Ebook International business (2nd edition): Part 2

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part
International
strategy

D


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9

Modes of
internationalization
Learning objectives
After reading this chapter, you should be able to:
✦ identify the factors motivating managers to commit resources abroad
✦ evaluate the trade vs. FDI decision in terms of its impact on the boundaries of
the firm
✦ discuss the relative merits of greenfield vs. brownfield investments
✦ assess the utility of international joint ventures and cross-border mergers and
acquisitions
✦ compare the costs and benefits of collaborating with foreign partners


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Case study 9.1
MNEs and internationalization: Bimbo bombs along

The Mexican company Group Bimbo has become the
world’s largest baked packaged-goods maker, with global
sales of $10 billion in 2010. Outside its home country,
which accounts for around half of total sales, Bimbo
brands have a significant share of markets as widely
dispersed as China, the USA, and South America. It is
an unusual achievement for an MNE originating in a
developing country.
Bimbo’s historical expansion has been more or less evenly
split between organic growth and the acquisition of high
profile brands in target markets. In October 2011, for
example, it purchased Sara Lee’s North American bakery
business, and Portuguese and Spanish operations. In a
2011 interview (McKinsey 2011), CEO Daniel Servitje spoke
of how Bimbo had learnt in the USA, its first big foreign
market, that it could, and actually needed to, target
segments beyond the Spanish-speaking communities with
which it was most comfortable. This ambition required
faster expansion than the company could achieve
organically, explaining a series of acquisitions it has
undertaken over the past 15–20 years.
Bimbo’s growth strategy in Brazil has also been geared
towards acquiring existing companies instead of building
up house brands, even if many of the companies involved
have been relatively modest in size. In part, this reflects
the fragmentation of a consumer market split between
modern hypermarkets and small grocery stores. The
result is that Bimbo tends to react opportunistically
in Brazil instead of pursuing a single growth strategy
throughout this country or, indeed, the rest of South

America.
Lastly, Bimbo’s experience in China has been closer to what
it first did in its home market in Mexico, when it had to try
to develop bread as a whole new product category in a
culture where the staple starch is cornmeal tortillas. This
common environment has facilitated the company’s
learning process in China, as has the fact that it originates
from another emerging economy and is therefore more
accustomed to the uncertainties characterizing business
in the developing world. Being comfortable with the
developing world means that Bimbo CEO Servitje is less
worried about the problems associated with growing
Bimbo’s small Chinese operations than the complications
he will face integrating his MNE’s American acquisition,

Mexican bakery firm Bimbo has organized market entry in different ways
in different countries
Source: Bimbo

Sara Lee. Bimbo’s main historical success at home in Mexico
involved nurturing localized segments over the long run. It
hopes to internationalize by following the same model.

Case study questions
1. To what extent is Bimbo operating in markets that
resemble or differ from its home country?
2. What factors determine whether Bimbo
internationalizes via organic growth or acquisition?

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212
Figure 9.1
The ladder of
internationalization
choices.

Part D International strategy

Internationalize by trading
from home or FDI

Trade from home
(import/export)

FDI

FDI: Is it an equity or a
non-equity arrangement?

Non-equity arrangements:
include licensing
and franchising

Equity arrangement: Is it a
new ‘greenfield’ investment
or the takeover of existing,
‘brownfield’ assets?

Brownfield takeover:
includes mergers and
acquisitions

‘Greenfield’ investment:
Is it done on a standalone
basis or as a joint venture?

Introduction

+ Commitment to
internationalization
Depth of a company’s
engagement of human,
physical, and financial
resources abroad.
Ranges from simple
import/export to
running large, wholly
owned foreign
subsidiaries.

Except for a few ‘born-global’ firms (Ripollés et al. 2011a), like the dot.com start-ups that
arose around the year 2000, most of the world’s leading MNEs were born in a home market
where they grew up before venturing abroad. The actual decision to internationalize, and
the way this is done, is often referred to as a ‘mode of entry’ choice. Figure 9.1 displays this
decision, using the terminology that this chapter will teach. The figure represents a decisionmaking ladder showing different levels of corporate commitment to internationalization.
The initial decision facing a manager who wants to internationalize is whether to trade from
home or engage in FDI. Where an MNE opts for FDI, the question then becomes whether the
company should commit equity capital or not. If so, the company must decide if the market

entry should involve building a brand new site or if it should take over another company’s
current operations. Additionally, at every stage of this process it will want to consider
whether it should act by itself or in cooperation with a partner.
Once the mode of entry is decided, managers must then decide how to structure relations
between the different units that have been put in place. Chapter 10 deals with these organizational aspects of companies’ internationalization drives. Altogether, the two chapters strengthen
the argument made throughout this book that international business is not a science but the
outcome of a series of decisions that are at least partially subjective in nature.

Section I: Leaving home: Theories, mindsets,
and strategies
The main focus in many international business studies is why and how companies decide
to go abroad. Chapter 4 discussed several theories that put such decisions into contexts
defined by different national economic policies. The theories underlying this chapter, on
the other hand, focus on actual market entry decisions.


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213

Modes of internationalization

The ‘Uppsala’ school
The main approach used in this chapter is called ‘stages of internationalization’ and derives
from the Uppsala model that views ‘the internationalization process [as being] characterized
by the management of complexities and uncertainties and that requires learning and commitment building’ (Vahne et al. 2011), with companies only engaging resources abroad
once they become more comfortable with the environments they discover. The expectation
is that MNEs usually internationalize first via simple import and export arrangements that
gradually become more complex over time (Ruzzier et al. 2006). This is due to the connection between managers’ perception of the degree and type of uncertainty associated with a
particular market entry mode, and their overall commitment to internationalization (Li and

Rugman 2007). Subsequently, once managers do feel ready to commit capital resources
abroad, this will often first involve entering a neighbouring country or culture before going
further afield later. The Uppsala school argues that the key factor in most companies’
overseas trajectory is the confidence that managers have in their internal capabilities and
accumulated expertise (Tuppura et al. 2008). It is rare for international managers to have a
complete understanding of the foreign environments to which they are thinking of moving.
This is illustrated in recent studies showing that Chinese private enterprises’ early stage
entry in Africa is more a reflection of the existence of local overseas Chinese networks
raising entrepreneurs’ level of comfort than of any understanding they might have of local
circumstances (Song 2011). Subjective decision-making in the face of imperfect knowledge
has always been an integral part of international business.

Other internationalization schools
International business literature offers a number of other theories (see ORC Extension
material 9.1) emphasizing different aspects of companies’ internationalization paths. This
includes long established constructs like ‘transaction cost economics’, which implies, where
MNEs are concerned, that internationalization decisions are largely motivated by the
desire to cut costs; ‘network theory’, which apprehends international business decisions
in terms of MNEs situating themselves within the web of companies comprising their
value chain; and Professor Alan Rugman’s ‘FSA/CSA matrix’, which highlights MNEs’ search,
respectively, for firm- and country-specific advantages. There are also more recent models
such as the ‘New Venture Theory’ or the ‘LLL framework’, which focus on fine-tuning current
understanding of internationalization processes by accounting for factors such as companies’ different organizational cultures, stages of development, or sectors of activity.
Lastly, some economists have highlighted factors such as home market saturation and
diversification as a prime driver behind internationalization, exemplified by California bank
Wells Fargo’s stated priority of buying European bank assets to offset a disproportionate
focus on its home market (Braithwaite 2012).
Given the wealth of different schools of thought, the only theoretical generalization that
can be made is that companies go abroad for a wide variety of reasons, which can broadly
be divided between internal strategic motives vs. responses and external circumstances

(Hutson et al. 2011). This diversity explains why internationalization has attracted so much
attention over the years. Going abroad is one of the most crucial decisions that international
managers will ever have to make.

