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Investment Mode of Entry
Welcome friends to the course International Business. I hope you must be enjoying thiscourse and learning at the maximum. So, in the initial lectures – the first three lectures,we discussed about the introduction, and we are still carrying on with it. And we startedalso with the mode of entry, actually what we are now carrying on is the mode of entrywhich started from the 2nd lecture, and the 3rd lecture was also on the same. And today– the 4th lecture also we will continue with the Mode of Entry.(Refer Slide Time: 00:59)So, what we had done in the mode of entry into the international business because as Ihad said earlier also, international business has its own complications right! Thecomplications arise because of the political climate, the cultural climate, the socialclimate, the different habits and all, and the government regulations.So, it is not that easy; it is very complicated. So, how should you enter, how should afirm enter? Why it should enter that is very we have understood, because there is a (youknow) market expansion, there is a need to expand your business, the markets are gettingsaturated in the home markets. So, all these are fine.But how do you enter, how should you enter right! So, in this we talked about twodifferent aspects, one is the trade related aspect which we have covered and thecontractual also we covered right!In trade related, we covered like exporting direct and indirect, then we coverpiggybacking and counter trade which we covered. Then in the contractual we coveredwhat is franchising, licensing, turnkey projects, then management contracts, contractmanufacturing, strategic alliance. And then we had started with the investment entry onwhich we just started with the FDI. And in the last lecture we had just stopped at the FDIok!.So, today we will start from there right! And we will go into the other forms which comeinto the investment mode category right! So, FDI, we all understood why FDI is soimportant because every government today is trying to attract foreigners or foreigncompanies to come into it to raise its employment level, and try to earn better foreignrevenue and all, so that is one thing we discussed. The next thing is which is verypopular as a mode of entry is joint venture.(Refer Slide Time: 02:40)Now, what is joint venture basically? Venture originates from adventure. So, the namecomes from adventure which means new, either market or technology or environment.So, there is a new market, new technology or new environment. So, you are looking at anew thing which you are not much aware of.A joint venture is a binding contract between two venture partners to set up a projecteither in the home country or host country or some third country right! In this case, bothparties are committed to joint risk taking and joint profit sharing. The biggest advantageof joint venture is that both the partners they jointly take the risk and the profit. So, nowthe element of risk is shared right!So, this is this happens true mostly in cases where there are huge investments required,for example, petrochemical, oil refinery. So, there a firm cannot takes the risk becauseyou might try to drill, and then you might not touch oil, so in such a condition it is saferto go for a joint venture right!(Refer Slide Time: 03:46)So, example I have brought is here you can see. Volvo and Uber have announced thatthey would form a joint venture to produce self-driving cars right! So, which is also (youknow) self-driving driverless cars we talk about, which Google is also doing at themoment. Mahindra and Mahindra has recently entered into a joint venture with Renaultto manufacture cars.So, this are some examples, and as I said all these you can see are generally being donewhen it is a capital intensive industry, especially, especially I am saying right!(Refer Slide Time: 04:19)Thus next one is a wholly owned subsidiary. Now, what is a wholly owned subsidiary? Itis a company that is completely owned by another company as the name suggests itself.The company that owns the subsidiary is called the parent company or holding companyright! The parent company will hold all of the subsidiary’s common stock right!Example, let us look! at a popular example.A popular example of wholly owned subsidiary is Volkswagen AG which wholly ownsthe Volkswagen group of America, and its distinguished brands Audi, Bentley, Bugatti,Lamborghini and Volkswagen. So, this is the firm entirely holds the complete subsidiaryall the subsidiaries are completely owned by them.Marvel entertainment which you must be looking at Avengers and all kind of moviestoday coming right, and EDL holding company LLC are wholly owned subsidiary of theWalt Disney company.So, many times we are not aware of this wholly owned subsidiary, the parent companysometimes, we are not aware even of that, but we think of the subsidiaries as a individualbrand, but then they are controlled by somebody else right! Coffee giant Starbucks Japanis a wholly owned subsidiary of the Starbucks Corporation ok!. So, these are some of the(you know) examples where you can learn that a parent company is holding the entirestake of the subsidiary ok!.