PART FIVE GLOBAL STRATEGY, STRUCTURE, AND IMPLEMENTATION CHAPTER ELEVEN THE STRATEGY OF INTERNATIONAL BUSINESS

OBJECTIVES
To examine the idea of industry structure, firm strategy, and value creation To profile the features and functions of the value chain framework To appreciate how managers configure and coordinate a value chain To identify the dimensions that shape how managers develop strategy To profile the types of strategies firms use in international business

CHAPTER OVERVIEW
Chapter Eleven presents tools and concepts used in analyzing and formulating international business strategy. First, the relationship between industry structure and competition in global industries is examined. Next, value chain analysis is used to identify the internal capabilities of the firm that can be leveraged to create competitive advantage. Effective international strategy depends greatly on the proper configuration and management of a companys global value chain. The sometimes conflicting demands of global integration versus local responsiveness are examined. Finally, a typology of strategic alternatives including multidomestic, international, global, and transnational strategies is presented.

CHAPTER OUTLINE
OPENING CASE: ZARAVALUE CREATION IN THE GLOBAL APPAREL INDUSTRY [See Map 11.1.] Zara, a large clothing retailer headquartered in northwest Spain, has used an innovative strategy to power its global expansion. The company has grown to more than 400 stores around the world with annual sales in excess of $4 billion since its founding in 1975. Zara has made extensive use of information technology and e-business methods to implement dramatic reductions in the time it takes to design, manufacture, and distribute fashionable clothing at moderate prices. Zara has achieved extraordinary speed and flexibility and can take a new design from the catwalk in Paris to its store shelf in New York in as little as two weeks, compared with the industry average of six months. Rather than having seasonal clothing collections, Zara has live collections in which no style lasts more than four weeks. The company purchases much of its fabric not yet dyed so it

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can make color changes quickly during and between seasons. Unlike many of its competitors, Zara produces its most time- and fashion-sensitive products internally. It employs more than 14,000 people in 20 company owned factories to produce about 40 percent of Zaras finished product. These factories are highly automated to control costs and further speed production. Sophisticated distribution centers in Spain, Brazil, and Mexico are used to keep inventory moving efficiently from factory and supplier to store. Most clothes are only in the distribution center a few hours, and none is ever there more than three days. Stores are located in high-profile locations. Store managers and staff choose their merchandise and keep in close touch with local trends. By constantly rotating merchandise, Zara creates a climate of scarcity and opportunity for loyal customers. TEACHING TIPS: Carefully review the PowerPoint slides for Chapter Eleven, as well as the opening case regarding Zara, which is cited throughout the chapter. I. INTRODUCTION This chapter shifts the focus from external factors that exert influence on the international business to internal decision making that helps determine how effectively a given firm competes in its industry. The concepts that anchor managers evaluation of strategy, the tools that support their strategic choices, and the processes that managers use to ultimately convert their analyses into strategies that create superior value in international markets are all examined.

II. INDUSTRY, STRATEGY, AND FIRM PERFORMANCE The industry a company operates in can significantly influence its profitability. As postulated by the industry organization (IO) paradigm, the forces in the MNEs environment that routinely have the greatest impact on its strategy are in its immediate industry and competitive environment. Research indicates that industry effects explain up to 75 percent of the difference in average returns for companies. Despite this influence, significant variation does occur within given industries and companies. Industry structure is not necessarily deterministic of firm performance the quality of both management and strategy also has an impact. The fact that competition is not necessarily perfect creates the potential for a company to convert an innovative strategy into superior competitiveness. Managers must understand what strategy is, the tools that they can use to make it, and the implication of their choices to the performance of their company. A. The Idea of Industry Structure Industry structure can be understood better by modeling the so-called five fundamental forces of an industry. These forces include (1) rivalry among competing sellers, (2) the potential for new entrants to enter the industry, (3) the likelihood that substitute products will be offered by firms in other industries, (4) the push by input suppliers to charge more for their inputs, and (5) the push by output buyers to pay less for products. This model helps managers to understand the industrys potential for profitability, as well as the basis for