Degrees of internationalization
Doing business outside one’s home country will always be challenging, with some studies
struggling to find evidence that firms with a greater cross-border presence necessarily perform
better than companies that work within their national boundaries (Contractor et al. 2003).
Transferring resources (mainly capital, knowledge, personnel, and materials) overseas is

> Go online


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214

+ Joint venture
Business unit
specifically created by
different companies
to achieve a particular
mission. Usually
involves pooling
resources like equity
capital, knowledge,
processes, and/or
personnel.
+ Pioneering costs
Costs associated

with the mistakes that
companies make when
entering an unfamiliar
market.

Part D International strategy

an expensive and difficult process for many companies and can create a wide range of new
problems (Nadolska and Barkema 2007). Some of these problems are industrial in nature,
like the difficulties that German car-maker BMW faced in the 1990s after buying Rover, a
UK company accustomed to lower quality manufacturing standards. Others involve financial aspects, like the debt that France’s Vivendi incurred to fund its 2000 acquisition of
US entertainment company Universal. Still others are intellectual property-related, as
exemplified by the dispute between French food company Danone and its Chinese partner
Wahaha, which it accused of setting up parallel operations rivalling the joint venture that
the two companies had established together. Lastly, some problems are more strategic in
nature, like when Pizza Hut sought a first-mover advantage by entering Brazil in the 1990s
before this volatile emerging economy had stabilized, and suffered high pioneering costs as
a result. Internationalization is never an easy step.
Despite these risks, international sales can be a saving grace for companies with little
room to grow at home. There are many sectors of activities (automobiles, beverages, etc.)
that are more or less saturated in the world’s older industrialized nations, whose MNEs
must therefore seek new opportunities in emerging economies in order to expand. Others,
like the accommodations business, are suffering from a great deal of volatility in once
stable regions like Europe, explaining why a giant in this sector, InterContinental Hotels, is
repositioning itself to centre new growth in emerging Asian and Middle Eastern markets
(Thompson and Jones 2012). Seen in this light, expanding overseas is often a necessity, not
a luxury. The main obstacle to internationalization then becomes managers’ psychological
predisposition to enter foreign markets, sometimes referred to as the opposition between
companies characterized by a ‘domestic mindset’ (Nadkarni and Perez 2007) vs. others
whose corporate culture emphasizes ‘international entrepreneurship’ (Ripollés et al. 2011b).

Derived from the Uppsala model with its learning focus, the more confidence a company has
in its ability to succeed abroad, the greater the amount of financial and other capital it will
be prepared to invest. The less confidence it has, the more it will prefer interacting with foreign
interests, when necessary, through less committed methods: trading (importing/exporting)
from its home base; or, at most, opening a tiny representative office abroad. This spectrum
of possible actions means that the main internationalization modes can be ranked (see
Figure 9.2) in order of the physical, capital, and human resources that each requires.

Managerial mindsets
Managers’ tendency to adopt a ‘domestic’ or ‘international entrepreneurial’ mindset varies
in time and place, and also depends on whether the proposed market entry involves an
operational ‘exploitation’ of relatively familiar capabilities or a riskier ‘exploration’ of
something unknown (Barkema and Drogendijk 2007). One way to analyse this sense of
difficulty is by using Porter’s ‘Diamond’ model (see Chapter 2), which states that firms that

Figure 9.2
Different modes of
market entry require
the internationalization
of different amounts
of financial capital,
human capital, and
knowledge.

Market entry mode

Description

Import/export from home

Firm remains domestic but buys
from foreign supplier/sells to
foreign buyer

Licensing/franchising

Firm gives permission to an agent
to manufacture/retail abroad on
its behalf

Joint venture
(form of FDI)

Firm makes equity investment
abroad together with partner

Wholly owned subsidiary (FDI)

Firm makes standalone equity
investment abroad

Scale of commitment
Low

High


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Modes of internationalization

215

have overcome tough challenges at home feel better prepared to deal with difficulties
abroad. Recent examples include Russian telecommunications operator Vimpelcom’s 2010
acquisition of two companies in neighbouring Ukraine, a successful decision in light of the
new subsidiaries’ strong contribution to 2011 group operating profits. The move signified
the MNE’s growing confidence in its ability to succeed in a business environment influenced
by a recent communist past, a context for which Vimpelcom was prepared given Russian’s
own political history. Similarly, there is also a tendency for MNEs to expand more quickly in
places where the business culture is similar to the one they grew up in. US multinational
Starbucks, for instance, has penetrated the English market with apparent ease in comparison
with the problems that it has suffered in India, where the MNE’s inability to find acceptable
partners limited its market entry until it finally signed a memorandum of understanding
with Tata, the giant Indian conglomerate, in January 2012.
A further factor affecting managers’ internationalization attitudes is how well they
process the failures of past foreign ventures (Desislava and van Witteloostuijn 2007). For
example, the problems that British retailer Marks & Spencer faced in the USA and France
in the mid-1990s did not prevent it from renewing its ambitions in these countries some
15 years later. Some companies are disheartened if their first internationalization efforts
fail but others keep trying.

SMEs and internationalization
Lastly, company size is also a major factor in internationalization. Small and medium-sized
enterprises (SMEs) face many obstacles when entering foreign markets, first and foremost
being their comparative lack of resources (see Chapter 5). SMEs are often family-owned, a
factor that can on occasion correlate negatively with internationalization (Fernandez and
Nieto 2006). One of the reasons is that a firm lacking corporate shareholders will have problems accessing the substantial funding that foreign operations often require. Even when
family-run SMEs do go abroad, observers have noted a tendency for many to go particularly
slowly, especially where the internationalization move involves bridging significant ‘psychic
distance’, or managers’ sense of how great a difference there is between home and host

country business cultures (Kontinen and Ojala 2010). Excluded from costlier opportunities
(large company takeovers or big marketing campaigns), family-run SMEs are often restricted to smaller actions in well-defined niches. This often forces them to join a network
with other firms to achieve critical mass. For example, small vineyards in south-west France
have tried to optimize their international marketing operations by banding together in an
association called the Conseil Interprofessionnel du Vin de Bordeaux (CIVB). Family-run firms
may also lack the managerial competencies to attack foreign markets, although it is worth
noting that this shortcoming has given birth to an entire consultancy activity for SMEs
trying to enter challenging international business environments. US computer-maker Intel,
for instance, has set up an alliance with partners from the Chinese city of Guangdong, establishing a payment platform facilitating SMEs’ local transactions (Hooi 2011). Similarly,
there is the ‘Launchpad’ service that the Chinese British Business Council provides to help
UK businesses to hire individuals capable of representing them in China. This has become a
necessity given many Chinese companies’ refusal to deal with anyone other than ‘the big
boys’ (Moody 2001).
In long-term strategic terms, SMEs can react to their size handicap in one of two ways.
Some become extremely cautious and opt for a less financially committed and faster form of
internationalization, such as exporting (Cassman and Golovko 2011) or licensing/franchising
(Hutchinson et al. 2006). Conversely, others decide to respond even more radically and opt
for ‘accelerated internationalization’, an approach where they change their entire focus
specifically to take advantage of foreign opportunities (Chetty and Campbell-Hunt 2003).
Observers have noted that these sudden shifts in strategy are often sparked by the fact that
managers in the internationalizing company have developed a particular relationship with
members of their ethnic community residing in the target host country (Prashantham 2011).

+ Licensing
Contract where
a licensor grants
permission to a
licensee to use one
of its assets, usually
intellectual property.

In return, the licensor
will receive royalties.
+ Franchising
Contract where
a franchiser grants
permission to a
franchisee to run
a business bearing
its name, often
using supplies that it
provides. In return, the
franchiser will receive
income, often based
on the franchise’s
performance.


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216

Part D International strategy

This is very different from the gradual approach envisaged under the Nordic (Uppsala)
‘stages’ theory. The choice between these two options depends on the strategic attitudes of
the SMEs’ owner-managers, whose personalities have a much greater impact within smaller
structures than they would in larger MNEs (Lloyd-Reason and Mughan 2002). At this level,
like so many others, the link between psychology and strategy is crucial to understanding
international business.

