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chapter 7

Strategies for Competing in International Markets

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Learning Objectives

This chapter will help you

LO 7-1 Identify the primary reasons companies choose to compete in international markets.

LO 7-2 Explain how and why differing market conditions across countries influence a company’s strategy choices in international markets.

LO 7-3 Explain the differences among the five primary modes of entry into foreign markets

LO 7-4 Identify the three main strategic approaches for competing internationally.

LO 7-5 Explain how companies are able to use international operations to improve overall competitiveness.

LO 7-6 Identify the unique characteristics of competing in developing-country markets.

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Globalization has created strong networks of markets, infra- structure, people, minds, jobs, and most of all hope. We must build on these networks and partnerships for inclusive global growth.

Arun Jaitley—Finance Minister of India

Our key words now are globalization, new products and busi- nesses, and speed.

Tsutomu Kanai—Former chair and president of Hitachi

You have no choice but to operate in a world shaped by globalization and the information revolution. There are two options: Adapt or die.

Andy Grove—Former chair and CEO of Intel

This chapter focuses on strategy options for expanding beyond domestic boundaries and com- peting in the markets of either a few or a great many countries. In the process of exploring these options, we introduce such concepts as the Porter diamond of national competitive advantage; and discuss the specific market circumstances that sup- port the adoption of multidomestic, transnational, and global strategies. The chapter also includes sections on cross-country differences in cultural, demographic, and market conditions; strategy options for entering foreign markets; the impor- tance of locating value chain operations in the most advantageous countries; and the special circum- stances of competing in developing markets such as those in China, India, Brazil, Russia, and eastern Europe.

Any company that aspires to industry leadership in the 21st century must think in terms of global, not domestic, market leadership. The world economy is globalizing at an accelerating pace as ambitious, growth-minded companies race to build stronger competitive positions in the markets of more and more countries, as countries previously closed to foreign companies open up their markets, and as information technology shrinks the importance of geographic distance. The forces of globaliza- tion are changing the competitive landscape in many industries, offering companies attractive new opportunities and at the same time introducing new competitive threats. Companies in industries where these forces are greatest are therefore under con- siderable pressure to come up with a strategy for competing successfully in international markets.

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WHY COMPANIES DECIDE TO ENTER FOREIGN MARKETS

• LO 7-1 Identify the primary reasons companies choose to compete in international markets.

A company may opt to expand outside its domestic market for any of five major reasons:

1. To gain access to new customers. Expanding into foreign markets offers potential for increased revenues, profits, and long-term growth; it becomes an especially attractive option when a company encounters dwindling growth opportunities in its home market. Companies often expand internationally to extend the life cycle of their products, as Honda has done with its classic 50-cc motorcycle, the Honda Cub (which is still selling well in developing markets, more than 50 years after it was first introduced in Japan). A larger target market also offers companies the opportunity to earn a return on large investments more rapidly. This can be par- ticularly important in R&D-intensive industries, where development is fast-paced or competitors imitate innovations rapidly.

2. To achieve lower costs through economies of scale, experience, and increased purchas- ing power. Many companies are driven to sell in more than one country because domestic sales volume alone is not large enough to capture fully economies of scale in product development, manufacturing, or marketing. Similarly, firms expand internationally to increase the rate at which they accumulate experience and move down the learning curve. International expansion can also lower a company’s input costs through greater pooled purchasing power. The relatively small size of coun- try markets in Europe and limited domestic volume explains why companies like Michelin, BMW, and Nestlé long ago began selling their products all across Europe and then moved into markets in North America and Latin America.

3. To gain access to low-cost inputs of production. Companies in industries based on nat- ural resources (e.g., oil and gas, minerals, rubber, and lumber) often find it neces- sary to operate in the international arena since raw-material supplies are located in different parts of the world and can be accessed more cost-effectively at the source. Other companies enter foreign markets to access low-cost human resources; this is particularly true of industries in which labor costs make up a high proportion of total production costs.