(Refer Slide Time: 05:49)Understanding a holding company, a company that owns the assets, but does not haveany operations, activities or other activity active business itself right! Johnson andJohnson is the holding company; the subsidiaries are JANSSEN PHARMACEUTICA,Depuy synthes, LIFESCAN, ACTELION, Neutrogena, and ETHICON, so these aresubsidiaries.Sometimes we are not aware of it. Many a times we are not aware, even we ask to thestudents also, we do not know; we think they are different, different companies, butactually there were wholly owned subsidiaries basically right!(Refer Slide Time: 06:28)What are the advantages? The parent organization can exert full control over itsoperations in a foreign nation right! So, all the policies are made and they are controlledright! The parent organization does not require to reveal its technology to others becausethe parent organization looks the whole activities of the subsidiary alone right!There is a cost synergy, because a parent and its subsidiaries could use common financialsystems, share the administrative services and develop joint marketing programs, so thatis an advantage that you have.But as I always say that if there is an advantage, there is also a disadvantage. Now, whatare the disadvantages? Establishing a subsidiary is an expensive undertaking, because theparent organization needs to make 100 percent equity investment in its subsidiary. So,you own it, so to own that you must have you have to put a lot of capital.So, this capital now is a risk right which you have already taken. So, if you have takenthe risk, the fruits are also sometimes are also yours right! So, the parent company alsobears all the risk of its subsidiary. So, some of the subsidiaries if they do not do well, it isthe risk comes to the holding company the parent company.Similarly, say risky proposition, if the subsidiaries do well say then the profit also comesto the holding company, again the parent company. So, these are the advantages and thedisadvantages of the wholly owned subsidiary.(Refer Slide Time: 07:54)So, a firm when it enters into the new market, it the factors that affect is what is the sizeof the firm? It is generally it is more easier if the firm size is large, it is generally easier,and because they have largest international experience there is a correlation betweenthem right!Technological capability are also good with big firm’s right! And similarly the productcharacteristics. So, when you are entering what is the kind of the what is the product youare selling, and how it is acceptable in the whether it is acceptable in the foreign marketsor not, so that thing also counts.What are the external factors? Some of them are only given here not all, but you can takeit. What are they? The cultural distance, now that is a very interesting, what is culturaldistance? How culturally two nations are different from each other, you might begeographically very close, but culturally very different right!Similarly, two different countries at two different distance points could be separatedthrough a distance – high distance, but culturally they might be very similar right! So,cultural distance is a very important factor because it has been seen that many companiesafter merger or there is a joint venture or a strategic alliance, they break down or there isa rift in between them just because of this cultural factors right! So, how youcommunicate, what is your culture, so maybe one culture does not appreciate the other’sculture, so these are the problems.The market size and the growth. So, what is the size of the market you are tapping right,you are trying to tap right, and what is the growth potential. So, if you want to enter intoa new market and that market you think it is untapped, but for a particular productcategory, this is already a very saturated, already saturated in that market, then you donot find much potential right! So, this research has to be done beforehand properly.Country risk is very, very important. Today when you see when there are so much apolitical tensions and things are changing so fast, it becomes very important for all of usto understand the risk that a country holds. Now, there are countries for example,although I do not want to name, but few of them I can say which are always on the radaror they are hot topics of discussion, for example Pakistan, Iran.So, the basically the oil exporting countries, and then in the European also you can findsome of the nations which are always into some (you know) some discussion. So, buthow much risk this country holds, African countries do hold much, so that underdevelopment and the developing ones are always at the in a point of discussion.So, country risk is very important. If I set up a business, I enter into that country, butthen the law is so rigid or something, then I am not able to do something, I am not able toexpand my business. And if I do, I may be taken in a wrong way. So, the point is andsometimes people are put behind bars because of for example India had a very I cancomment because I am an Indian I can talk about Indian policy.So, India at one time when there was FERA (Foreign exchange regulation act). At thattime there was (you know) one case where an Indian company a very importantexecutive of the Indian company right was arrested because of FERA violations, buttoday the same would not have hold true because of the change in policy right, so that isone case.And then legal barriers legal barriers of course, are very, very important because in somecountry what you define bribe may be different in another country. So, it is just a gift.So, how it is how those things are defined? So, corruption, how do you define bribery,corruption and all. So, these are very important right!