Trade vs. FDI: Drawing the boundaries of the firm

+ Boundaries
of the firm
Range of value chain
operations that a
company does by
itself without turning
to outside partners.
> Go online

Figure 9.3
Value added in a
shared international
value chain.

International business theory has traditionally suggested that export is the better market
entry choice if a company faces major cultural or institutional barriers (and if economies of
scale are a key factor of success), whereas FDI is more suitable when the target market is
very distant from the MNE’s home country (Lankhuizen et al. 2011). This proposition has
been somewhat weakened in recent years by the way in which ICT facilitates long-distance
customer servicing and intra-firm communications (Philippe and Leo 2011). The simpler
and safer explanation is therefore that managers’ internationalization decisions are rooted
in their corporate culture. Thus, companies characterized by a minimal commitment to
internationalization might prefer, irrespective of the strategic argument, to take delivery
of foreign purchases, or transfer ownership of foreign sales, at their ‘factory gate’, if only
because they want to avoid logistics complications or similar problems. In this sense, trade
is easier than FDI since it does not require the company to go beyond its current capabilities.
The attraction for easier solutions explains why some large MNEs that could afford to
develop wholly owned foreign affiliates have decided otherwise. As explained in Chapter 5,

since the 1980s more and more companies have opted for a ‘small is beautiful’ mindset, preferring to outsource certain operations to other companies who might be able to do them
better and/or more cheaply. Designing the boundaries of the firm is one of the main actions
that international managers must take (see Figure 9.3) and the trade vs. FDI choice is a
crucial part of this decision, which has financial aspects as well as psychological and
strategic ones. If the FDI costs the firm more than the profit margins that will have to be paid
to external suppliers or vendors once they become part of the value chain, then using
import/export as a prime mode of internationalization makes sense. If FDI costs less, then it
is worth considering.
Firms that take direct responsibility for few of their value chain operations are said to have
narrowly drawn boundaries (see ORC Extension material 9.2). Such firms necessarily rely
on having good relations with partners operating in their value chains. This dependency is
a source of potential problems. Contracts with other firms may be incomplete and not cover
Value of
product/
service

Part of value added captured by
downstream vendors

Part of value added captured by
company acting as importer/processor/exporter
Part of value added captured by upstream suppliers
Value chain—processing of goods/service
Row materials

Finished product


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Modes of internationalization

Trade only
(import/export)

Advantages

Disadvantages

•

Easier to manage, requires less
knowledge
Engages less capital, thus lower risk
Keeps balance sheet smaller and
more flexible, thus more responsive
to changing economic situations

•

Control/confidentiality
Higher profit potential/visibility
Increases knowledge of/comfort
with foreign market

•
•
•

•
•

FDI

•
•
•

•
•

Firm develops less overseas
experience
The value added generated during
the good’s transformation will have
to be shared with other companies
Depends on partners; risk of
opportunistic behaviour
Harder to manage
Harder to finance
Greater risk of failure

certain scenarios, performance can be disappointing (bad quality, unreliable deliveries, late
payments), and sharing crucial know-how is always a problem (Gilpin 2001). There is also
the risk that an opportunistic supplier or vendor will expand its own operations down or up
the value chain and become a direct competitor. These and many other problems explain
why, despite the added difficulties and expense, MNEs often prefer FDI as a prime mode of
internationalization (see Figure 9.4).
Even after opting for internationalization via FDI, firms still have many aspects to
consider. The first is whether the FDI is more property-related or knowledge-based, with
studies offering evidence that the latter has a more lasting influence on international growth

than the former (Tseng et al. 2007). In 2011, for instance, Australian building materials
supplier Boral bought out the interests of its French partner, cement-maker Lafarge SA, in
their Asian plasterboard manufacturing joint venture. This was a useful FDI that had had
some consequences for Boral’s production organization, but its strategic scope was clearly
far narrower, for instance, than Hewlett-Packard’s purchase that same year of British software provider, Autonomy Corporation, whose online data search capabilities might help to
spearhead the US computing giant’s transformation from hardware manufacturing to IT
services. FDI that is based on a firm developing a new line of business may be riskier than
one seeking a straightforward expansion of existing commercial territory (Doukas and Lang
2003), but the potential rewards are also higher.
The most fundamental distinction in FDI analysis is whether a particular action is vertical
or horizontal in nature. The cost factors associated with these two modes, first defined in
Chapter 5, are worth exploring in greater detail (Barba Navaretti and Venables 2004).

Vertical vs. horizontal internationalization
As explained previously, the main reason for MNEs to engage in vertical FDI up and down
their global value chains is to reduce dealings, hence potential problems, with outside
partners. At an extreme, vertical FDI can lead to specialist ‘focused factories’ being built
in different countries, each engaged in one specific aspect of the total production processes
(see Chapter 11). The strength of this kind of manufacturing organization is that all units
can benefit from the particular competitive advantages inherent to their location. In Asia,
for example, it is noteworthy how low-skill work like textile weaving has generally moved to
countries like Bangladesh, where labour is abundant, whereas more technological work like
microprocessor development is centralized in scientifically more advanced countries like
Singapore, where capital is abundant. This trend fits in with the Heckscher–Ohlin factor
proportions theory discussed in Chapter 2.

217
Figure 9.4
Trade is often a simpler
option than FDI but

also creates strategic
vulnerabilities.


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218

Part D International strategy

Vertically integrated
MNEs like ABB
will centralize the
production of certain
sub-assemblies in
particular plants before
transferring them to
sister units elsewhere
Source: ABB

Vertical internationalization
The consequence of having factories focused on a single activity (see Chapter 11) is that each
plant in the value chain will then produce and/or export a larger quantity of the particular
good for which it is responsible. This increases plant-level economies of scale and learning.
Swiss–Swedish MNE ABB, for instance, uses its Ludvika site to make many of the electrical
modules (like current transformers or voltage transformers) that it sells to customers and/
or fits into more complex products that ABB manufactures elsewhere. Many companies’
internationalization efforts involve FDI creating a specialist in-house unit that will then
trade with sister units worldwide up and down the value chain. The separation between
MNEs’ trade and FDI activities can be artificial. The two are often complementary.

The downside for MNEs with this sort of configuration is that it increases the need to ship
goods (and services) between different sites, adding to ‘trade costs’ such as packaging,
freight, and tariffs. More time can also be lost in transit. Some MNEs address this problem
by running production operations on only a very few sites, often located near their final
product assembly plants. Examples include the maquiladora components factories that
several US industrials have set up in north Mexico near the American border, or automotive
parts plants that German car-makers have built in neighbouring East European countries
like Hungary. At a certain point, however, managers may decide that vertical internationalization’s firm-wide trade costs outweigh its benefits. They might then opt for ‘vertical disintegration’, or the outsourcing solution that Chapter 11 describes in greater detail.