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estimating the kinds of strategic moves that companies in the industry are likely to use. A. Industry Change The structure of industries is dynamic, with new products, new firms, new markets, and new managers triggering new developments that impact the five industry forces. Changes in variables such as the long-term industry growth rate, new technologies, new consumer buying and usage patterns, manufacturing innovations, government regulation, and the diffusion of business and technical expertise across countries can all lead to industry change. B. Strategy and Value A great strategy defines the perspectives and tools managers use to appraise the companys present situation, identifies the direction the company should go, and determines how the company will get there. Strategies are ultimately about creating value. Value is the measure of a firms capability to sell what it makes for more than the costs incurred to make it. Therefore, strategy is the efforts of managers to build and strengthen the companys competitive position within its industry in order to create value. D. Creating Value Companies create value either by making their products for a lower cost than any other firm in their industry (the strategy of low-cost leadership) or making those products that consumers are willing to pay a premium price for (the strategy of differentiation). 1. Low-Cost Leadership. This strategy usually targets a broad market and pushes a firm to sell its products either at average industry prices to earn a higher profit than rivals or at lower than average prices in order to increase market share. This strategy is a key advantage in highly competitive industries. Cost leaders are well positioned to withstand price wars in the industry. 2. Differentiation. This strategy requires the development of products that offer unique attributes that are highly valued by customers and demand a price premium. The uniqueness that companies generate must be difficult to copy if the differentiation strategy is to be successful. III. THE FIRM AS A VALUE CHAIN Questions central to the task of creating value include how the company will design, make, move, and sell products; how it will find efficiencies in doing so; and how it will coordinate the decisions in one part of the business with those made in other parts. Thinking of the firm as a value chain provides a strong tool to deal with these challenges. The value chain is a representation of the firm as a series of discrete value creating activities. The value chain has four organizing dimensions (see Figure 11.4): Primary activitiesthose that are involved in the physical movement of raw materials and finished products, the production of goods and services, marketing and subsequent services of the outputs of the business. Support activitiesinclude procurement, technology and system development, human resource management, and firm infrastructure.

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Profit marginrepresents the ultimate purpose of the value chain which is to result in more revenue generated by sales than the costs of the activities that led to those sales. Upstream and downstreamupstream refers to those activities which gather and process the inputs that the company uses to make a product while downstream refers to those activities that deal more directly with the end customer. A. Using the Value Chain A companys competitiveness is determined by how effectively it manages its value chain. Value chain analysis serves to guide managers efforts to build expertise in those value activities that are critical to reducing costs or improving differentiation. Configuration of the value chain refers to the process of dispersing value chain activities to those locations around the globe where perceived value is maximized or where the costs of value creation are minimized. Coordination of the value chain describes the process of integrating dispersed activities into a cohesive, coherent whole. B. Configuration Every MNE looks to establish elements of its value chain in the best spots in the world. Location economies arise when MNEs locate activities in the optimal location for that activity, wherever in the world that may be. Effective configuration is difficult to achieve, however, due to the complexity and dynamism of the international business environment. Conditions that shape how managers configure value chains worldwide include cost factors, business environments, cluster effects, logistics, degree of digitization, economies of scale, and buyers needs. 1. Cost Factors. Differences in wage rates, worker productivity, inflation rates, and government regulations create significant variations in production costs from country to country. In 2003, the average hourly wage for production workers in China was $.80 versus $25.34 in the United States. 2. Business Environment. Companies also configure their value chain to take advantage of favorable business conditions such as lower tax rates, more flexible operating requirements, and public policies or to avoid riskier environments. 3. Cluster Effects. The cluster effect occurs when a particular industry gradually clusters more and more related value creation activities in a specific location. Examples of these clusters are Wall Street for global finance, Silicone Valley for information technology, Hollywood for mass media, Baden Wurttemberg for cars and electrical engineering, and Mumbai for business process outsourcing. 4. Logistics. Refers to how companies obtain, produce, and exchange material and services in the proper place and in proper quantities for the proper value activity. 5. Degree of Digitization. The degree to which an analog product can be converted into a digitized product influences value chain configurations. Processes that were once rooted to a place can now be digitized and moved easily and outsourced or offshored.