(Refer Slide Time: 13:03)So, let us see some of the internal factors. Smaller firms have limited financial humanresources at the disposal. While larger firms possess greater productive resources, greatermarket power, greater knowledge and economies of scale. International experience – thefirms potential to project the cost and returns, to gauge the market demand, to assess thecustomer need and to evaluate the true economic worth of the foreign market also helpsright!On the other hand, firms with lesser experience tend to perceive greater uncertainty, andare likely to wrongly estimate the risks and returns. So, many a times the experiencecounts right! If you have a good experience and you can estimate the potential in anothermarket, it helps you and gives to the returns.Firms which poses high R & D capability face greater risk of leaking proprietarytechnology to the rivals. So, technological capability also is an internal factor which alsoimpacts right!Finally, what was the product characteristics we are talking about, product characteristicprovide the firm with the ability to differentiate its product offering from its rivals likedegree of product uniqueness, extent of product establishment, training, needs of salesforce, and the degree of maintenance.When it comes to product characteristics, I will talk about one case which I have writtenmyself about it was a very popular case of Welspun. Welspun fell into a very difficultsituation very recently (on the) .It was a case of product placement where there a towelswhich they said to be made up of very fine cotton, they say the (you know) Egyptiancotton, it was a case that they which was actually not true.And because of this reason, the company Welspun fell into a very difficult situation.There was a case against it; they were sued in the US court. And there was a lot ofdifficulties which was per had to face right! So, this is because they did not understandhow to handle the international business condition in a proper manner right!(Refer Slide Time: 15:03)External, as I said greater the cultural distance between the home and the host country,greater will be uncertainty and greater will be the cost of collecting information andcommunication. Sometimes, it is very interesting to note that what is right in one country(is may not be) may be considered wrong in another country because of the culturalproblems right!Larger the size of the market the greater is the potential for growth. If it is a large market,why is India so popular today, why is everybody eyeing towards India? Because Indiahas a large population base and the economy is growing right! So, every company isthinking that it if it can set a (you know) foothold in India, they would obviously do wellbecause of its sheer size right!Country risk emanates from political and economic factors both of which significantlyinfluence the political attractiveness of a country. Why would anybody go to a countrywhere there is a lot of instability and there is a fear of the company not (being do not)doing well right! For example, in the past Iraq and Iran were very popular for such cases.Legal barriers also I said imposition of tariffs and quotas on the import of foreignproducts and excessive trade regulation encourages local production and will lead thefirm to go for an equity entry mode like wholly owned subsidiary or joint venture. So,for example, you see India for example, I would like to criticize here, it is good or bad,we have to take it in a different taste.But Indian government has been trying to protect the local producers which is fine,because absolutely fine because our country is not so, it is not a developed country, andwe are in the stage of growing; it is absolutely fine we need to support our domesticproducers also.But sometimes (this) what is the limitation, what is the right limit that we need tounderstand. And this sometimes makes it difficult for the foreign firms especially whenin India because of (you know) issues like patent not being (you know) describedproperly, cyber security laws not being described properly, there is a problem of (youknow) legal problems that arise when firms come to India.Many a times it has been seen that the (firm) drug manufacturers, they find that theirproducts are being copied and they can do nothing because the laws does not supportthem right ok!.