Horizontal internationalization
Chapter 5 introduced the concept of horizontal FDI, where firms reproduce abroad the
same activities as the ones they run at home. This kind of internationalization is often driven
by knowledge transfers and reflects MNEs’ particularly strong presence in technologically
advanced sectors, characterized by complex production processes. Where there is value in
‘bundling’ different manufacturing stages together, an approach that countless Japanese hitech companies have put to good use over the years, it can make more sense for manufacturers
to maximize their global production activity on a single manufacturing site, especially since
this helps to maintain the confidentiality that is so important in hi-tech. Some companies


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Modes of internationalization

Vertical FDI

Horizontal FDI

Purpose

Internalize global value chain

Leverage existing competencies abroad

Facilities

Focused factories

Multi-function facilities

Economies of scale

Plant-level

Firm-level

Trade

Often intra-firm

Often in host country

Weakness

High trade costs

Duplication of overheads

219
Figure 9.5
The two main FDI
strategies.

might even feel that the best way to protect trade secrets is simply to export finished products
from their original plant(s) and avoid FDI altogether. However, if international sales expand
too quickly, a single site can quickly run into capacity constraints. Horizontal internationalization is the logical response to this.
Of course, horizontal FDI also costs more, since it involves duplicating certain activities
on several sites. This can become particularly expensive when each new site is designed
to service one specific market instead of servicing customers or sister units worldwide.
Moreover, output from the new plants that an MNE has built according to a horizontal logic
tends to reduce the need for exports from existing units, affecting their economies of scale.
It remains that these are losses felt at the individual plant level. On a broader plane, it is
possible to develop firm-level economies of scale through horizontal FDI, since many assets
will not have to be replicated everywhere. This includes some tangible assets but especially
intangible ones like scientific know-how, patents, or brand reputation. In large MNEs with
worldwide sales, shared resources of this kind go a long way towards paying the extra cost
of horizontal FDI as opposed to other modes of internationalization. Figure 9.5 summarizes
the advantages and disadvantages of these two modes of market entry.
In sum, most large MNEs have a variety of reasons for, and ways of, venturing abroad.
The course that they choose will depend on many different factors, including whether the
expansion is for upstream or downstream purposes, the depth of managers’ willingness to
commit to internationalization, and the kinds of resources being transferred. Like all international business decisions, there is no optimal solution—just the response that managers
consider most appropriate to a given set of circumstances.

Section II: Entering foreign markets
The speed with which MNEs go abroad can vary greatly. Many companies (especially SMEs)
might first enter a market via an ‘intermediate step’ like a small, representative office. The
purpose is to increase organizational learning about a destination before risking greater
resources there. Representative offices are places where company executives travelling to
a country can stop off to get their bearings when first visiting. This was a common practice,
for instance, for Western banks entering China in the 1990s.
Where companies opt for full-blown FDI, an initial decision is whether to build new

greenfield facilities (alone or with a partner) or take over existing assets via a brownfield
strategy. This choice is often referred to as the ‘build or buy’ dilemma.

Greenfield vs. brownfield investments
There are several reasons why an MNE might opt for a greenfield or a brownfield investment
as its mode of market entry. At a strategic level, greenfield investments are preferred when
the purpose of the expansion is to exploit technologies, whereas brownfield investments are

+ Greenfield
investment
Where a firm enters a
new market by building
new facilities.
+ Brownfield
investment
Where a firm enters a
new market by buying
existing facilities.


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220

+ Goodwill
Difference between
the price at which
a company can be
purchased and the
break-up value of

its assets.

Part D International strategy

preferred when the purpose is to acquire downstream capabilities and service the local
market (Anand and Delios 2002). This largely reflects the fact that, with a greenfield mode,
it is easier to preserve the confidential nature of a company’s technological knowledge,
since this can be transferred internally from the MNE’s existing sites to its new locations.
For example, Intel’s chosen method for growing its operations in Costa Rica has been to construct greenfield ‘campuses’ hosting research and other functions on sites located 12 miles
outside the nation’s capital. Novartis did something similar when it developed its Changshu
Pharmaceutical Development Centre alongside the Yangtze River, using this new platform
to develop, manufacture, and ship products targeting diseases that have a high incidence
in China. On the other hand, where commercial knowledge is the key factor of success,
a brownfield entry will usually be deemed more appropriate. One example is the decision
made in 2011 by British educational specialist Pearson to enter China by acquiring successful local English language test company Global Education and Technology Group, paying
$294 million instead of growing organically and building its own facilities. Among other
reasons, it was felt that the target company’s longstanding relationships with school networks
would have taken too long to replace.
In practical terms, MNEs facing this ‘build or buy’ dilemma have different variables to
consider. One advantage of the greenfield approach is that it saves a firm from having to
spend time and effort on identifying and acquiring an appropriate target—assuming that
one even exists. One example was when German retailer Metro realized that, to develop a
functional supply chain in India, it needed to build its own facilities (refrigerated transportation is a key capability for modern supermarkets). The relative lack of local agents capable
of this function forced Metro to start from scratch (Bellman and Rohwedder 2007).
A greenfield entry also means avoiding goodwill costs associated with the purchase of an
existing asset. At times when stock market valuations are high, this can be very expensive.
The advantages of brownfield entry, on the other hand, include the fact that the approach
avoids the start-up problems inherent in any new venture. One example of this is the decision by French banking giant BNP Paribas Walmart to enter the Ukrainian market by taking
a large stake in UkrSibbank (totalling 84.99 per cent by 2011) instead of establishing its
own subsidiary as rival Deutsche Bank had done. BNP managers had previous experience

entering other Eastern European countries and possibly decided to accelerate market
entry through this brownfield approach. Otherwise, a second advantage is the possibility of
benefiting from the target company’s brand image. This explains why target firms are often
allowed to keep their old name. One example is Vivo Energy’s acquisition of giant energy
company Shell’s retail operations in Africa, with the decision being made that while the new
corporate entity will still bear the name Vivo, when the deal is completed, the 1300 stations
that it runs across the continent will continue to sell products under the old Shell brand
name. Brownfield expansion also means that a company is taking over an existing producer
instead of adding to the sector’s total production capacities and increasing the global
supply, the effect of which would be to drive down market prices, something that is not in
a producer’s interest. In addition, increasing environmental constraints argue against the
unlimited construction of new assets on previously undeveloped green fields. After all,
with the notable exception of primary sectors such as agriculture or mining, many areas of
economic activity already suffer from excessive productive capacities.
Lastly, it is worth mentioning that the preference for a greenfield or brownfield entry will
also depend on how foreign a particular market feels to the manager making the decision.
People sense different levels of (dis)comfort when entering a particular market. Research
has revealed some MNEs’ tendency to prefer brownfield investments when expanding into
countries that are culturally very different from their home market. This is especially true if
the firm lacks significant previous international experience or plans to allow the new affiliate
to develop its own marketing strategy and therefore needs to acquire good customer relationship skills (Slangen and Hennart 2008). Once again, there is an apparent link between
managers’ willingness to commit resources abroad and their confidence in their ability to
cope with foreign environments and cultures.


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221
A key FDI decision

is whether to invest
in a greenfield or
brownfield site

Equity arrangements
Greenfield investments are often motivated by managers’ conviction that they can acquire a
first-mover advantage in a foreign market. Chapter 10 offers a fuller explanation of this
proactive, ‘push’ orientation. For the moment, it suffices to note that, in the absence of local
knowledge, companies are usually assuming greater risk when starting a foreign operation
from zero because they know less about the host market than home country professionals
do. Radically new visions developed by distant corporate executives may not be very appropriate to local conditions. In many cases, it is simply safer to try to fit into a country’s existing
economic fabric. This is one of the reasons why brownfield investments are the prime vehicle
for modern equity-based internationalization arrangements.

International mergers and acquisitions
One of the leading categories of equity-based market entry is international mergers and
acquisitions (M&A). This form of brownfield entry is usually driven either by downstream
motives like the search for new markets, or upstream motives such as the search for
resources or the strategic assessment that a sector is suffering from over-capacity and needs
to consolidate. M&A tends to occur in waves, often because managers in a given line of
business have come to similar conclusions about which strategies are most appropriate at a
particular moment in time. Different waves of international M&A can have different causes,
but the net effect is often to consolidate a sector in the hands of a few enormous MNEs and
create monopoly positions. This is what makes M&A such a controversial topic for many
critics of globalization. In turn, it often receives attention from national competition agencies,
one of the main areas where state authorities continue to intervene in international business
(see Chapter 3).
Examples of ‘merger-mania’ include the telecommunications sector, which witnessed a
wave of cross-border M&A operations in 2005, or the international banking sector, which
went through a similar experience in 2008. This latter transition occurred largely in

response to the global financial market crisis that year, raising questions as to how many
international M&A deals are motivated by long-term strategy considerations as opposed to


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222
Figure 9.6
Value of cross-border
M&As by region/
economy of seller,
in US$ billion
(UNCTAD 2012;
reproduced with the
kind permission of the
Department of Public
Information, United
Nations)