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6. Economies of Scale. Economies of scale refers to the decrease in the unit cost of production associated with the increase in total output. Scale economies generally occur in industries with high capital costs and high production volumes, allowing capital costs to be spread over many units of production. 7. Customer Needs. The physical location of activities is often influenced by a need to be close to buyers, especially such activities as distribution to dealers, sales and advertising, and after sale service. Some companies physically locate these capabilities in every country in which they operate. DOES GEOGRAPHY MATTER? Labor Costs and Location Decisions AUTHOR: INFO NEEDED

C. Coordination Coordination is the way that managers connect the discrete activities of the value chain. The task of coordinating the different activities that go into making and moving a product around the world has emerged as the basis of the superior performance that separates good from great MNEs. As seen in the opening case, Zaras strategy of rapid response to ever-changing fashion trends demands lots of coordination in order to succeed. MNEs often try to identify core competencies, unique skills and/or knowledge that is better than that of its competitors, and link these through different parts of the value chain. Examples of core competencies include Procter & Gambles marketing and distribution skills and R&D capabilities or Apples ability to convert innovative ideas into well designed products. A core competency can emerge from various factors such as: Product development Employee productivity Manufacturing expertise Marketing imagination Executive leadership As a companys value chain becomes more globally dispersed, the challenges of coordination increase. Coordinated well, MNEs can leverage their core competencies, using them to boost sales and profits. With poor coordination, MNEs will not be able to transfer even more mundane capabilities and resources from country to country. Several factors moderate managers analyses of how to coordinate value activities. 126

1. Operational Obstacles. Communication challenges resulting from the need to synchronize languages and electronic interfaces can hinder the efficient flow of materials and information. Differences in currencies and measurement systems (i.e., metric vs. decimal) can also lead to breakdowns in coordination. 2. National Cultures. The performance of even the simplest value chain depends on each link meeting a specified timetable. Differences in cultural perceptions of the importance of schedules and deadlines can wreak havoc with tightly timed supply channels. Other conflicts revolving around disagreements about how much and what types of information should be shared with other units within the company and who should take lead responsibility for certain activities are often culturally based and can result in delays, misunderstandings, and inefficiencies. 3. Learning Effects. Learning effects refer to cost savings that come from learning by doing. Managers learn through experience how to transfer best practices from one country to another. Companies learn through experience what approaches work best in different parts of the world. An MNE with a factory in Mexico, for example, might adopt a traditional labor intensive assembly line operation there while a similar operation in Japan may use lean production systems. Differences in capital structures and productivity present challenges of coordination that can only be overcome through experiential learning. 4. Subsidiary Networks. The growing connectivity within and between MNEs, as well as the growth in the number of companies operating internationally, has resulted in an integrated market ecology where ideas can emerge from and easily travel to subsidiaries around the world. Skills, ideas, and technologies can be created anywhere within an MNEs global network of subsidiaries. It is, therefore, becoming increasingly vital that managers are able to identify new sources of value creation within the subsidiary network and transfer them effectively to other parts of the network where they can further enhance value creation. D. Value Chains and Change The configuration and coordination of a value chain responds to changes in customers, competitors, industries, and environments. Because the features and functions of products that consumers judge most critical change over time, the basis of value creation in an industry evolves. POINTCOUNTERPOINT: Value ChainsReal or Virtual? POINT: Value chain analysis has a long history. It was begun in the 1960s and 1970s as a tool for industry planners looking to develop certain industries within a single nation. It has since been adapted to the company level of analysis and is currently used as a powerful concept that helps managers (1) evaluate the companys strengths and weaknesses (2) interpret the determinants of the internal cost structure, the basis of core

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competencies, and relationships with customers and (3) link the internal features and functions of a competitor to the content of its marketplace strategy. This use of the model is rooted in an analysis of the real activities of the firmthe functions and business processes the firm actually performs in moving a product from conception, through its design, its sourced raw materials and intermediate inputs, its marketing, its distribution, and its support to the end consumer. The tractable ideas of real value chains better equip an MNE to deal with the enduring complications posed by geographic, cultural, political, and economic distance between countries. COUNTERPOINT: The recent emergence of the Internet has given rise to the alternative idea of the virtual value chain as the basis of superior value creation and competitive advantage. The internet creates a new basis for value creation through virtual value networks, rather than through static, internally focused chains. Core competencies can be leveraged more flexibly through new paths, letting managers rethink how to capture the benefits of lower search, coordination, contracting, and other transaction costs between people, agents, firms, and institutions. It then becomes possible to outsource many value creating activities to other entities while still controlling the overall process. The relative importance of a real versus virtual value chain depends primarily on the characteristics of a particular companys products and services.

