INTERNATIONAL

UNIT 1 SECTION 3 MODE OF ENTRY INTO THE FOREIGN MARKET

BUSINESS Unit 1, section 3: Mode of entry into the foreign market

Dear student, you are welcome to Section 3 of Unit 1 of your course manual
on International Business. Thanks for your keen interest so far! In this
Section, we are going to discuss why some firms or enterprises decide to go
into the international market, and how they choose to do this. This is what is
referred to as the mode of entry into the international market. Finally, we
will discuss the advantages and disadvantages of each mode of entry.
But do remind yourself of your basic economic theory that the international
market, like all other markets, is not a fixed place but rather any
arrangement of bringing buyers and sellers together for the exchange of
goods and services at an agreed price. And kindly keep in mind also that
now trading via the Internet is a very big business, which is growing by the
day.

By the end of this Section, the student should be able to:

 Explain why some firms choose to go into the international market
 Discuss their mode of entry into the international market
 Appreciate the advantages of going into the international market
 Examine the disadvantages associated with the international market

Many firms will like to go abroad or international for reasons that can be
categorised as either aggressive or defensive. However, all of these reasons
can be linked in some way to the desire to increase (aggressive) or protect
(defensive) profits, sales, markets, cheaper sources of raw materials, power
or energy, cheap labour, less regulation, and tax incentives all with a view as
to increase profits, or reduce costs.

Reasons why firms go into the international market

To obtain greater profits: The desire of every business is to make profit
for its shareholders or investors. Hence, businesses will go international or
global to increase their total revenue or reduce cost of production thereby
increasing their profit margin.

To gain access to more reliable or cheaper sources of raw materials:

Businesses, especially petrol, chemical, and mining firms, often go
international to get a more reliable and cheaper supply of raw materials than
they can find at home. Such firms are able to produce goods and services
much cheaper abroad than businesses in their home country.

To increase market share: According to Steven Hymer, companies that

expand internationally tend to be “oligopolistic”; that is, they tend to
dominate their domestic market, either because their products are highly
desirable or because their size lets them reap economies of scale. In order to
continue growing, such companies may have to enter the foreign markets so
as to increase their market share globally.

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To rise against foreign competition: Domestic businesses often see

imports invade their market. These importers are a concern because they
take business away from domestic firms. Frequently, a firm will go
international to protect its domestic market when it faces competition from
low-priced foreign importers. By moving part, or all of its production
facilities abroad, such can enjoy the same advantages such as cheap labour,
raw materials, or energy.

To satisfy management’s desire for expansion: Stockholders and

financial analysts expect firms to continue to grow and those companies
operating only in the domestic market have found it increasingly difficult to
sustain that expectation. As a result, many firms have expanded into foreign
markets.

To decentralise operations: Some companies that see themselves highly

centralised in their home countries try to spread their production facilities or
operations around the globe for purposes of decentralisation and
diversification. A typical example is the banking industry

To take advantage of new technology: Still some businesses prefer to go

into the international market just to take advantage of new technologies they
have discovered or innovated. This is more pronounced within the
communication industry

To take advantage of tax havens: Again some businesses go into the

international market in order to take advantage of tax havens that are
specifically created by some countries in order to attract actual and potential
investors.

How do Firms Enter the Foreign Market

An enterprise may enter the international market in many ways, including
exporting, licensing, franchising, contract manufacturing, joint ventures, or
the creation of wholly-owned subsidiaries.

Exporting: Exporting occurs when a business sells its products and

services to customers in other nations. Export companies try to match
buyers and sellers from different countries and provide other services (such
as dealing with documentation and customs regulations) to ease the export
of products to the foreign market.

Licensing: A firm may decide to compete in a growing global market by

licensing through a foreign company. This refers to acquiring the right to
manufacture its products or use its trademark on a fee (royalty) basis.
Licensing can be defined as a trade arrangement in which a producer
(licensor) allows a foreign company (licensee) to use its company’s
trademark in exchange for a fee usually called royalties. Soft drink giant,
Coca Cola, usually uses this method as a means of marketing their products

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abroad. Through licensing, businesses can gain additional revenues from a

product that it would not have normally generated domestically.