Part D International strategy

1995

2000

2002

2007

2009

2011

World

112.5

905.2

248.4

1022.7

249.7

525.8

Developed economies

105.1

852.3

204.1

891.9

203.5

409.0

93.4

94.2

82.2

87.2

81.5

78.1

Percentage of total

MNEs simply seeking to take advantage of one-off opportunities, often in the wake of a
sudden and favourable change in stock market valuations. Most noteworthy of all is the
historic rise and fall in different sectors’ relative share of total international business
volumes at different points in time, the best example being the explosion in raw material
and commodity-related international M&A activity since the turn of the century, which shot
up from around 10–15 per cent of total global volumes in 2000 to nearly a third of all deals
a decade later.
Figure 9.6 provides data on cross-border M&A since 1995. The first notable aspect is its
cyclical nature. Activity levels tend to skyrocket during boom years but collapse completely
during difficult periods, like after the 9/11 attacks on New York or the 2008 financial
crisis. For instance, after embarking on a slew of acquisitions in the early 2000s (Thomas
and Sakoui 2012), British telecommunications giant Vodafone had reversed its strategy
by the year 2012, generating cash by selling existing subsidiaries but hesitating before using
its healthy treasury position to acquire new assets (often because of fears about regulatory
constraints). A second noteworthy trend in cross-border M&A is the older industrialized

countries’ declining share of total deal volumes. Whereas stock exchanges in the developing world used to lack the maturity to enable market-based M&A operations, this has
changed in recent years, as has emerging economies’ relative share of the global economy
(see Chapter 15).
The 2011 European sovereign debt crisis also had a serious dampening effect on international M&A activity, with the slight recovery witnessed since the 2008 credit crunch
grinding to a halt as funding possibilities (whether stock market or banking system based)
froze up again. The downturn was particularly evident for MNEs with headquarters in
Europe, whose share of cross-border acquisitions plunged in volume terms to 31 per cent of
the global total, the lowest since 1990 (Sivertsen 2012). Conversely, the size of American
and especially Asian acquisitions in Europe rose significantly, another indication of shifting
geography of power in international business (see Chapter 15). The appetite for crossborder acquisitions cannot be analysed separately from the outlook for the global economy
as a whole.
All in all, international M&A can be studied at many levels. The main macro-economic
issue is whether a particular country is a net provider or receiver of M&A-related capital
flows. Cross-border M&A operations are more widespread in the absence of capital market
controls (see Chapter 4) and when a host country government tolerates foreign ownership
of national companies. On the other hand, M&A will not flourish in countries where there
is resistance to foreign ownership or suspicion that international oligopolies are trying to
undermine competition or limit consumer choice. High stock market valuations can also be
an obstacle to M&A.
At a micro-level, cross-border M&A offers two main advantages as a mode of expansion.
As demonstrated by Figure 9.7, by bringing together companies with complementary
capabilities, it enables significant synergies. It can also be a relatively quick way to build
an international presence.
Once a cross-border M&A has been concluded, managers will still have a great deal of
work to do to ensure the new entity’s success. This area of international business is explored
in Chapter 10’s discussion of MNEs’ ‘change-management’ strategies, but it is worth noting
that screening and choosing partners who will be trustworthy and offer a good strategic fit
constitutes a major challenge for all international collaborative arrangements. Of course,

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Type of international acquisition

Recent examples

Upstream (backward integration):
Acquisition of inputs

Ongoing purchase of mines in
Africa and elsewhere by Chinese processor
Minmetal Resource Ltd

Downstream (forward integration):
Acquisition of market share

Indian telecoms giant Bharti’s 2010
purchase of Zain’s African mobile phone
infrastructure to access new customers

Complementarities: Geographic
(former companies had strengths
in different parts of the world)

2012 Swedish telecom MNE Ericsson
buys operations/business support system
firm Telcordia for its US customers

Complementarities: Product

(former companies had strengths
in different product ranges)

US medical devices maker Johnson &
Johnson buys Swiss Synthes for its portfolio
of orthopaedic tools

Efficiency savings:
Synergies

Italian utility Enel’s purchase of Spanish
counterpart Endesa. Aim: save
€1 billion a year by 2012 on administration,
R&D, operations, and procurement

there are also many success stories in this area. One was the 2009 merger between British
Airways and Iberia from Spain. The new combined entity was able to benefit from the partners’ ability to rationalize existing computer systems and branch networks, and from their
complementary presence in different growth markets, respectively Asia and Latin America.
By 2012, the combined entity, now called International Airlines Group, was able to announce
strong growth in traffic even as rival operators were announcing disappointing results.
Another success story is the way that Renault has been able to learn frugal, labour-intensive
low-cost manufacturing methods from its Indian joint-venture partner Mahindra and
Mahindra and put these techniques to good use at Dacia, the company it had acquired in
Romania. Finding a suitable foreign partner is a real concern for MNE executives. Similarly,
there is hope that Mattel’s 2011 takeover of Hit, the company that produces Thomas the Tank
Engine and other children’s favourites, will be successful because of the good relationship
that already exists between the US giant and the British target. Where no friendly partner
exists, however, companies may be forced to resort to risky organic growth or even turn
down overseas opportunities from which their competitors might then be able to profit.

Practitioner insight
Takahiro Izuta is Chief Financial Officer
at Sumitomo Corporation Europe Group
and Corporate Officer, Sumitomo
Corporation. Much of his career in the
group has focused on market entry and
FDI issues.

‘Historically, Sumitomo’s international
operations started with trading activities where we imported raw materials
and other inputs and exported production. Often, this initial arrangement was
followed by our establishing overseas
offices supporting these trading activities. Indeed, much of what we do is in response to
changing customer relationships. For instance, where we might once have simply purchased

223
Figure 9.7
Different kinds of
business strategy in
recent international
M&A.


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224

Part D International strategy

raw mineral resources on customers’ behalf, over time many could manage by themselves. In

response, we would then invest directly in mines and secure long-term purchases, providing
advanced solutions to customer needs.
This approach is reflected in sales activities. We generally market goods on customers’
behalf—after all, if they could export themselves, they would. Sometimes we enter a market
through simple sales to local agents but decide over time to establish a local distribution
company and sell goods directly. It depends on factors such as local distribution capabilities
and product portfolio issues. The raison d'être of a trading company is to provide solutions to its
customers around the world, but this means different things at different times and in different
places.
Generally the key questions, once we decide to enter via FDI, are the size and nature of the
risk; the growth potential and strategic importance; the balance between Sumitomo and local
personnel; country risk; and Sumitomo’s role in any joint venture. In countries where we
already have experience and are confident of investing by ourselves, acting alone is the norm.
Conversely, in regions where we historically have limited experience or the investment climate
is poor and we are unsure about FDI protections, we proceed cautiously. We hesitate to grow a
business if we are not confident of government support.
We have worked, however, to address such issues. In Bolivia, for instance, we have overcome
negative attitudes towards foreign mine owners by being a model corporate citizen. Above all,
we mitigate certain risks by collaborating with trusted local business partners who share our
principles and can also bring additional expertise or benefits, especially since legislation in
some countries does not allow 100 per cent foreign ownership of trading entities. In these
cases we devise a joint venture with local companies or seek other structures.
At that point, we weigh the advantages of an acquisition (immediate market access, established organization) against the disadvantage of having to transform the operation to meet our
needs. In some instances we might have no choice. There might be not be any operations inviting
us to join them or the number of concessions may be limited. Alternatively, we might find an
operation requiring reorganization. The problem is that if we change an organization, this might
cause customers or good managers to abandon it. Lastly, for a Japanese company such as ourselves, there are always cultural differences. The key here is to manage overseas operations fully
respecting people’s differences while ensuring agreement on our business principles.’