4. To further exploit its core competencies. A company may be able to extend a market- leading position in its domestic market into a position of regional or global market leadership by leveraging its core competencies further. H&M Group is capitalizing on its considerable expertise in fashion retailing to expand its reach internationally. By 2018, it had retail stores operating in 67 countries, along with online presence in 43 of these. Companies can often leverage their resources internationally by rep- licating a successful business model, using it as a basic blueprint for international operations, as Starbucks and McDonald’s have done.1

5. To gain access to resources and capabilities located in foreign markets. An increas- ingly important motive for entering foreign markets is to acquire resources and capabilities that may be unavailable in a company’s home market. Companies often make acquisitions abroad or enter into cross-border alliances to gain access to capabilities that complement their own or to learn from their partners.2 In other cases, companies choose to establish operations in other countries to utilize local distribution networks, gain local managerial or marketing expertise, or acquire spe- cialized technical knowledge.

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In addition, companies that are the suppliers of other companies often expand inter- nationally when their major customers do so, to meet their customers’ needs abroad and retain their position as a key supply chain partner. For example, when motor vehicle companies have opened new plants in foreign locations, big automotive parts suppliers have frequently opened new facilities nearby to permit timely delivery of their parts and components to the plant. Similarly, Newell-Rubbermaid, one of Walmart’s biggest suppliers of household products, has followed Walmart into for- eign markets.

• LO 7-2 Explain how and why differing market condi- tions across countries influence a company’s strategy choices in international markets.

WHY COMPETING ACROSS NATIONAL BORDERS MAKES STRATEGY MAKING MORE COMPLEX Crafting a strategy to compete in one or more countries of the world is inherently more complex for five reasons. First, different countries have different home-country advan- tages in different industries; competing effectively requires an understanding of these differences. Second, there are location-based advantages to conducting particular value chain activities in different parts of the world. Third, different political and economic conditions make the general business climate more favorable in some countries than in others. Fourth, companies face risk due to adverse shifts in currency exchange rates when operating in foreign markets. And fifth, differences in buyer tastes and prefer- ences present a challenge for companies concerning customizing versus standardizing their products and services.

Home-Country Industry Advantages and the Diamond Model Certain countries are known for their strengths in particular industries. For example, Chile has competitive strengths in industries such as copper, fruit, fish products, paper and pulp, chemicals, and wine. Japan is known for competitive strength in consumer electronics, automobiles, semiconductors, steel products, and specialty steel. Where industries are more likely to develop competitive strength depends on a set of factors that describe the nature of each country’s business environment and vary from country to country. Because strong industries are made up of strong firms, the strategies of firms that expand internationally are usually grounded in one or more of these factors. The four major factors are summarized in a framework developed by Michael Porter and known as the Diamond of National Competitive Advantage (see Figure 7.1).3

Demand Conditions The demand conditions in an industry’s home market include the relative size of the market, its growth potential, and the nature of domestic buyers’ needs and wants. Differing population sizes, income levels, and other demographic fac- tors give rise to considerable differences in market size and growth rates from country to country. Industry sectors that are larger and more important in their home mar- ket tend to attract more resources and grow faster than others. For example, owing to widely differing population demographics and income levels, there is a far bigger market for luxury automobiles in the United States and Germany than in Argentina, India, Mexico, and China. At the same time, in developing markets like India, China, Brazil, and Malaysia, market growth potential is far higher than it is in the more mature economies of Britain, Denmark, Canada, and Japan. The potential for market growth

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FIGURE 7.1 The Diamond of National Competitive Advantage

Firm Strategy, Structure, and Rivalry:

Di�erent styles of management and organization; degree of local rivalry

Factor Conditions:

Availability and relative prices of inputs (e.g., labor, materials)

Related and Supporting Industries:

Proximity of suppliers, end users, and complementary industries

HOME-COUNTRY ADVANTAGE

Home-market size and growth rate; buyers’ tastes

Demand Conditions:

Source: Adapted from Michael E. Porter, “The Competitive Advantage of Nations,” Harvard Business Review, March–April 1990, pp. 73–93.

in automobiles is explosive in China, where 2017 sales of new vehicles amounted to 28.9 million, surpassing U.S. sales of 17.2 million and making China the world’s larg- est market for the eighth year in a row.4 Demanding domestic buyers for an industry’s products spur greater innovativeness and improvements in quality. Such conditions fos- ter the development of stronger industries, with firms that are capable of translating a home-market advantage into a competitive advantage in the international arena.