IV. GLOBAL INTEGRATION VERSUS LOCAL RESPONSIVENESS Global and local pressures challenge how the firm configures and coordinates its value chain. On the one hand, firms must often respond to global competitive pressures demanding efficiency and lower cost achieved through standardization and scale economies. On the other hand, local competitive pressures place demands on the firm to customize its products or services to meet distinctive needs country by country. The strategic alternatives available to MNEs are often influenced by the relative strength of pressures for global efficiency and local responsiveness. A. Pressures for Global Integration Global markets produce more than 20% of world output currently, and are projected to increase to 80% of output by 2025. The trend toward rapid economic integration appears poised to continue. Although many factors can explain this trend, the two primary factors behind pressures for global integration are the globalization of markets and the efficiency gains of standardization. B. Globalization of Markets Global buying patterns and company strategies suggest that consumers seek and accept standardized global products. Consumers are searching for products which meet their needs and provide superior value, regardless of where they originate. As communication and transportation infrastructures have become more integrated across borders, consumer preferences have begun to homogenize and companies abilities to meet those preferences on a global scale have increased. The resulting economies of scale translate to even lower prices, higher quality standardized goods, and yet more homogenization of consumer

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demand. More and more goods are being viewed as commoditiestraded on the basis of price, not on differences in quality or features. In global markets, product differentiation is difficult and competition tends toward price wars. C. Efficiency Gains of Standardization Standardization is the process of increasing the uniformity of a product or service by decreasing the extent of variation. Worldwide standardization of an MNEs products, purchases, methods, and policies can significantly reduce the costs of its operations. Standardization is also a powerful means to exploit location economies, since value chain activities can be placed in optimal locations for global production and distribution. Standardization pressures have steadily increased as more countries have joined the global economy in general and the WTO in particular. D. Pressures for Local Responsiveness Consumer divergence and host-government policies are two of the major forces contributing to pressures for local responsiveness. 1. Consumer Divergence. Contrary to the globalization of markets thesis, some argue that differences in consumer tastes and preferences across countries emerge and endure due to cultural predisposition, historical legacy, emergent nationalism, economic prosperity, and other factors. In some industries, like food production, products are unsuitable for standardization and local preferences remain strong. 2. Host-Government Policies. Differences in policies among hostcountry governments contribute to great variability in political, legal, and economic situations in various markets. Policies such as trade protectionism, local content rules, and national product standards require some degree of local responsiveness and counterbalance the policy shifts toward privatization, economic freedom, legal uniformity, and deregulation that encourage standardization. E. Interaction. Pressures for global integration and local responsiveness interact as expressed in the integration-responsiveness grid (Figure 11.5). This grid expresses how a companys choice of strategy is a function of the particular relationship the company sees between its idea of value creation and the corresponding pressures for global integration or local responsiveness in its industry. V. STRATEGY TYPES Generally, MNEs choose from four basic strategies to guide how they will enter and compete in the international environment (Figure 11.6). These strategies correspond to the relative demands for global integration and national responsiveness and include the international, multidomestic, global, and transnational strategies. A. International Strategy. The international strategy emphasizes the transfer of core competencies from the domestic operation to foreign subsidiaries. It allows for limited local customization. Examples of companies using this strategy include McDonalds, Kellogg, Yahoo!, Wal-Mart, and Microsoft. Many critical activities, such as research and development or branding, are usually centralized at headquarters. Some subsidiaries may have latitude to adapt products to local

