In international business, choosing the right entry mode is essential to maximize the success of your international expansion. How you enter a foreign market is highly dependent on your company’s capabilities and strategy, as well as on your target market. It also depends on the presence of local and international competition, on regulation, on industry specifics etc. This is why having a deep understanding of your target market is very important to your choice of entry mode. Evaluating international market potential can help you grasp the specificities of foreign markets and even guide you in the market selection process.
After choosing the markets offering the most opportunities for your company, you will then have to consider how to enter each of them. There is no one specific mode of entry an organization can adopt to enter into a new international market. In this article we will examine the main entry modes for international expansion, and how companies can determine which one is best for their business model and international aspirations. We’ll also highlight the importance of adapting your international expansion strategy and entry mode choice to suit your target market.
What is a market entry mode?
First of, let us understand the definition of an entry mode to international markets. An entry mode describes a company’s approach to enter a new foreignmarket that has not been targeted by the company before. The process aims at bringing a product or service to a targeted international market. It can also initiate the entry of related business activities, such as technology, human resources, management and other resources to the new target country. It is important to consider that there are several ways of entering an international market. Compared to a new market entry in your home country, in case of foreign market entry, the specificities of the targeted country should be considered when making a decision regarding the appropriate market entry mode.
The main international market entry modes
Depending on the company’s requirements, capabilities and constraints, the idea of the market entry and the favored scope of engagement, risk, control and profit potential, companies choose from many available market entry modes. All these entry modes combine different advantages and disadvantages of what companies should be aware of before making their choice.
Exporting is a common method used by organizations when they first enter a new country. Companies choose this option as it’s low risk and requires less commitment. Export modes can occur in the form of direct as well as indirect exports.
The direct export mode usually occurs when the producing firm takes care of exporting activities and is in direct contract with the clients in the foreign target market. The firm is typically involved in negotiation, contract signature, handling documentation, physical delivery and pricing policies, with the products being sold to final clients.
In case of an indirect export mode, the company sells the products or services in the foreign market via an intermediary. This can be, for example, an export agent, a broker or a trading company that buys the product and then in turn resells it in the foreign target market. This can be useful especially for companies that are short on experience with international trade and that have only limited expansion objectives.
Indirect export is often the entry mode of choice for many small and medium sized companies seeking to enter new markets, at least for markets further away where they may have different cultures, languages and time differences. Apart from more control in the delivery process, the local partner can also play a role in marketing your goods and in aftersale services. It is important to note that through indirect export, the company has limited contact and feedback from its international markets and has a high dependency on the agent and very low control over the market development. That is why our recommendation is for companies not to rush, and to choose very carefully their indirect export partners and view them as a long term relationship.
– Licensing or franchising
Licensing and franchising are both entry modes that require relinquishing some control and working with a local partner.
International licensing is a cross border agreement that permits organizations in the target country the rights to use the property of the licensor. This property is generally intangible and can include trademarks, patents, and production techniques. The licensee is required to pay a fee in exchange for the rights specified in the contract between the parties. Licensing is commonly chosen because it’s low risk, has low exposure to economic and political conditions, has high return on investment and is preferred by some local governments.
Coca Cola is an example of a large multinational that has had success in foreign markets using licensing as their entry mode. Coca Cola works with many bottling companies around the world, which are licensed to use its branding and production processes. Coca-Cola sells ingredients and syrups to these companies that manufacture and distribute the products to consumers in local markets. Whilst licensing has been a very successful market entry mode for many companies, it does also have its limitations. Licensing can reduce the potential profit of full ownership, affect the image of the brand due to lack of control over licensee, and nurture a potential future competitor. The risk of intellectual property theft is also present, and is usually higher for innovative or technologically advanced products.
Franchising is a foreign market entry strategy where a semi-independent business owner (the franchisee) pays fees and royalties to the franchiser to use a company’s trademark and sell its products or services. The terms and conditions of a franchise package vary depending on the contract. However, it generally includes: equipment, operations and management instructions, staff training, and location approval. Franchising is commonly used and a largely successful method of cross border market entry, however organizations pursuing this entry mode need to consider both the positive and negative aspects of franchising.
The most common advantages of franchising are related to its capitalization on an already successful strategy. The franchisee generally also has local knowledge, and the franchiser isn’t directly exposed to risks associated with the foreign market. This also means that the franchiser has limited control on his international operations. Starbucks(USA), Clarks(UK), and Yves Rocher(France) are just a few examples of organizations that have been successful using franchising as their foreign market entry mode.
