CHAPTER 9

International Strategy

LEARNING OBJECTIVES

Studying this chapter should provide you with the knowledge to:

1. Discuss the globalization of business. 4. Explain the three primary types of international strategy
and be able to use the international strategy triangle
2. Explain why firms choose to expand internationally.
to determine which international strategy is right for a
3. Describe different kinds of distance and how they specific firm.
affect successful international expansion and how
5. Explain when a firm should use each of four major ways
this affects the choice of where firms should go when
to enter a foreign market.
they expand.

Lincoln Electric Learns Some Difficult Lessons

objects together, known as welding consumables. Yet, in the last

20 years, Lincoln Electric captured the majority market share in the
United States competing against such big-name firms as GE. It then
went on to capture the largest share of the welding equipment and
Paco Navarro/Blend Images/Getty images

consumables market in the entire world. Lincoln currently manu-

factures in 20 countries and has distributors and sales offices in
more than 160 countries worldwide.1 Not bad for a Cleveland, Ohio-
based manufacturing company.
Lincoln’s success is often attributed to the way it pays its
workers. Management believes that the way it compensates its
workers maximizes their incentives to be productive. The three
­cornerstones of the company’s compensation policy are:

1. Piecework:2 Workers’ pay is based on the number of pieces

they produce rather than the number of hours they work.
2. Year-end bonuses: Big bonuses at the end of the year, based
on personal evaluations and company performance, can often
double workers’ yearly earnings.
Lincoln Electric is one of the most celebrated companies in US his-
3. Guaranteed employment:3 Since 1951, Lincoln Electric has
tory. Business schools across the entire world have made it the
promised not to lay off employees, no matter how difficult
No. 1 case study about how companies manage their workforces. At
things become, a promise the company has kept to this day.4
first glance, it seems odd that Lincoln Electric should be so famous.
Unlike Apple or Exxon, it doesn’t have the highest market capi- Lincoln Electric’s success story has not been free of trials. In
talization. Unlike Facebook or Google, it isn’t in an industry that fact, the first time Lincoln Electric decided to expand internation-
is fashionable or that innovates quickly. Lincoln makes welding ally, it nearly killed the company. From the mid-1940s until 1986,
machinery and the sticks of metal that welders melt to bond two Lincoln Electric was primarily a US firm. Nearly all production

152
    The Globalization of Business  153

occurred in Cleveland. The company had opened plants in Can- company, they used a hands-off policy and weren’t aware of
ada, Australia, and France shortly after World War II, but these exactly why things weren’t working. When Lincoln’s CEO retired in
were mostly autonomous units. However, from 1986 to 1992, the 1992, the new CEO was handed the reins to a company in which
company—fearing a slowdown in the US market and seeing for- losses in the foreign units had become so huge that Lincoln Electric
eign competitors grabbing market share in the United States— had to borrow money for the first time in its history. The company
embarked on a period of rapid international expansion. then nearly defaulted on its bank loans—twice—surviving only by
During those 6 years, Lincoln Electric went from little inter- begging the banks for more generous terms. Twice, Lincoln had to
national presence to buying or building three overseas plants per borrow money to pay the year-end bonuses that were so critical to
year. Lincoln acquired and built a plant in Venezuela, acquired its competitive advantage.
existing plants in Mexico, Brazil, Scotland, Norway, the United To fix the foreign operations, the new CEO moved to the
Kingdom, the Netherlands, Spain, and Germany, and built a plant United Kingdom and spent more than a year personally oversee-
in Brazil and three in Japan, among others—a total of 17 plants in ing the plants in Europe. He broke local unwritten cultural rules
15 countries. None of the top management team, however, had any about taking market share from other local companies by aggres-
international experience. The company bought plants intending to sively selling Lincoln Electric US-branded products at trade shows
rely on the existing plant managers’ local knowledge. Lincoln also and in every other venue he could introduce them. He also broke a
decided to use the local brands of the plants it bought, because long-standing Lincoln Electric policy of promoting managers from
local managers had assured Lincoln’s executives that Europeans, within the company. Instead, he worked to lure key managers from
in particular, would not buy US-branded products. other US firms that had significant international experience. He led
Lincoln’s leaders had hoped to install the renowned Lincoln the company to close plants in Germany and Japan—despite hav-
Electric incentive system in each of its new international plants. ing just bought or built them—and rationalized production in the
However, none of the foreign units implemented the system. Lin- remaining plants, so that each was manufacturing a different prod-
coln’s managers were not aware that many local laws forbid parts uct, rather than competing with other Lincoln plants.
of the Lincoln system. In some locations, local management and By the middle of 1994, Lincoln had turned things around. Its
workers didn’t see its value. None of the foreign units except Can- foreign operations had become profitable as outlined in Table 9.1.5
ada and Australia, the older ones, turned out to be profitable. Since then, the lessons the company learned have been applied
Top management in Cleveland knew that the foreign units over and over, with great success, leading to Lincoln’s current posi-
were struggling but, not having experience running a multinational tion as market leader in many countries around the world.