International joint ventures

> Go online

Most MNEs that want to enter a foreign market via an equity arrangement but are unwilling
(or not permitted by the host country’s government) to do so on a standalone or M&A basis
will end up opting for a ‘strategic alliance’ with another company. In general, the term refers
to limited one-off cooperation arrangements in specific functions such as transportation
or research. The alliance in question can be given a specific mission, as exemplified by the
agreement between French tyre manufacturing giant Michelin and California renewable
chemicals and fuels company Amyris to develop natural isoprene. Alternatively, it can be
the foundation of a broader relationship, such as the ongoing technical partnership between
Japanese technology giant Fujitsu and German software designer SAP. In its broadest sense
(see ORC Extension material 9.3), a strategic alliance can include any kind of international collaboration. For clarity’s sake, however, it is best to apply the term in its more
limited sense and specify different classes within this category.
An international joint venture (IJV) exists when a strategic alliance involves an equity
arrangement where the MNE and its partner each take a percentage stake in a new company,
often built on a greenfield basis. Some IJVs feature 50–50 joint ownership, but in others one
of the partners will have at least a 51 per cent share to ensure overall control.
IJVs are interesting as a market entry mode, largely because of the nature of partners’
relationships. By putting up equity capital, an MNE entering a joint venture is making


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Modes of internationalization

strong commitment to internationalization even as it seeks outside help. At the same time,
this partnership aspect creates certain complications, particularly if the cultural fit between
the foreign and local partner is suboptimal (Lu 2010). MNEs considering an IJV will often
wonder whether it is worth the almost inevitable aggravation.
Some IJVs occur because the host country (often an LDC) requires incoming multinationals

to enter partnerships with local firms. Such requirements are often motivated by the desire
to engineer a more extensive transfer of technology, taking advantage of the R&D-intensive
nature of many IJVs, particularly export-oriented ones (Zhang et al. 2007). At other times,
host governments impose an IJV arrangement on incoming MNEs because they fear being
dominated by interests over which they have no control. This defensive stance is particularly frequent in so-called ‘strategic’ areas of activity: always defence; but often banking,
which most countries tend to classify as a cornerstone of national sovereignty, especially
after the 2008 global financial crisis revealed the impact this one sector of activity can have
on the rest of an economy.
Banking sector IJVs are particularly prevalent in countries with a strong tradition of
government intervention, like China, the leading example of a country with a policy of
requiring IJVs. There is no doubt that joint-venture stipulations in Chinese FDI legislation
have liberalized in recent years, especially since China joined the WTO in 2001. The country’s
first attempts to harmonize its banking norms with global standards, including with regards
to the conditions governing MNEs’ market entry date from 1994. Yet many restrictions
remain in place, depending on the exact kind of banking activity in question, branch location, and whether the bank is listed on a Chinese stock market. An additional consideration
is whether the IJV started out as a new, ‘wholly foreign-owned enterprise’ or began with
the takeover of an existing entity. In the latter case, foreigners’ maximum shareholdings are
capped at 49, 33, and 20 per cent, respectively, depending on whether the venture is a
commercial bank, investment bank, or stockbroker. This patchwork of regulations may be
confusing but there is one constant: in most cases, banking MNEs seeking to enter China
should expect to work with a local partner. This is a country where IJV tends to be mandatory, not voluntary.
Many firms do not mind this requirement. Indeed, IJVs are an attractive solution for
MNEs afraid of having to manage the market entry process without help from the outside.
Liberalization has not been a one-way street in China, and national interests regularly pressure
local authorities into placing tighter controls on foreign affiliates. Thus, having a local partner
who knows how to handle government officials can be of great use to non-Chinese MNEs.
Similarly, tax bills can vary markedly in China, depending on how bureaucrats decide to
classify a particular venture. There is often a great deal of flexibility in the way such decisions
are made. Here too it pays to have a good local lobbyist (see Chapter 5). In complicated
foreign environments, it may be impossible for MNEs to succeed on their own.

Local government contacts are only one of several reasons that multinationals often opt
for IJV. With this kind of market entry, MNEs have to put up far less equity capital than they
would if operating alone. Furthermore, like international M&As, IJVs can help companies to
achieve synergies, reduce competitive pressures, and implement vertical internationalization
strategies—or, often even more profitably, horizontal ones (Slovin et al. 2007).
In terms of choosing local partners, MNEs tend to seek parties capable of fulfilling specific
functions in the host country. This can involve personnel recruitment, supply chain operations, and/or customer relations. In turn, the incoming MNE is usually expected to offer
technological expertise based on its processes and/or products, provide access to international funding sources, and, where possible, bring a recognizable brand name. The exact
breakdown of partners’ roles within the new venture, as well as its legal status (usually a
partnership or limited liability company), depends on how each side’s bargaining position
evolves over time (Abdul-Aziz and Wong 2011) and whether the purpose of the IJV is to sell
into the host country or use it as a manufacturing base for exports elsewhere.
The great weakness of the IJV structure is the potential for arguments between partners.
In 2011, for instance, global consultant KPMG appointed as its Head of Joint Ventures

225


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Part D International strategy

Dr Marc van Grondelle who stated on the company website that, ‘ In my experience, more
than 80 per cent of joint ventures fail to deliver the value for which they were created’. In
addition to how hard it can be to find an able and willing partner in the first place, tensions
can subsequently arise for a number of reasons, including one side’s sense that the other is

not performing in operational terms; changes in either partner’s strategic goals; and problems of culture, communications, and above all trust, defined as ‘positive expectations of
predictability, reliability, and competence’ (Macduffie 2011). A company that loses faith in
its partner will often try to limit the scope of the cooperation. An example from the early
twenty-first century was when Mitsubishi engineers refused to discuss a new design with
their Volvo partners simply because the latter wanted to introduce changes at the last
minute. Their idea had been a good one but, because the working method was jarring to the
Japanese culture, tempers flared (Manzoni and Barsoux 2006). Once trust has been lost,
it is hard to restore. Managers are human, after all; irrationality is as much a part of international business as rationality.
Many IJVs are born out of a desire to split the costs associated with a new activity but, if
the partners are rivals outside the joint venture, both will be concerned that the other does
not benefit disproportionately. Two relevant examples taken from the automotive industry
in the year 2011 include the announcement by rivals BMW and Toyota of a joint R&D programme looking into a new generation of lithium-ion batteries; and a joint venture in China
between Guangzhou Automobile Group Component Company and a subsidiary of its giant
Canadian rival, Magna International, aimed at allying the former’s knowledge of local
supply chains with the latter MNE’s technical experience. It is not unfair to predict that these
partnerships might face their own peculiar tensions and it should be stressed again that IJVs
have a higher failure rate than other modes of internationalization. This is one explanation
for the rise of international business literature devoted to market entry failures, often
encapsulated in MNEs’ exit and re-entry decisions (see ORC Extension material 9.4).
Because of these problems, there are many situations where MNEs will consider joint
ventures too challenging, and standalone FDI too risky and expensive. In this case, they will
start to consider other, less-committed modes of internationalization.

Case study 9.2
For Chinese joint ventures, the sun sets in the West

China’s development since the mid-1980s is possibly one
of the most dramatic growth trajectories ever witnessed
in international business history. Yet it can be difficult for
MNEs to figure out how to take advantage of this trend.

