expansion effort
   (choose one of the following or the one that your professor has assigned):
3. Choose a firm that has not yet expanded internationally. Choose a market for the firm to enter. Use the four types of distance to evaluate the firm’s likelihood of successfully entering that market.
4. Choose a firm that has already expanded internationally. For one or more of the firm’s markets, measure all four types of distance between the firm’s home country and the country entered. Evaluate the degree to which distance played a role in the success or failure of the expan- sion. Which type of distance mattered the most? Why?
5. Read the Samsung case. Use the case, along with data you gather from outside sources, to measure the distance, using all four types of distance, between each company’s home (South Korea for Samsung, the Netherlands for Philips, and Japan for Panasonic) and a target

expansion country of your choice. Based on your measurements, which firm is most likely to succeed in entering the country? Why?
Exercise 3: Develop and interpret an international strategy triangle (choose one of the following or the one that your professor has assigned):

1. For the industry of your choice, determine the correct measures for each axis, and find the median and 90th percentile points for the industry. Pick the top three competitors and draw their triangles. What do your results say about the strategy of each firm and its competitive advantage?
2. Use data from the Samsung case. Draw the triangles for two or more of the four companies on Figure 9.9 (a generic international strategy triangle). Create triangles for 1960 (estimating the points on the axes from the descriptions of the firms in the case) and 2016 (use older data if the case doesn’t have up-to-date data). What do your results say about the international strategy that each firm has pursued? What

do they say about the firms’ efforts to adapt to changing conditions? Which firm is succeeding?
Exercise 4: Determine the appropriate mode of entry (choose one of the following or the one that your professor has assigned):

1. Choose a firm that has not yet expanded internationally. Choose a market for the firm to enter. Determine which mode of entry is the right one for the firm to use. Justify your choice.
2. Choose a firm that has already expanded internationally. Choose one foreign market that the firm entered. Determine which mode of entry it used. Given the firm’s international strategy, evaluate whether it used the right mode of entry.
3. Use the Samsung case. Assume that none of the four firms has entered any African markets. Given their respective strategies, deter- mine which mode of entry each firm should use to enter the African market of your choice. Justify your decision.

Strategy Tool
The International Strategy Triangle—Determining Which Strategy to Use
Professor Pankaj Ghemawat has developed a tool for assessing the international strategy of firms, the international strategy triangle—or the AAA triangle, as Ghemawat labels it—AAA for adaptation (multi- domestic strategy), aggregation (global strategy), and arbitrage. The triangle can be a helpful tool for determining which international strategy a company should pursue or for helping outsiders analyze the international strategies of firms, and can also help a firm assess the current strategic positions of competitors.
The international strategy triangle plots the strengths of a firm and its primary competitors along three axes, each axis correspond- ing to one of the primary strategies: multidomestic, global, or arbi- trage. Figure 9.8 shows an international strategy triangle for the major competitors in the medical diagnostic imaging industry: Philips, GE, and Siemens. The farther along an axis a company ranks, the more the company should follow that strategy. One point of Philips’s triangle, for example, is quite far toward the end of the multidomestic axis, while the other two points are closer toward the center of the global and arbitrage axes. This indicates that Philips should pursue, if it doesn’t already, a multidomestic strategy. The two corners of GE’s triangle that are farthest from the center are along the global and arbitrage axes, suggesting that GE might be pursuing a two-pronged approach com- bining a global strategy with an arbitrage strategy. Siemens’s triangle suggests that its most promising strategy might be a global strategy.
How are the firm’s places along each axis calculated? The meas- ures you use for the three axes depend on the type of industry you are analyzing. For many industries, the following ratios of costs as percent- ages of sales are good measures:

Multidomestic

Arbitrage

Global

Philips Siemens GE

• Multidomestic axis—Ratio of advertising costs to sales
• Global axis—Ratio of R&D costs to sales
• Arbitrage axis—Ratio of labor costs to sales
Other measures are possible, depending on a company’s goals or the industry it is in. These could include the following:
• Multidomestic axis—Percentage of local employees in country-level management positions or rate of new product development at the country level
• Global axis—System integration across countries, standardization of business practices, or the percentage of revenue from customers that are global in nature
• Arbitrage axis—Percentage of back-office activities (labor other than manufacturing labor) that are offshored to low-cost countries
Remember that the appendix can help you find sources for the

FIGURE 9.8 International Strategy Triangle—Medical Diagnostic Imaging Industry
Source: Adapted from P. Ghemawat, Redefining Global Strategy
(Cambridge: Harvard Business School Press, 2007).