(Refer Slide Time: 17:20)So, this is a mode of entry. So, there are two things which is very important you can see.On the ‘x’ axis, we have taken the degree of ownership and control; and in the ‘y’, wehave taken the extent of investment and risk right! So, on basis of these two factors, wehave tried to divide the various modes of entry in terms of the ownership and risk right! –investment risk.So, basically if you see exporting comes at the low, right! that means, investment risk islow and ownership is also low. And maximum wholly owned subsidiary the investmentis high risky (and) but the ownership is also very high, that means, 100 percent ok!, youare seeing 100 percent right the parent company holds all that is risk. So, these are thedifferent conditions.Strategic, joint venture also falls in a similar condition where the degree of ownership issuitably high, investment risks are also high. So, they are basically as I said capitalintensive industries – oil exploration, drilling, etc., shipbuilding and all right! And if youlook at the other cases for example, licensing, franchising, they relatively come under thelow or degree of ownership, and low investment risk right!So, these are some of the, and there are other things also which are explained – theGreenfield acquisition, and FDI equity based, and all these things explained. What doyou can do is just go through this diagram and try to understand, and try to place theother modes of entry that (you have been just now just now) we have discussed, try toplace them in the according to the ‘x’ and ‘y’-axis right according to their coordinatesok!.(Refer Slide Time: 18:53)Now, this is a case study which I have brought for discussion. Today as in this class, wewill be discussing this case study. This is a real case study. So, first I will discuss thecase; and after we discuss the case I have two three questions which I have set up, andthen there are possible answers right! What we will do is first you go with me throughthe case.So, this is a case of Indian Oil Corporation – IOC has formed a wholly owned subsidiaryin Mauritius right, Indian Oil Mauritius Limited with a huge projected investment. Thecompany is setting up a state-of-the art bulk storage terminal at Mer Rouge to stock 24thousand Metric tones of vital petroleum products, auxiliary and bunkering facility and25 modern petrol and gas stations ok!.It is in the process of building infrastructure for storage, bottling and distribution ofIndane, LPG and market servo lubricants in Mauritius. Besides, IOC also has found awholly owned subsidiary in Sri Lanka right! One is in Mauritius; the other is in SriLanka known as Lanka IOC Private Limited.Now, this LIOC Lanka Indian Oil Corporation took over 100 retail outlets owned byCeylon Petroleum Corporation which is their local in February 2003. It is the onlyprivate owned company besides the state owned Ceylon Petroleum Corporation thatoperates retail petrol stations in Sri Lanka. Building and operating storage facilities atTrincomalee tank farm, LIOC is involved in bulk supply to industrial customers. So, thisis the basic case study right! It is this small case let in fact; it is not a case studies case letright!(Refer Slide Time: 20:42)So, let us continue. In order to facilitate operations, Lanka Indian Oil Corporation, theGovernment of Sri Lanka has extended the following concessions. Now, this is how youattract the foreign players.A tripartite agreement signed between the Sri Lankan Government, CPC and LIOCguarantees that only three retail players including these two will operate in the SriLankan market for the next 5 years. So, 2003 to 2008. LIC has also been allowed incometax exemption for 10 years from the date of commencement of operations, and aconcessional tax of 15 percent thereafter against the prevailing rate of 35, so 35 plusanother 15.Indian oil subsidiary has also been granted customs duty exemption for import ofproject-related, plant, machinery and equipment during project implementation periodfor a 5 years, besides free transfer of dividend income to India. Now, the government has(done) taken some action, some kind of strategy build up, some policies strategies toattract (you know) people or different countries firms to come to their local country, hostcountry and set up their business right!(Refer Slide Time: 22:05)Now, (this question), there are three questions. First, evaluate the factors affecting IOCselection of the entry mode. Now, the government has attracted, but the company has itsown choice right! Which mode of selection should they use? Second question, if a singleentry strategy need to be adopted, which one would be a better strategy? And why?Right!, third, in view of the emerging economic and political scenario, evaluate IOCsentry into Sri Lanka as a Wholly Owned Subsidiary.So, what I am doing is, I am leaving you with these questions now for a second right!What you do is, you close this or take a pause, and you try to first answer them, and thenI will go through my answers right! So, (what) this is a real case study as I said, so whathas happened let us see. So, for one question, we have the real answer. And for othersthere are hypothetical which I felt; and then you might also have your own opinion itthrough differ from mine also. So, no issues right, but you need to justify why.