Franchising: This is a form of licensing. Franchising agreement is an

arrangement whereby a business (the franchisor) grants another business
(the franchisee) the right to use its name, logo, methods of production, or
advertising and to sell its product or services in a given territory in return for
a financial commitment. The franchisee is mandated to conduct business in
accordance with the franchisor’s standard of operations. Through licensing
and franchising businesses are able to enter foreign markets without
spending large sums of money hiring or transferring expatriates to manage
overseas affairs.

Contract Manufacturing: This involves a domestic company hiring a

foreign company to produce a specified volume of the firm’s product to
specification. The final product bears the domestic firm’s brand name or
trademark.

Joint Venture: It is a partnership agreement among businesses for the

purpose of achieving mutual success in a particular market or industrial
sector, especially to do projects they could not handle alone. An example is
the merger between the two mining companies in South Africa and Ghana
that created Anglo Gold Ashanti.

Turnkey Projects
In a turnkey project, the home contractor agrees to handle every detail of the
project for the host client, including the training of operating personnel. At
the completion of the project, the host client is handed the ‘keys’ to the plant
that is ready for full operation, hence the term, turnkey project. This is
actually a means of exporting process technology from home countries to
hosts countries. Such turnkey projects are most common in the chemical,
pharmaceutical, petroleum and metal refining industries, all of which use
complex, and expensive production technologies.

Creating Subsidiaries: As the size of a foreign market expands, a firm

may want to establish a foreign subsidiary. A foreign subsidiary is a
company that is owned by another company (called the parent company) in
a foreign country. They normally operate like a domestic company with
production, distribution, pricing, and other business functions under the
control of the foreign subsidiary and also observe all the legal requirements
of that country.

Advantages for going into the International Market

The reasons adduced for entering the international market are the same
advantages in themselves such as:
 Increased profits
 Cost reduction

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 Increased market share

 Cheaper sources of raw materials
 Reliable sources of energy

Disadvantages of going into the International Market

Below are some of the disadvantages a business firm may face for entering
into the foreign market:
 Increased transportation cost
 Trade restrictions
 Anti-dumping laws
 Increased operational expenses
 Tall and cumbersome bureaucratic administration
 Thinly spread company resources
 Double taxation of foreign income
 Linguistic barriers in host countries
 Cultural barriers in host countries
 Host government nationalisation of foreign business

The Future of International Business

With the world becoming more inter-dependent and inter-connected,
international business is gradually becoming the norm, rather than the
exception. This has been given much impetus as a result of the numerous
trading blocs or economic integration springing up every now and then. The
latest in line in this connection is BRICS [Brazil, Russia, India, China, and
South Africa]

With the growth in ICT [Information Communication Technology], and the

widespread use of the Internet, the prospects for international business are
very huge and bright. Indeed, sooner than later, most firms would be driven
out of existence if they do not go into the international market via the
Internet

Summary
Dear student, we have attempted to explain the reasons why firms or
businesses go abroad and the mode of entering into these markets. They do
so to obtain greater profit, gain access to more reliable and cheaper
resources, increase market share, rise against foreign competition, or
management’s desire for expansion. Also, there are different methods of
entering into the foreign market and this depends on the company’s goals
and objectives. A company may rely on any of these methods to enter into
the market.

Political changes, especially in Africa, make direct investment risky since

new regimes sometimes nationalise foreign-owned business facilities with
little or no compensation to the original foreign owners. This Section has

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explained the reasons why firms go international, in spite of the risk of

nationalisation, and how they enter into the international market.

Please, refer to other texts in the references provided for further information
on the meaning and importance of this topic. Put down any important notes
you come across in the blank sheet provided below for face-to-face
discussions with your course lecturer.

Now assess your understanding of this Section by answering the following

Self-Assessment Questions [SAQs]. Good luck!

Activity 1.3
 Give three reasons why firms go international
 Explain four ways in which a business can enter into a foreign market.
 What is the difference between licensing and franchising?
 List five advantages of going into the international market
 What is a turnkey project?
 Explain six disadvantages of going into the international market

Did you score all? That’s great! Keep it up.

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