Factor Conditions Factor conditions describe the availability, quality, and cost of raw materials and other inputs (called factors of production) that firms in an industry require for producing their products and services. The relevant factors of production

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vary from industry to industry but can include different types of labor, technical or man- agerial knowledge, land, financial capital, and natural resources. Elements of a coun- try’s infrastructure may be included as well, such as its transportation, communication, and banking systems. For instance, in India there are efficient, well-developed national channels for distributing groceries, personal care items, and other packaged products to the country’s 3 million retailers, whereas in China distribution is primarily local and there is a limited national network for distributing most products. Competitively strong industries and firms develop where relevant factor conditions are favorable.

Related and Supporting Industries Robust industries often develop in locales where there is a cluster of related industries, including others within the same value chain system (e.g., suppliers of components and equipment, distributors) and the mak- ers of complementary products or those that are technologically related. The sports car makers Ferrari and Maserati, for example, are located in an area of Italy known as the “engine technological district,” which includes other firms involved in racing, such as Ducati Motorcycles, along with hundreds of small suppliers. The advantage to firms that develop as part of a related-industry cluster comes from the close collaboration with key suppliers and the greater knowledge sharing throughout the cluster, resulting in greater efficiency and innovativeness.

Firm Strategy, Structure, and Rivalry Different country environments foster the development of different styles of management, organization, and strategy. For example, strategic alliances are a more common strategy for firms from Asian or Latin American countries, which emphasize trust and cooperation in their organiza- tions, than for firms from North America, where individualism is more influential. In addition, countries vary in terms of the competitive rivalry of their industries. Fierce rivalry in home markets tends to hone domestic firms’ competitive capabili- ties and ready them for competing internationally.

For an industry in a particular country to become competitively strong, all four factors must be favorable for that industry. When they are, the industry is likely to contain firms that are capable of competing successfully in the international arena. Thus the diamond framework can be used to reveal the answers to several questions that are important for competing on an international basis. First, it can help predict where foreign entrants into an industry are most likely to come from. This can help man- agers prepare to cope with new foreign competitors, since the framework also reveals something about the basis of the new rivals’ strengths. Second, it can reveal the coun- tries in which foreign rivals are likely to be weakest and thus can help managers decide which foreign markets to enter first. And third, because it focuses on the attributes of a country’s business environment that allow firms to flourish, it reveals something about the advantages of conducting particular business activities in that country. Thus the diamond framework is an aid to deciding where to locate different value chain activities most beneficially—a topic that we address next.

Opportunities for Location-Based Advantages Increasingly, companies are locating different value chain activities in different parts of the world to exploit location-based advantages that vary from country to country. This is particularly evident with respect to the location of manufacturing activities. Differences in wage rates, worker productivity, energy costs, and the like create siz- able variations in manufacturing costs from country to country. By locating its plants

The Diamond Framework can be used to 1. predict from which

countries foreign entrants are most likely to come

2. decide which foreign markets to enter first

3. choose the best country location for different value chain activities

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in certain countries, firms in some industries can reap major manufacturing cost advantages because of lower input costs (especially labor), relaxed government regu- lations, the proximity of suppliers and technologically related industries, or unique natural resources. In such cases, the low-cost countries become principal production sites, with most of the output being exported to markets in other parts of the world. Companies that build production facilities in low-cost countries (or that source their products from contract manufacturers in these countries) gain a competitive advan- tage over rivals with plants in countries where costs are higher. The competitive role of low manufacturing costs is most evident in low-wage countries like China, India, Pakistan, Cambodia, Vietnam, Mexico, Brazil, Guatemala, the Philippines, and sev- eral countries in Africa and eastern Europe that have become production havens for manufactured goods with high labor content (especially textiles and apparel). Hourly compensation for manufacturing workers in 2016 averaged about $3.27 in India, $2.06 in the Philippines, $3.60 in China, $3.91 in Mexico, $9.82 in Taiwan, $8.60 in Hungary, $7.98 in Brazil, $10.96 in Portugal, $22.98 in South Korea, $23.67 in New Zealand, $26.46 in Japan, $30.08 in Canada, $39.03 in the United States, $43.18 in Germany, and $60.36 in Switzerland.5 China emerged as the manufacturing capital of the world in large part because of its low wages—virtually all of the world’s major manufacturing companies now have facilities in China.