– Joint venture
The joint venture is a form of strategic alliance where a local company and a foreign entrant agree to share equity in running a partnership together. The equity participation of both companies varies concerning their agreement. Major forms include majority stake, equal stake, minority stake or a controlling stake. A joint venture presents a number of advantages for a foreign entrant. It eliminates the need to start over from scratch in a new territory which could be a risky and a capital-intensive endeavor. The local company’s distribution, manufacturing, and retailing facilities are also leveraged to produce service to the foreign entrant.
The entrant also benefits from the local company’s network and managerial skills in the local market, which allows for focus in producing products suitable for the market. Joint ventures are a complex and sometimes long process that has had many companies avoid them. The complexities are brought about by the need to adapt to foreign market regulations and the process of reaching into agreeable terms with the local company regarding the sharing of stakes. Many countries have regulations that manage the formation of joint ventures between their local companies and foreign entrants, especially when strategic sectors are concerned. The regulations are mostly meant to ensure that the people and the economy of the country benefit from the merger as the joint venture will be using resources from the host country.
Take for instance the asian market, where in some cases it is necessary for foreign companies to form joint ventures with local companies due to the customer specificities and often regulations in the country. This was the case for many automakers that entered the fast growing chinese market through joint ventures. For instance, BMW formed a joint venture with Brilliance Auto Group, a chinese automotive and automotive parts maker, to enter the chinese market in 2003. BMW Brilliance Automotive (BBA) was the name of this new joint venture that will over the years introduce several of BMW’s popular models in China. BMW has decided to consolidate its investments in China by increasing its stake in the joint venture in february 2022 (source: company website). BMW has paid 3.7 billion euros to increase its share in BBA from 50% to 75% and to take control of this joint venture as reported by Reuters.
Another fascinating example is the joint venture between Puig, a Spanish family-owned fashion and fragrance business, and Luxasia, Asia’s beauty omni-channel leader. In 2017, they entered into a joint venture to address Asian markets such as Singapore and Malaysia. (source: companies’ websites).
In some markets, acquiring an existing local company may be the most appropriate entry strategy. This may be because the company has substantial market share, is a direct competitor to you or due to government regulations this is the only option for your firm to enter the market. It is certainly the most costly, and determining the true value of a firm in a foreign market will require substantial due diligence. International acquisitions can get very complicated when it comes to integration, and this strategy is often reserved for larger companies with the appropriate resources to manage an acquisition. On the plus side, this entry strategy will immediately provide you with the status of being a local company and you will receive the benefit of local market knowledge, and be treated by the local government as a local firm.
An acquisition also allows the company to quickly reach an established customer base, which can be very enticing especially in a market with well established competitors. This was the case for Uber Technologies which in 2019 acquired UAE based ride hailing app Careem for 3,1 billion US dollars as reported by Forbes. Careem was the dominant ride hailing service in the middle east and north africa regions, and through this acquisition Uber was able effectively gain access to these markets and to Careem’s customer base, without having to compete with an already established local player.
– Greenfield investment
Setting up a wholly-owned local subsidiary provides the parent company with complete control over sales. It requires a significant amount of investment in both time and money, and is a riskier proposition. The company will enter the new international market by establishing a completely new operation and legal entity. Greenfield investment represents high risk due to the costs and length of establishing a new business in a new country. A firm may need to acquire knowledge and expertise of the existing market by third parties, such as consultants or business partners. This entry strategy takes much more time due to the need of establishing new operations, distribution networks, and the necessity to learn and implement appropriate marketing strategies to compete with rivals in a new market.
Greenfield investment is a long game with many challenges including recruitment, meeting regulations, understanding the nuances of the market and gaining local knowledge. However, it is also a method which provides for complete control of the brand and the highest potential returns.
What are the factors affecting market entry mode choice?
No one market entry strategy works for all international markets. Direct exporting may be the most appropriate strategy in one market while in another you may need to set up a joint venture and in another you may well license your manufacturing. There are a number of factors that can affect the choice of the appropriate entry mode. These include internal factors regarding the firm itself, and external factors related to the target market.
– Internal factors
Internal factors such as company size and available resources are very relevant to entry mode choice. Firm size, whether measured in terms of revenue or number of employees, is an indicator of the company’s resources availability. Although SMEs may desire a high level of control over international operations and wish to make heavy resource commitments to foreign markets, they are more likely to enter foreign markets using export modes. This is because they do not have the resources necessary to achieve a high degree of control or to make these resource commitments.
