The four types of international businesses are:
- Foreign Direct Investment (FDI)
Exporting is often the first choice when manufacturers decide to expand abroad. Exporting means selling abroad, either directly to target customers or indirectly by retaining foreign sales agents or/and distributors. Either case, going abroad through exporting has minimal impact on the firm‘s human resource management because only a few, if at all, of its employees are expected to be posted abroad.
Exporting is the practice of shipping goods from the domestic country to a foreign country. This term export is derived from the conceptual meaning as to ship the goods and services out of the port of a country. In national accounts ―exports‖ consist of transactions in goods and services (sales, barter, gifts or grants) from residents to non-residents.
The seller of such goods and services is referred to as an ―exporter‖ who is based in the country of export whereas the overseas based buyer is referred to as an ―importer‖. An export‘s counterpart is an import. In international trade, exporting refers to selling goods and services produced in the home country to other markets. Export of commercial quantities of goods normally requires the involvement of customs authorities in both the country of export and the country of import. Data on international trade in goods is mostly obtained through declarations to customs services. If a country applies the general trade system, all goods entering or leaving the country are recorded.
Licensing is another way to expand one‘s operations internationally. In case of international licensing, there is an agreement whereby a firm, called licensor, grants a foreign firm the right to use intangible (intellectual) property for a specific period of time, usually in return for a royalty. Licensing of intellectual property such as patents, copyrights, manufacturing processes, or trade names abound across the nations. The Indian basmati (rice) is one such example.
When considering strategic entry into an international market, licensing is a low-risk and relatively fast foreign market entry tactic.
Compared to the other potential entry models for foreign market entry, licensing is relatively low risk in terms of time, resources, and capital requirements.
Advantages of licensing include localization through a foreign partner, adherence to strict international business regulations, lower costs, and the ability to move quickly.
Disadvantages to this entry mode include loss of control, potential quality assurance issues in the foreign market, and lower returns due to lower risk.
When deciding to license abroad, careful due diligence should be done to ensure that the licensee is a strong investment for the licensor and vice versa.
A ‗licensor‘ in a licensing relationship is the owner of the produce, service, brand or technology being licensed. And a ‗licensee‘ is the buyer of the produce, service, brand or technology being licensed.
A licensor (i.e. the firm with the technology or brand) can provide their products, services, brand and/or technology to a licensee via an agreement. This agreement will describe the terms of the strategic alliance, allowing the licensor affordable and low risk entry to a foreign market while the licensee can gain access to the competitive advantages and unique assets of another firm. This is potentially a strong win-win arrangement for both parties, and is a relatively common practice in international business.
Example: Due to food import regulations in Japan, the licensor in a company involved in energy health drinks cannot sell the product at local wholesalers or retailers. In order to circumvent this strategic barrier, the licensor finds a local sports drink manufacturer to license their recipe to. In exchange, the licensee sells the product locally under a local brand name and kicks back 15% of the overall revenues to the licensor.
Licenses are signed for a variety of time periods. Depending on the investment needed to enter the market, the foreign licenses may insist on a longer licensing period to pay on the initial investment. The license will make all necessary capital investment such as machinery inventory and so on and market the products in the assigned sales territories, which may consist of one or more countries. Licensing arrangements are subjected to negotiations and tend to vary considerably from company to company and from industry to industry.
The Pros and Cons
Before deciding to use licensing as an entry strategy, it‘s important to understand in which situations licensing is best suited.
- Licensing affords new international entrants with a number of advantages:
- Licensing is a rapid entry strategy, allowing almost instant access to the market with the right partners lined up.
- Licensing is low risk in terms of assets and capital investment. The licensee will provide the majority of the infrastructure in most situations.
- Localization is a complex issue legally, and licensing is a clean solution to most legal barriers to entry. Cultural and linguistic barriers are also significant challenges for international entries. Licensing provides critical resources in this regard, as the licensee has local contacts, mastery of local language, and a deep understanding of the local market.
- While the low-cost entry and natural localization are definite advantages, licensing also comes with some opportunity costs:
- Loss of control is a serious disadvantage in a licensing situation in regards to quality control. Particularly relevant is the licensing of a brand name, as any quality control issue on behalf of the licensee will impact the licensor‘s parent brand.
- Depending on an international partner also creates inherent risks regarding the success of that firm. Just like investing in an organization in the stock market, licensing requires due diligence regarding which organization to partner with.
- Lower revenues due to relying on an external party are also a key disadvantage to this model. (Lower risk, lower returns.)
Franchising is closely related to licensing and is a special form of it. Franchising is an option in which a parent company grants another company/firm the right to do business in a prescribed manner. A‗franchisee‘ is a holder of a franchise; a person who is granted a franchise. And a ‗franchiser‘ is a person who grants franchises.
Franchising differs from licensing in the sense that it usually requires the franchisee to follow much stricter guidelines in running the business than does licensing. Further, licensing tends to be confined to manufacturers, whereas franchising is more popular with service firms such as restaurants, hotels and rental services.
Franchisee will take the majority of the risk in opening a new location (e.g. capital investments while gaining the advantage of an already established brand name and operational process. In exchange, the franchisee will pay a certain percentage of the profits of the venture back to the franchiser. The franchiser will also often provide training, advertising, and assistance with products.
Franchising business is very important to companies here and abroad. At present, the prominent examples of the franchise agreements in India are Pepsi Food Ltd., Coca-Cola, Wimpey‘s Domino, McDonald, and Nirula. In USA, one in 12 business establishments is a franchise.