For other types of value chain activities, input quality or availability are more important considerations. Tiffany & Co. entered the mining industry in Canada to access diamonds that could be certified as “conflict free” and not associated with either the funding of African wars or unethical mining conditions. Many U.S. com- panies locate call centers in countries such as India and Ireland, where English is spoken and the workforce is well educated. Other companies locate R&D activities in countries where there are prestigious research institutions and well-trained scientists and engineers. Likewise, concerns about short delivery times and low shipping costs make some countries better locations than others for establishing distribution centers.

The Impact of Government Policies and Economic Conditions in Host Countries Cross-country variations in government policies and economic conditions affect both the opportunities available to a foreign entrant and the risks of operating within the host country. The governments of some countries are eager to attract foreign invest- ments, and thus they go all out to create a business climate that outsiders will view as favorable. Governments eager to spur economic growth, create more jobs, and raise living standards for their citizens usually enact policies aimed at stimulating business innovation and capital investment; Ireland is a good example. They may provide such incentives as reduced taxes, low-cost loans, site location and site development assis- tance, and government-sponsored training for workers to encourage companies to construct production and distribution facilities. When new business-related issues or developments arise, “pro-business” governments make a practice of seeking advice and counsel from business leaders. When tougher business-related regulations are deemed appropriate, they endeavor to make the transition to more costly and stringent regula- tions somewhat business-friendly rather than adversarial.

On the other hand, governments sometimes enact policies that, from a business per- spective, make locating facilities within a country’s borders less attractive. For example, the nature of a company’s operations may make it particularly costly to achieve compli- ance with a country’s environmental regulations. Some governments provide subsidies

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and low-interest loans to domestic companies to enable them to better compete against foreign companies. To discourage foreign imports, governments may enact deliberately burdensome procedures and requirements regarding customs inspection for foreign goods and may impose tariffs or quotas on imports. Additionally, they may specify that a certain percentage of the parts and components used in manufacturing a product be obtained from local suppliers, require prior approval of capital spending projects, limit withdrawal of funds from the country, and require partial ownership of foreign company operations by local companies or investors. There are times when a govern- ment may place restrictions on exports to ensure adequate local supplies and regulate the prices of imported and locally produced goods. Such government actions make a country’s business climate less attractive and in some cases may be sufficiently oner- ous as to discourage a company from locating facilities in that country or even selling its products there.

A country’s business climate is also a function of the political and economic risks associated with operating within its borders. Political risks have to do with the instability of weak governments, growing possibilities that a country’s citizenry will revolt against dictatorial government leaders, the likelihood of new onerous legislation or regulations on foreign-owned businesses, and the potential for future elections to produce corrupt or tyrannical government leaders. In industries that a government deems critical to the national welfare, there is sometimes a risk that the government will nationalize the industry and expropriate the assets of foreign com- panies. In 2012, for example, Argentina nationalized the country’s top oil producer, YPF, which was owned by Spanish oil major Repsol. In 2015, they nationalized all of the Argentine railway network, some of which had been in private hands. Other political risks include the loss of investments due to war or political unrest, regula- tory changes that create operating uncertainties, security risks due to terrorism, and corruption. Economic risks have to do with instability of a country’s economy and monetary system—whether inflation rates might skyrocket or whether uncontrolled deficit spending on the part of government or risky bank lending practices could lead to a breakdown of the country’s monetary system and prolonged economic distress. In some countries, the threat of piracy and lack of protection for intellectual property are also sources of economic risk. Another is fluctuations in the value of different currencies—a factor that we discuss in more detail next.

The Risks of Adverse Exchange Rate Shifts When companies produce and market their products and services in many different countries, they are subject to the impacts of sometimes favorable and sometimes unfa- vorable changes in currency exchange rates. The rates of exchange between different currencies can vary by as much as 20 to 40 percent annually, with the changes occur- ring sometimes gradually and sometimes swiftly. Sizable shifts in exchange rates pose significant risks for two reasons:

1. They are hard to predict because of the variety of factors involved and the uncer- tainties surrounding when and by how much these factors will change.

2. They create uncertainty regarding which countries represent the low-cost manufac- turing locations and which rivals have the upper hand in the marketplace.