Sourcing supplies from Chinese exporters is the easiest step
but has certain weaknesses, such as MNEs’ lack of control
over product specifications. Engaging with China on a trade
basis also makes it hard for the MNE to sell into the country
as its consumer markets develop. Hence the decision by
growing numbers of MNEs to invest directly in China.
MNEs must consider how to choose IJV partners in
a country where intellectual property theft and poor
operational performance is rife. When China first

opened up in the 1980s, MNEs often partnered with
agents who had a close relationship with the communist
government. This did not always work, however, since
the two sides often did not view the business world in the
same way. Otherwise, in sectors like banking, foreign
organizations must take a Chinese partner. HSBC’s
presence in China has been constrained, for instance, by
its small 20 per cent stake in BoCom, one of the country’s
largest banks (Sender 2012). To raise its presence from
110 branches currently to 800, HSBC’s CEO may try to
increase this holding substantially.
Nowadays companies tend to choose partners with
complementary interests, as US solar panel maker


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227

Ascent did in 2011 when it licensed its photovoltaic
module manufacturing technology to TFG Radiant
group, a Chinese metal roofing and construction firm.
This course of action can be complicated, however, by
many Chinese companies’ ambition to become global
players in their own right. One potential response is
to adopt a very narrow definition of the cooperation
agreement to avoid any confusion in the future about
whatever innovations the joint venture develops.

in which TFG also took a hefty equity stake in Ascent.
The idea was to create an incentive scheme where it
would be in both companies’ interest to ensure that both
benefit from their long-term cooperation. By 2012, TFG
had boosted its stake in Ascent to 41 per cent, effectively
integrating backwards up the value chain. The lesson is
that international joint ventures need to be analysed not
only in terms of their current operations but also in light
of their overall strategic impact.

To avoid intellectual property conflicts, some analysts
(Bosshart et al. 2010) advise companies to avoid bringing
their newest technology to China, hide detailed design
specifications, and make the local partner pay upfront for
accessing intellectual property. Ascent chose the last of
these routes with its Chinese partner but went one step
further by organizing a cross-shareholding arrangement

Case study questions
1. How will FDI strategies evolve in China over the next

ten years?
2. Was Ascent naive in its partnership with TFG or
is the outcome of their relationship a desirable
one?

Non-equity arrangements
Companies that are hesitant about investing equity capital in a foreign venture can choose
instead to share intangible assets (knowledge, brand name) with a local partner in exchange
for the payment of fees and/or royalties. These kinds of non-equity arrangements, called
licensing or franchising contracts, are a common long-term market entry strategy. Other
strategic alliances, such as turnkey projects or management contracts, tend to be devised on
a more ad hoc basis.

International licensing
There are two ways for firms to enforce private property rights. First, where they own a
particular process or item, they can try to sue anyone copying their intellectual property
without permission to get them to cease such behaviour and, if possible, pay compensation.
Secondly, they can proactively authorize another party to borrow their intellectual property
rights, specifically because this will allow them to enter a foreign market more quickly and
for a lower investment (thus a lesser risk) than if they were acting on their own. The legal
term for this kind of authorization is licensing, materializing in a contract between one
party granting rights (the ‘licensor’) and another party (the ‘licensee’) receiving them,
usually in exchange for the payment of licensing fees and/or royalties.
Licensing contracts typically contain many specific clauses, starting with a precise
definition of the product or process covered in the agreement and including the geographic territory where it applies, the duration, the licensor’s remuneration, and any contract
termination/renewal terms. International licensing agreements apply in many different
areas but are often manufacturing-related. According to the International Licensing Industry
Merchandisers’ Association (), the four leading areas of licensing
are: character and entertainment (replication of figures from movies, television, and so on);
corporate trademarks and brands (for example, Coca-Cola licenses bottlers worldwide to

produce and market its products); fashion licensing (involving the world’s biggest names,
such as Nike, Louis Vuitton, or Gap); and sports licensing (for example, replications
worldwide of Tottenham Hotspur or David Beckham football shirts). In addition to these

+ Turnkey projects
Large projects where
a group of companies,
called a consortium,
bids to win the right
to build an asset
(plant, infrastructure).


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Part D International strategy

headline-grabbing examples, licensing also drives many other international business transactions. A frequent example is when a pharmaceutical MNE makes a discovery and licenses
a rival in another country to market it there, partially because the cost of developing the new
product means that the innovator no longer has sufficient funds to finance its distribution
abroad (see Chapter 11). It is impossible to get an accurate calculation of the total volume of
international licensing agreements at a given point in time. For some companies, however,
this is clearly an enormous source of income. Thus, the world leader in this category, Disney
Corporation, estimated its 2011 global licensed merchandise sales at $37.5 billion. By offering a quick and relatively low-risk way of entering new markets, licensing overcomes some
of the main obstacles to internationalization.

International franchising
Franchising’s rationale and contractual aspects are similar to licensing, but the focus is more

on downstream commercial actions. A ‘franchisor’ signs a contract (‘master licence’) with its
local agent (‘franchisee’), granting the latter the right to operate under the former’s trade
name and distribute its goods or services in a particular territory. To enable the franchisee
to perform this function, the franchisor will typically provide all necessary support, including supplies, training, and advertising. The remuneration it receives in return is based on
royalties, usually calculated as a percentage of the franchise’s gross sales.
Many famous MNEs, often in the retail and fast-food sectors (Starbucks, McDonald’s,
Burger King), have internationalized using this mode because it is quick and easy. Indeed,
franchising is used in many sectors of activity worldwide. The advantage for the MNE is
that it does not need to invest equity capital in overseas commercial outlets and can take
advantage of local partners’ experience in operating outlets and attracting customers. The
advantage for local agents is that they can benefit from the brand name and know-how of
a company with a tried-and-tested business model.

Running licensing/franchising partnerships
In an ideal scenario, an MNE will sign a collaborative agreement with a local partner
and things will run smoothly. Of course, like all foreign ventures, non-equity arrangements
have their downsides. The royalties that the MNE receives may offer significant returns
(especially since it has been able to enter the market without putting up any equity capital)
but are necessarily far lower than the unshared potential profit of a wholly owned subsidiary. Secondly, like all collaborations, licensing/franchising is associated with a number
of networking risks. These include confidentiality (industrial espionage), exclusivity (whether
the partner might open up a rival operation one day), and performance (whether the
materials that the partner uses or the business practices that it implements will harm the
MNE’s reputation).
The question then becomes how to control one’s foreign partners. The contracts linking
MNEs and their local agents must reflect legal conditions in the host country and be enforceable. This is easier to achieve if the MNE has a local presence staffed by individuals with
knowledge of the local environment. In the UK, for instance, McDonald’s has staff members
charged with monitoring local franchises’ performance. This optimizes contract performance but also represents an additional cost for the company.
Above all, the question is how the MNE is going to find a partner it trusts, one that has
useful and compatible business competencies but can be counted upon not to turn into a
rival in the future. At a certain point, companies may decide that no such partners exist—in

which case consideration will be given to the possibility of the company itself taking responsibility for market entry, for example, via greenfield FDI. The net effect would be that the
company would revert to doing in-house (‘internalizing’) the operations that it had hoped to
allocate to external partners under a collaborative arrangement. This is an example of how
an MNE’s market entry possibilities shape its ultimate configuration.


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229
Ibis, the international
hotel company, uses
franchising to grow in
China
Source: Ibis Chengdu
Yongfeng. Photographer:
Fabrice Rambert

Ad hoc non-equity arrangements
When a public infrastructure project (like the Bangkok public transportation system or
the Channel Tunnel) is so huge that no one company has the financial or technical resources
to complete it alone, the contractor or order-giver will often organize a ‘call for tender’
from groups of companies organized into a consortium, inviting them to bid for the contract. Such a consortium will usually have a prime contractor who coordinates the tasks
allocated to each participant. Partners in the consortium are contractually allied, in the
sense that they work on the same overall project. At the same time, their ties are generally
too temporary to justify an investment of equity capital. Once the project is completed,
the consortium will be expected to hand over the keys of a fully functional system to the
order-giver and then disband. This explains why such arrangements are known as turnkey
projects.
By definition, gigantic ventures of this kind are few and far between. There is, however,

every chance that as increasing amounts of capital accumulate in the hands of developing
countries that, by definition, require significant infrastructure investment, turnkey projects
will become a more common mode of market entry. They are already widespread in certain
growth sectors, such as water systems and public transportation.
A final category of non-equity arrangements involves ‘management contracts’, where
companies receive payment in exchange for sending competent staff members to foreign
organizations on temporary work assignments. This mode of entry is relatively widespread
in certain specialist sectors like health care, one example being the way that Johns Hopkins
Medicine International, a subsidiary of a major university in the US state of Maryland,
enhances its income by running a large hospital in Abu Dhabi. Similarly, another US-based
organization (University of Pittsburgh Medical Center) has announced plans to run at least
25 cancer clinics worldwide by the year 2018, leveraging international contracts signed
by its partner General Electric to build relationships with local decision-makers (Glader
and Whalen 2008). Details for all such agreements (fees, ownership structure) will vary
depending on local circumstances. As an entry mode, management contracts are sufficiently
light and flexible to accommodate the diversity required for particular kinds of service
activities.