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conditions, but ultimate control resides in the home office. An international strategy makes sense if a firm has a core competence that local competitors in other markets lack and if industry conditions do not push the firm to improve its cost controls or local responsiveness. The liability of the international strategy is that headquarters central role hinders identifying and responding to local conditions and can lead to missed market opportunities. B. Multidomestic Strategy. Firms following a multidomestic strategy adjust products, services, and business practices to meet the needs of individual countries and regions. Management that chooses the multidomestic strategy believes in responding to the unique conditions prevailing in different markets. This strategy makes sense when the demands for local responsiveness are high and the demands for global integration are low, but there are high costs. The multidomestic strategy leads to widespread duplication of management, design, production, and marketing activities since each local subsidiary must perform each of these activities. Corporate headquarters may have a harder time controlling more independent subsidiaries. C. Global Strategy. A global strategy requires worldwide consistency and standardization in order to be effective. Firms that choose the global strategy face strong pressures for cost reductions but weak pressure for local responsiveness. Operationally, MNEs that adopt a global strategy usually are or aim to become the low-cost player in their industry. This generally requires global-scale production facilities in a few low-cost locations. R&D, production, and marketing activities are also concentrated in the most favorable locations, which may not all be in the same country. Dispersed activities are coordinated by formal linkages, overseen by executives at the centralized world headquarters who standardize practices and processes. Strategic decision making authority resides almost exclusively at headquarters. D. Transnational Strategy. This strategy aims to simultaneously exploit location economies, leverage core competencies, and pay attention to local responsiveness. It is arguably the most direct response to the growing globalization of business. Capabilities and contributions are differentiated from country to country, with an emphasis on learning from various environments and then integrating and diffusing this knowledge throughout global operations. Rather than a top-down (global strategy) or bottom-up (multidomestic strategy) flow of ideas, the transnational strategy champions a flow from the idea generator to idea adopters wherever these may be. LOOKING TO THE FUTURE: New Strategy Types? The changing nature of technologies and regulations that has led to a more globalized business environment has also led to a greater diversity of firms and strategies. In the future, the business world is likely to be populated by a variety of local firms, regional firms, firms that operate in a few countries, firms that operate in many countries, centralized firms, and networks of firms. Questions about the co-location of different places with different types of firms means strategy will emerge from the interplay among

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firms and places. One possibility is the emergence of the metanational as a new type of global corporation that thrives on the process of seeking out uniqueness that it might exploit elsewhere or that might complement its own existing operations. This type of company would build competitive advantage by uncovering and transferring knowledge from many locations around the world. The metanationals value chain would be based on three core competenciesthe capability to prospect for and access untapped pockets of technology and emerging consumer trends from around the world, to leverage knowledge scattered throughout its local subsidiaries, and to mobilize this fragmented knowledge to generate innovations that produce, market, and deliver value on a global scale. Another emerging organizational form is the cybercorp, a company that operates exclusively in cyberspace and is not impacted by the physical geography of lines on a map. Strategically, the cybercorp looks to develop competences that make it ready to react in real time to changes in its customers, competition, industry, and environment. The cybercorp will be built for speed, emphasizing the ability to learn, evolve, and transform in a rapidly changing virtual environment. Whatever new organizational forms and strategies emerge in the future will likely be also firmly rooted in the past. No successful firm can abandon the traditional principles of superior value creation, superb core competencies, and bright management who can articulate clear visions and practical goals consistent with the real and virtual context.

CLOSING CASE: The Globalization of eBay eBay was founded in 1995 and has expanded rapidly in the United States and around the world (see Table 11.1) with net revenues of $3.2 billion and gross margins of 81% in 2004. eBay is a Web-based forum that provides an efficient market for buyers and sellers of products that typically dont have an efficient distribution system because of either information or price inefficiencies. The company is really nothing more than an intermediary software program linking buyers and sellers, charging listing fees, payment fees, and final value fees to its sellers. After establishing a strong base in the United States, eBay has aggressively pushed the idea of global expansion and has developed or acquired local on-line auction sites in more than 20 countries. Overseas markets are seen as having tremendous growth potential, but they do present a number of challenges. Language differences, the lack of widespread Internet access in many countries, cultural attitudes about e-commerce, and government regulations all pose significant obstacles to eBays expansion plans. Furthermore, as eBay has rushed to globalize, it has spent large sums to acquire and develop foreign operations without strong prospects for immediate returns. eBay sees these moves as part of a long term strategy, however, and believes that future growth will justify current investments. The companys lofty vision, according to CEO Meg Whitman, is to transform countries and cities and villages and empower people to make a living in ways they could not before and to create new trade on a global basis that the world has never seen. Whether the company can realize this vision remains to be seen, but it is clear that eBay has already had a transformative effect