Franchising enables organizations a low cost and localized strategy to expanding to international markets, while offering local entrepreneurs the opportunity to run an established business.
A franchise agreement is defined as the franchiser granting an entrepreneur or local company (the franchisee) access to its brand, trademarks, and products.
Franchising is designed to enable large organizations rapid access to new markets with relatively low barriers to entry.
Advantages of franchising (for the franchiser) include low costs of entry, a localized workforce (culturally and linguistically), and a high speed method of market entry.
Disadvantages of franchising (for the franchiser) include loss of some organizational and brand control, as well as relatively lower returns than other strategic entry models (with lower risk).
Lower Barriers to Entry
Franchising is a particularly useful practice when approaching international markets. For the franchiser, international expansion can be both complex and expensive, particularly when the purchase of land and building of facilities is necessary. With legal, cultural, linguistics, and logistical barriers to entry in various global markets, the franchising model offers and simpler, cleaner solution that can be implemented relatively quickly.
Franchising also allows for localization of the brand, products, and distribution systems. This localization can cater to local tastes and language through empowering locals to own, manage, and employ the business. This high level of integration into the new location can create significant advantages compared to other entry models, with much lower risk.
It is also worth noting that franchising is a very efficient, low cost and quickly implemented expansionary strategy. Franchising requires very little capital investment on behalf of the parent company, and the time and effort of building the stores are similar outsources to the franchisee. As a result, franchising can be a way to rapidly expand both domestically and globally.
Downsides to Franchising
Franchising has some weaknesses as well, from a strategic point of view. Most importantly, organizations (the franchisers) lose a great deal of control. Quality assurance and protection of the brand is much more difficult when ownership of the franchise is external to the organization itself. Choosing partners wisely and equipping them with the tools necessary for high levels of quality and alignment with the brand values is critical (e.g., training, equipment, quality control, adequate resources).
It is also of importance to keep the risk/return ratio in mind. While the risk of franchising is much lower in terms of capital investment, so too is the returns derived from operations (depending on the franchising agreement in place). While it is a faster and cheaper mode of entry, it ultimately results in a profit share between the franchiser and the franchisee.
4. Foreign Direct Investment (FDI)
Exporting, licensing and franchising make companies get them only so far in international business. Companies aspiring to take full advantage of opportunities offered by foreign markets decide to make a substantial direct investment of their own funds in another country. This is popularly known as Foreign Direct Investment (FDI).
FDI is practiced by companies in order to benefit from cheaper labor costs, tax exemptions, and other privileges in that foreign country. FDI is the flow of investments from one company to production in a foreign nation, with the purpose of lowering labor costs and gaining tax incentives. FDI can help the economic situations of developing countries, as well as facilitate progressive internal policy reforms.
A major contributing factor to increasing FDI flow was internal policy reform relating to trade openness and participation in international trade agreements and institutions.
Foreign direct investment (FDI) is investment into production in a country by a company located in another country, either by buying a company in the target country or by expanding operations of an existing business in that country.
FDI is done for many reasons including to take advantage of cheaper wages in the country, special investment privileges, such as tax exemptions, offered by the country as an incentive to gain tariff-free access to the markets of the country or the region. FDI is in contrast to portfolio investment which is a passive investment in the securities of another country, such as stocks and bonds.
Increase in the inward flow of FDI is a best choice for developing countries. However, identifying the conditions that best attract such investment flow is difficult, since foreign investment varies greatly across countries and over time. Knowing what has influenced these decisions and the resulting trends in outcomes can be helpful for governments, non-governmental organizations, businesses, and private donors looking to invest in developing countries.
Foreign direct investment refers to operations in one country that are controlled by entities in a foreign country. In a sense, this FDI means building new facilities in other country. In India, a foreign direct investment means acquiring control by more than 74% of the operation. This limit was 50% till the financial year 2001-2002.
There are two forms of direct foreign investment: joint ventures and wholly-owned subsidiaries. A joint venture is defined as ―the participation of two or more companies jointly in an enterprise in which each party contributes assets, owns the entity to some degree, and shares risk‖. In contrast, a wholly-owned subsidiary is owned 100% by the foreign firm.
Joint venture is a business agreement in which parties agree to develop a new entity and new assets by contributing equity. They exercise control over the enterprise and consequently share revenues, expenses and assets.
When two or more persons come together to form a partnership for the purpose of carrying out a project, this is called a joint venture. In this scenario, both parties are equally invested in the project in terms of money, time and effort to build on the original concept. While joint ventures are generally small projects, major corporations use this method to diversify. A joint venture can ensure the success of smaller projects for those that are just starting in the business world or for established corporations. Since the cost of starting new projects is generally high, a joint venture allows both parties to share the burden of the project as well as the resulting profits.
Since money is involved in a joint venture, it is necessary to have a strategic plan in place. In short, both parties must be committed to focusing on the future of the partnership rather than just the immediate returns. Ultimately, short term and long term successes are both important. To achieve this success, honesty, integrity and communication within the joint venture are necessary.
A consortium JV (also known as a cooperative agreement) is formed when one party seeks technological expertise, franchise and brand-use agreements, management contracts, and rental agreements for one-time contracts. The JV is dissolved when that goal is reached. Some major joint ventures include Dow Corning, Miller Coors, Sony Ericsson, Penske Truck Leasing, Norampac, and Owens-Corning.