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Part D International strategy

Challenges and choices
➙ MNEs are challenged by market entry more than by
any other international business choice. One problem is
that many key decisions must be taken without managers
having sufficient understanding of the market being targeted.

This could be resolved with help from a local company
but that raises a new issue of whether the potential partner

is trustworthy or not. Some MNEs view all competitors as
rivals, whereas others focus more on doing whatever it
takes to get the business done. In the absence of a crystal
ball telling international managers which markets are
promising, or which partners are trustworthy, their decisions
will necessarily remain at least partially subjective.

Chapter summary
The chapter started by detailing why some MNEs choose to enter foreign markets via trade
and others through FDI. This decision relates to how much of the global value chain a company wants to occupy by itself and how much it is willing to share with partners. Responses
vary depending on different factors, including company size. The chapter continued with
an analysis of international managers’ varying levels of comfort with investing abroad. The
section concluded with a comparison of vertical and horizontal forms of FDI.
The second section reviewed MNEs’ different modalities for entering foreign markets.
For companies with sufficient resources to make substantial equity investments, one of the
first decisions is whether to build a new greenfield site or acquire brownfield operations, for
example, through international M&A. A related question for larger MNEs is whether to
develop a wholly owned subsidiary or ally with a foreign partner, for example, within an
international joint venture. The chapter ended with a study of non-equity-based collaborative arrangements such as international licensing and franchising. The point was made that,
where companies cannot resolve problems with partners, they might prefer to run their
multinational activities in-house. This begs the question of how such operations are to be
structured. Chapter 10 tries to provide an answer.

Case study 9.3
From Spain to your doorstep: Inditex goes global

Having grown within one generation from a small

provincial company to one of the world’s two largest
clothing manufacturers, Inditex’s internationalization
trajectory deserves close analysis. After an early period
where the company () merely
made clothes, founder Amancio Ortega Gaona decided
on a forward integration strategy in 1975 and opened
up his first Zara brand store in La Coruna in north-west
Spain. His new ‘fast fashion’ concept of ensuring that
changing consumer tastes are quickly reflected in
changing product lines was very successful and within a

decade his commercial brand, Zara, had a chain of stores
throughout Spain. The next step was to look abroad.
In 1988, Inditex opened its first foreign outlet in Portugal.
This choice was very much in line with theories stating
that most managers’ first internationalization efforts are
in a country that is physically and/or culturally close
to their home market. Having gained confidence in its
own ability to operate internationally, Inditex quickly
expanded into the larger retail markets like Paris and New
York that are capable of giving a brand the kind of high


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Modes of internationalization

profile shop window that it needs to gain global visibility.
This process accelerated through the 1990s, although a
variety of approaches were used. On some occasions,
Inditex’s market entry would be based on organic growth,

with the company using its own resources to undertake
downstream FDI in markets defined by strong retail
demand and the absence of significant barriers to entry
(cost, regulation, consumer culture). On other occasions,
Inditex’s growth strategy revolved around the acquisition
of existing outfits, such as Massimo Dutti or Stradivarius.
In 2009, Inditex signed a joint venture with India’s
powerful Tata Group before opening stores in that
country the following year, reasoning that the challenge
of entering this dynamic but complicated emerging
market required greater local input. MNEs may have
a preference for one or the other kind of market entry
mode but it is rare to find one that has not implemented
a combination of different approaches.
By 2004, the Group had opened its 2000th store (in
Hong Kong) and was a recognized high street presence in
most major cities in the developed and, increasingly, the
developing world. There had also been some attempts at
product diversification over the years. For instance, 2003
saw the opening of the first Zara Homes outlet, which
opened its own online store in 2007. 2010 saw Inditex
extend online retailing to its basic Zara products, while
also focusing on the development of a new ‘Strategic
Environmental Plan’. But in general, the group stayed
focused on its initial competitive advantage, based on
quick communications and concentrated production and
distribution transiting through very few logistics centres.

231

While the business model for many other clothing
companies had been based on outsourcing production
to low-cost countries like China, Sri Lanka, Bangladesh, or
Indonesia, Inditex sources more than half of its products
in Spain and neighbouring Morocco and Portugal
(Economist 2012). Its reasoning is that this shorter supply
chain allows the company to react more quickly to
changing customer preferences, allowing the group to
compete on that basis as well as price.
Inditex still has a number of risks to manage in the future,
starting with the fact that in 2011 it achieved 70 per cent
of its €13.8 billion revenues in the European market. This
concentration is dangerous, especially given concerns
that as households spend more and more on energy
and food, they will have less available income for more
discretionary items like the kind of fast fashion clothing
it offers. Hence the group’s decision to accelerate Zara’s
move into Asia generally and China in particular, opening
respectively 179 and 156 new stores there in 2011 alone.
One problem is that unlike the situation in Europe,
Zara clothes are not especially cheap in China, especially
items that need to be shipped all the way from the
group’s main production centres in south-west Europe.
To overcome this problem, the group might consider
adapting its historical model and open up new
production centres in China itself. It could also increase
the proportion of designers it employs in Shanghai
as opposed to the more than 250 working out of its
La Coruna home base. The decision it finally takes
in this respect will depend to some extent on its strategic

philosophy, which might change when Mr Ortega retires
and is replaced by a new CEO who is less focused on the
commercial side of the business and more on its financial
aspects. Like other areas of international business,
decisions relating to the way in which MNEs approach
certain markets depend on the attitudes of the
individuals involved.

Case study questions

Advanced logistics help Inditex to focus its production activities in
fewer locations than most other MNEs
Source: INDITEX

1. To what extent will the market entry decisions of
MNEs like Inditex be planned and to what extent will
they be reactions to sudden opportunities?
2. What are the advantages of Inditex’s particular value
chain organization?
3. Should Inditex change its organization because of the
Chinese venture, and why?


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232

Part D International strategy

Discussion questions

1. Is a ‘global’ mindset necessarily riskier than a ‘domestic’ one?
2. What determines the speed at which a company
internationalizes?

4. What effect will future environmental constraints
have on the choice of greenfield vs. brownfield
expansion?

3. Can SMEs ever be as comfortable with
internationalization as large MNEs?

5. When do the risks of international partnerships outweigh
the advantages?

Online resource centre
Go online to test your understanding by trying multiple-choice questions, and assignment and
examination questions.

Further research
Readers will note that this chapter contains more references than usual from academic reviews,
starting with the Journal of International Business Studies ( JIBS), published by the Academy of
International Business (AIB), a leading association of scholars and specialists in this discipline. This
was intentional. Not only has JIBS been a benchmark review since the 1970s, but the ‘modes of
internationalization’ topic treated here is a key topic for international business authors.
Similar to JIBS is the International Business Review (IBR), a publication by the European
International Business Academy (EIBA), which was founded in 1974 under the auspices of the
European Foundation for Management Development. Both AIB and EIBA are active associations
that, in addition to publishing reviews, organize regular events and themed conferences.
Barber, J. and Alegre, J. (eds.) (2010). Reshaping the Boundaries of the Firm in an Era of Global
Interdependence. Bingley, UK: Emerald Group Publishing Limited

This compilation volume combines two basic themes in international business studies: continued
global interconnectedness, despite the recent financial crisis; and the way in which companies
continue to test new organizational arrangements as they seek optimal international configurations.

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