Another important internal factor to take note of is the company’s international experience. This refers to the firm’s previous experiences in operating in foreign markets and dealing with international clients. This also includes the international experience of the managers and the decision makers themselves, as an experienced team will manage the entry mode selection much differently than a team targeting international markets for the first time. International experience can help the company manage more risks and increase its commitment of resources to foreign markets.
The choice of entry mode will also depend on the company’s products or services. For instance, when it comes to low cost and low margin products, a company might be more inclined to move production to the target market either through a licensing agreement or through a direct investment in the form of a joint venture, an acquisition or establishing a local production subsidiary. This is also the case when there is a need to adapt the product to the local market, which can push companies to work with local partners. In the case of an innovative product, the firm can place a lot of value on retaining full control of its entry and operations in foreign markets. This means that it will less likely go for licensing and joint venture as an entry mode of choice.
– External factors
The size of the market and its potential can lead to different considerations regarding the choice of entry mode. The larger the country and the size of its market, and the higher the market growth rate, the more likely management will be to commit resources to its development. This means that companies might be more inclined to establish a wholly owned subsidiary or to seek an acquisition when entering a large market with significant growth opportunities.
The ease of market access plays an important role in deciding the appropriate mode of entry for each market. Trade barriers and custom duties on the import of foreign goods favor the establishment of production operations locally. Preferences for local suppliers and tendencies to buy local products can encourage a company to consider a joint venture or other contractual partnerships with a local company. The local partner can help in negotiating sales and in developing local contracts and distribution channels. Generally, hard to access markets require the commitment of more resources and leave the company with less flexibility when choosing the appropriate entry mode.
Sociocultural differences between a company’s home country and its target country can create some uncertainty for the firm, which influences the mode of entry desired by that firm. In cases where the target market has significant differences in culture, in product preferences and consumption habits related to the company’s product, it can be helpful to commit more resources to the target market for adaptation purposes. These resource commitments can translate to establishing a joint venture with a local partner that can give insights for a successful adaptation to this new market. For markets that are very similar to the company’s home market where there will be a limited need for adaptation, entry modes requiring less commitment such as export might be favored.
The risks associated with international markets are also taken into account when choosing a mode for market entry. The amount of risk a company faces depends not only on the target market itself but also on the chosen entry mode. A company must properly evaluate country risk before deciding on an entry mode. This would include an evaluation of political, economic and market related risks as well as exchange rate risk. Companies tend to restrict their resource commitments to markets with high associated risks, to limit their exposure to such risks. This is why highly flexible entry modes such as export are favored in these situations, as most companies would be discouraged to commit heavy investment to enter high risk markets.
How to select the right entry mode?
Understanding the internal and external factors affecting the choice of entry more can guide you in selecting the appropriate mode of entry for your international expansion. There isn’t one entry mode that is perfect for every company, every market and every situation. The company must consider various factors to come to a reasonable decision when it comes to entry mode choice. Generally, after selecting the target market offering the most opportunities for your company and products, a deeper analysis of this market and its characteristics should take place. The company should also analyze its internal capabilities and resources, and set clear objectives for what it seeks to achieve in the target market. This analysis should highlight the entry modes that would be more appropriate for the company.
Ultimately, the choice of entry mode will depend on the amount of resources the firm intends to commit to the expansion and the extent it wishes to be operationally involved in the target market. Seeking more involvement and control over its international operations will push the company towards entry modes that require high resource commitments such as greenfield investment and acquisition. While firms looking to be more flexible and that are ready to relinquish some control will tend towards entry modes such as export and licensing. Some firms might even take an incremental approach to market entry, starting with a low commitment mode such as export and then increasing their involvement in the target market. This gradual increase of involvement and investment could lead to an acquisition or establishment of a local subsidiary to seize more opportunities in the target market.
Selecting the most suitable entry mode is an important step in a firm’s internationalization, as this choice can determine the success or failure of a company’s expansion towards a new foreign market. Basing this decision on an extensive evaluation of the available options can help the firm choose the most appropriate entry mode for a specific market. Make sure to also properly evaluate market potential as it can guide you in your choice of the most suitable entry mode.
Kompass can accompany you in your international business project, with decades of experience and a far-reaching international physical network. Kompass’s Market Ranking Report can help you evaluate the market potential of 5, 10 or 20 countries simultaneously, and identify new export markets with the highest potential. This comprehensive and personalized Market Ranking Report can minimize risk, saving time and money, as well as identify new business opportunities abroad.