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on markets for many products in many countries that is only likely to intensify in the future. Questions 1. What is eBays core competency? How does it relate to their chosen strategy? eBays core competency is in developing and improving software and digital infrastructure tools that lead to the creation of a safe, secure, information-rich on-line trading community. The companys strategy is to allow users to innovate using the tools that it provides, regardless of what they are buying or selling or where they are buying or selling it. How would you explain how eBay has decided to configure and coordinate its value chain? eBay has a very lean value chain, providing only the tools to make transactions possible and letting users do the work of managing transactions. The core technologies eBay uses are centralized, but because of the need to confine shipping of goods to shorter distances, the need to conduct many transactions in local currencies, and the need to list product descriptions in local languages, eBay has decentralized its value chain configuration by developing largely independent country subsidiaries as well. The companys vision may be one of seamless global commerce, but the reality is often one of more isolated single country marketplaces. Would you characterize eBays value chain as virtual or real? Why? Most of eBays value chain is virtual, due to the fact that the company doesnt ever actually handle any of the products that are sold on its sites. eBays entire objective, in fact, is to create a safe and secure virtual community through which tangible products can be traded by users. eBays role in the process is to stimulate, maintain, and strengthen the virtual ties created by users that lead to the real exchange of goods. Consider again your description of eBays strategy. Is it different from what it was ten years ago? Why? eBays fundamental strategy has not changed in the last 10 years. The only thing that has changed is the scale on which that strategy is implemented. eBay has expanded its presence within its core market, the United States, and broadened its operations to a host of other countries as well. The nature of eBays competitive advantage and the processes the company uses to establish and defend those advantages have not changed significantly. What implications to the challenges identified in the case have for eBays strategy today and in the future? The key challenge facing eBay is how to expand both regionally and globally. There is a natural tension between responding to local conditions by making things easier for users in their own country and creating a centralized global marketplace. eBay

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needs to focus on developing more tools that allow sellers in one country to seamlessly interact with buyers in many other countries. This would include further development of automatic translation software and refinements to payment systems that would automatically convert payments from the buyers currency to that of the seller. An even more difficult prospect is how to deal with differences in government regulations across countries. eBay has tried to avoid policing its site for activities that violate local rules and instead has chosen to issue disclaimers and rely exclusively on its sellers to abide by local rules. In a more globalized on-line community, it will become increasingly complex for sellers to understand and follow the wide variety of government regulations that might apply to their circumstances. To continue expansion, eBay will likely have to also develop tools and invest significant resources to help sellers navigate these difficult issues. WEB CONNECTION Teaching Tip: Visit www.prenhall.com/daniels for additional information and links relating to the topics presented in Chapter Eleven. Be sure to refer your students to the online study guide, as well as the Internet exercises for Chapter Eleven. _________________________ CHAPTER TERMINOLOGY: value, p. 380 strategy, p. 380 value chain, p. 381 _________________________ economies of scale, p. 384 core competency, p. 387

ADDITIONAL EXERCISES: The Strategy of International Business Exercise 11.1. Have the students perform a value chain analysis on Zara. Which of Zaras value chain activities create the most value for the company? What are Zaras core competencies? Exercise 11.2. Ask the students to use the five fundamental forces model (Fig. 11.3) to analyze one of the industries listed in the integration-responsiveness grid (Fig. 11.5). Does the pressure for local responsiveness and/or global integration impact the five forces in the industry they selected? Exercise 11.3. Have the students refer to the Fortune Global 500 (http://money.cnn.com/magazines/fortune/global500/). Categorize each of the top five global firms in terms of strategy types (Fig. 11.6). Ask the students to specify what information they would need to make an informed judgment on strategy type for any given company. Have them identify sources for that information.

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Exercise 11.4. Select two large multinational enterprises that are known to the students, one consumer-oriented (e.g., Toyota) and one industrial (e.g., BASF). Then ask students to discuss the pressures for local responsiveness and global integration faced by each firm. Which experiences the greater pull toward local responsiveness? Why? Which faces a greater need for global standardization? Why?

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