To illustrate the economic and competitive risks associated with fluctuating exchange rates, consider the case of a U.S. company that has located manufactur- ing facilities in Brazil (where the currency is reals—pronounced “ray-alls”) and that

CORE CONCEPT Political risks stem from instability or weakness in national governments and hostility to foreign business. Economic risks stem from instability in a country’s monetary system, economic and regulatory policies, and the lack of property rights protections.

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exports most of the Brazilian-made goods to markets in the European Union (where the currency is euros). To keep the numbers simple, assume that the exchange rate is 4 Brazilian reals for 1 euro and that the product being made in Brazil has a manu- facturing cost of 4 Brazilian reals (or 1 euro). Now suppose that the exchange rate shifts from 4 reals per euro to 5 reals per euro (meaning that the real has declined in value and that the euro is stronger). Making the product in Brazil is now more cost- competitive because a Brazilian good costing 4 reals to produce has fallen to only 0.8 euro at the new exchange rate (4 reals divided by 5 reals per euro = 0.8 euro). This clearly puts the producer of the Brazilian-made good in a better position to compete against the European makers of the same good. On the other hand, should the value of the Brazilian real grow stronger in relation to the euro—resulting in an exchange rate of 3 reals to 1 euro—the same Brazilian-made good formerly costing 4 reals (or 1 euro) to produce now has a cost of 1.33 euros (4 reals divided by 3 reals per euro = 1.33 euros), putting the producer of the Brazilian-made good in a weaker competitive posi- tion vis-à-vis the European producers. Plainly, the attraction of manufacturing a good in Brazil and selling it in Europe is far greater when the euro is strong (an exchange rate of 1 euro for 5 Brazilian reals) than when the euro is weak and exchanges for only 3 Brazilian reals.

But there is one more piece to the story. When the exchange rate changes from 4 reals per euro to 5 reals per euro, not only is the cost-competitiveness of the Brazilian manufacturer stronger relative to European manufacturers of the same item but the Brazilian-made good that formerly cost 1 euro and now costs only 0.8 euro can also be sold to consumers in the European Union for a lower euro price than before. In other words, the combination of a stronger euro and a weaker real acts to lower the price of Brazilian-made goods in all the countries that are members of the European Union, which is likely to spur sales of the Brazilian-made good in Europe and boost Brazilian exports to Europe. Conversely, should the exchange rate shift from 4 reals per euro to 3 reals per euro—which makes the Brazilian manufacturer less cost-competitive with European manufacturers of the same item—the Brazilian-made good that formerly cost 1 euro and now costs 1.33 euros will sell for a higher price in euros than before, thus weakening the demand of European consumers for Brazilian-made goods and acting to reduce Brazilian exports to Europe. Brazilian exporters are likely to experience (1) rising demand for their goods in Europe whenever the Brazilian real grows weaker relative to the euro and (2) falling demand for their goods in Europe whenever the real grows stronger relative to the euro. Consequently, from the standpoint of a company with Brazilian manufacturing plants, a weaker Brazilian real is a favorable exchange rate shift and a stronger Brazilian real is an unfavorable exchange rate shift.

It follows from the previous discussion that shifting exchange rates have a big impact on the ability of domestic manufacturers to compete with foreign rivals. For example, U.S.-based manufacturers locked in a fierce competitive battle with low-cost foreign imports benefit from a weaker U.S. dollar. There are several reasons why this is so:

• Declines in the value of the U.S. dollar against foreign currencies raise the U.S. dol- lar costs of goods manufactured by foreign rivals at plants located in the countries whose currencies have grown stronger relative to the U.S. dollar. A weaker dollar acts to reduce or eliminate whatever cost advantage foreign manufacturers may have had over U.S. manufacturers (and helps protect the manufacturing jobs of U.S. workers).

• A weaker dollar makes foreign-made goods more expensive in dollar terms to U.S. consumers—this curtails U.S. buyer demand for foreign-made goods, stimulates

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greater demand on the part of U.S. consumers for U.S.-made goods, and reduces U.S. imports of foreign-made goods.

• A weaker U.S. dollar enables the U.S.-made goods to be sold at lower prices to consumers in countries whose currencies have grown stronger relative to the U.S. dollar—such lower prices boost foreign buyer demand for the now relatively cheaper U.S.-made goods, thereby stimulating exports of U.S.-made goods to foreign countries and creating more jobs in U.S.-based manufacturing plants.

• A …