(Refer Slide Time: 23:06)So, let us evaluate the factors affecting IOC selection of this entry mode. What are thefactors? First is growth and profit, mitigation of risk, cost of R & D, product portfolioexpansion, and modern technology right! So, what was the first question? Evaluate thefactors affecting IOC selection of the entry mode. So, we said so these are the factorswhich we are looking into to decide what IOC should do, how you should enter into theSri Lankan market right!So, the answer for the second question is, if a single entry strategy need to be adoptedwhich one would be a better strategy? And why? So, what they did was they adopted theturnkey projects strategy (need to be adopted). Why? Economic incentive, first there arethree points, there are some points let us see. The profits in the turnkey project are veryhigh. As IOC had low cost operation exporting oil and related products waseconomically effective.Second – operation considerations, physical infrastructure is poor also the governmentwants to develop skill set in their nation with the help of outside companies right! Third– political consideration, the government and their policies must be favourable forturnkey project. The level of competition is also low. So, what happened here is thegovernment use that the IOC use a turnkey project method to enter into this market right!Now, the third question which is asked to you is in view of the emerging economic andyou might (you know) for the second, you might have another answer, but I gave you theanswer which is which has happened right! In view of the emerging economic andpolitical scenario today, let us talk about today, evaluate the entry into Sri Lanka as awholly owned subsidiary.What would have happened if the company would have used the wholly ownedsubsidiary method? So, (you know) recently Sri Lanka has you gone through someturmoil and the there is a lot of political instability which happened right!(Refer Slide Time: 25:07)So, in view of the emerging economic and political scenario, evaluate IOCs entry into SriLanka as a wholly owned subsidiary. So, the following conditions will have to take intoaccount. Human rights violation can affect the operations of LIOC in Sri Lanka whichwould further hamper the growth, (first) right! There would be there is a violation ofhuman rights, so that would affect maybe the company right!Economically any bad sentiment between the two countries which between let us sayIndia and Sri Lanka can result in economic losses right for IOC. Leverage therelationship between the two countries. Finally, it will compensate the current accountdeficit losses due to high cost inputs right!So, the third question which (asked) was asked was in view of the emerging economicand political and economic scenario evaluate its entry. So, we have done a small analysison that right! So, this is something we did. And we now have analyzed the case-let in ourin my own way I have done it. So, you might differ, you can have your own argumentand also put in your opinion right!(Refer Slide Time: 26:20)Now, this is one more which I have brought for your as a homework. You can take it anddiscuss with your friends and your maybe your family, or teachers, and come out withsome solution. This is a case-let in which we are saying Mahindra and Mahindra as amajor player in the tractor and certain segments of the automobile market in India. Afteran impressive growth for a few years, the tractor market in India has been stagnatingright! M & M has been selling its tractors and utility vehicles in foreign marketsincluding USA.Some of the components for its products have been sourced from abroad. M & M has ahundred percent subsidiary in US, Mahindra USA with a strong network of 100 dealers.Mahindra has a 5 percent market share in the US market in that 20 to 30 horsepowerrange. As a part of the strategy aimed at building a global supply chain, Mahindra USAhas signed a MoU with the Korean tractor major Tong Yang a part of the 2 billionMoolsam group right!According to which Mahindra will source high horsepower mostly in the 25 to 40horsepower range and sell them around the world under the M & M brand name. To startwith the premium range of tractors will be sold in the US, and M & M’s current tractorrange is more utility-oriented, at the current at the moment what they are selling is moreutility-oriented and lacks the aesthetic appeal the Tong Yang’s tractors have, a must for astrong presence in the US market.(Refer Slide Time: 27:48)So, now the questions are, what are the advantages and disadvantages of globalsourcing? How will the foreign market expansion help M & M? How does the strategicalliances with Tong Yang benefit M & M? What are the possible risks of the alliancehow can they be overcome or minimized?So, I am not giving any answer for it right! This is where I am ending. So, what you cando is you can go through the case right, you can even discuss the earlier cases (so) IOCcase, and now discuss this case let, and find out a solution what you would have donehad you been in this case right!So, this will if you do this, this will give you a very clear picture of what internationalbusiness comprises of, what are the different modes of entry, how should you enter intodifferent markets, and what how should you evaluate the economic and political scenarioof the various regions, and what is the best alternative that is possible in your hand rightat that moment. So, this is all we have for the day right!Thank you very much. I hope you have got some idea a little more idea about what youhad initially about entry’s (into you know) the modes of entry into foreign countries. Andif I come if you compare today might be you are little you have added a little bit of moreknowledge to yourself. So, I wish you all the luck.Thank you so much.