data you will need to compute these ratios.
After you have determined the appropriate measures for the axes, you’ll need to obtain information to help you plot two points along each axis:

1. The median of the industry you are analyzing
2. The 90th percentile of the industry you are analyzing—the point below which 90 percent of the firms in the industry rank on that particular measure
   To find the median and 90th percentile points, you will need to get information about a variety of firms in your industry, particu- larly the most important firms, such as those with the most market share or the most recognized brand names. The appendix at the end of the book contains extensive information about how to obtain such information.
   Figure 9.9 shows an international strategy triangle for a generic industry. The median and 90th percentile points are connected, highlighting two triangles, to help you visualize how you might con- struct your international strategy triangle. As an illustration, in this generic triangle, the median ratio of labor costs to sales, the bottom axis, is 20 percent, and the 90th percentile is 50 percent—meaning that 90 percent of firms in the generic industry have a labor-to- sales percentage of less than 50 percent. When you use the trian- gle, the median and 90th percentile points—as well as the measures you use on each axis—should be customized to the industry that you analyze.

This tool can be very helpful in determining what international strategy a firm should use. If a firm ranks at any point beyond the median along any axis, managers should consider pursuing that strat- egy. If a firm ranks beyond the 90th percentile it is critical that a firm consider that strategy.
It is also useful to plot a firm’s biggest rivals. This can tell you a lot about the dynamics of competition in the industry, including who is likely to win and who is likely to lose. For example, refer to the inter- national strategy triangle for the medical diagnostic imaging industry in Figure 9.8. Although Siemens’s triangle suggests that it pursues a global strategy, notice that Siemens does not rank as strongly on the global axis as GE does. This suggests that, unless things change, Siemens might be at a cost disadvantage to GE, losing sales on price.
The triangle also suggests that Siemens would also likely lose sales to Philips, which is better at meeting local needs, as indicated by the firms’ positions on the multidomestic axis. Furthermore, this triangle also shows that Philips, although the most adapted, is likely to have the highest cost structure. Although GE does not have Philips’ strengths for adapting to local needs, GE might nonetheless be able to meet a good portion of local demand at a much lower price, enough so that Philips can’t count on maintaining market share, even though it may meet local needs better.
The steps in using the international strategy triangle are summa-

Multidomestic Advertising to Sales

Global R&D-to-Sales

rized as follows:

1. Determine the appropriate measures to use for the three axes. For

10% 10%
8% 8%
6% 6%

many manufacturing industries, these measures will be:
• Multidomestic axis—Advertising to sales
• Global axis—R&D to sales

4% 4%
2% 2%

20%

40%

60%

80%

100%
Arbitrage Labor-to-Sales

90th percentile Median

• Arbitrage axis—Labor to sales

2. Plot the median and 90th percentiles for the industry as a whole on each axis. You will do this by gathering data on the measure for each axis from the most important firms in the industry you are exam- ining. When you have that data, calculate the median and the 90th percentile point, where 90 percent of the firms are below that point. This is likely to be close to the firm who is farthest along the axis.
3. Plot the appropriate point on each axis for the firm you are ana- lyzing. Draw a triangle connecting these three dots. You might also want to carry out this process for two or more of the firm’s major competitors. FIGURE 9.9 Generic International Strategy Triangle
   Source: Adapted from P. Ghemawat, Redefining Global Strategy
   (Cambridge: Harvard Business School Press, 2007).
4. Use the shape of the triangle to help determine the appropriate international strategy for the firm being analyzed and to under- stand competitive dynamics in the firm’s industry.

References
1J. Osawa and S. Schechner, “Huawei Makes Push to Get Ahead of Apple, Samsung in Smartphone Market,” The Wall Street Journal (April 5, 2016).
2https://www.statista.com/statistics/271496/global-market-share-held
-by-smartphone-vendors-since-4th-quarter-2009/, accessed July 31, 2017.
3T. Xiao, T. Tong, G. Chen, and K. Wu, “A Dark Horse in the Global Smart- phone Market: Huawei’s Smartphone Strategy,” Insead case, 2017.
4“Huawei Expects 2018 Revenue to Rise 21 Percent Despite International Scrutiny,” https://www.reuters.com/article/us-huawei-outlook/huawei
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-idUSKCN1OQ0F9; “Huawei Says It Will Hit $100 Billion in Revenue in 2018,” https://www.cnbc.com/2018/11/30/huawei-says-it-will-hit-100-billion
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5“Global Marketshare Held by Smartphone Vendors Since 4th Quarter 2009,” https://www.statista.com/statistics/271496/global-market-share
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6Statista, Smartphone Statista Dossier, https://www.statista.com
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