TA B LE 9 .1    Lincoln Electric Income (in US $millions)

1987 1988 1989 1990 1991 1992 1993 1994

United States 49.9 55.9 53.0 28.2 30.8 24.9 42.6 71.7

Europe 1.5 3.1 4.4 2.1 −14.4 −52.8 −68.9 3.9

Other regions 1.3 2.0 −0.6 −6.8 −2.9 −7.2 −22.9 5.5

Total 52.7 61.0 56.8 23.5 13.5 −35.1 −49.2 81.1

This chapter will help you to answer three critical questions about strategy, specifically
concerning international expansion: Why, Where, and How. Carefully researched and thought-
ful responses to those three questions can make the difference between a successful expansion
effort and failure, or near failure, like Lincoln experienced.

The Globalization of Business

During the last 50 years, the scope of business has changed for most organizations. Com-
panies used to compete primarily within their own country. Technological advancements in
communications and transportation, along with falling trade barriers, have changed that for
most firms. The average tariff, the tax on goods imported into a country, dropped from more
154  C H A PT E R 9   International Strategy

than 40 percent to an average of 4 percent in developed nations. At the same time, countries
across the globe repealed regulations that kept foreign firms from buying local companies
and building plants and stores in their markets. As a consequence, the volume of interna-
tional trade and companies selling across national borders, has increased more than 28-fold
since 1970.
International trade in merchandise alone topped $12 trillion last year.6 During the same
foreign direct investment  Direct period foreign direct investment (FDI), companies building factories and stores in foreign
investment in production or countries, increased more than 500 percent (see Figure 9.1).7 Although there is no consensus on
business in one country by a why FDI flows to some countries and not others, common factors include low labor and tax
business from another country.
costs, low trade barriers, and favorable exchange rates.8
This trend toward increased international trade has allowed organizations to place parts of
their value chains in different countries, depending on where each part can generate the most
value. Manufacturing, as well as service industries, has become global. Trade in commercial
services, such as licensing and franchise fees, as well as other types of services such as finan-
cial, information, computing, insurance, and consulting services has increased 272 percent just
in the last decade, totaling more than $4.8 trillion in 2015.9
What this means for strategy is that both production and the market for many products
and services isn’t national anymore—it’s regional (a part of the world) or global.10 For most
industries, the competition isn’t just local or national anymore, either—it’s also global, and key
competitors may be located in another country. Indeed, the World Trade Organization says that
multinational firms  Firms half of all the productive wealth in the world is generated by multinational firms that compete
that sell or produce in multiple with an international strategy.
countries. Even for small companies, international strategy is the key to success. Of the more than
408,000 US firms that competed across borders in 2014, 98 percent were small to medium-sized
firms.11 Companies that do international strategy right tend to dominate both at home and
throughout the world. Most organizations that hope to be leaders in their industry realize that
they have to compete on a global scale.12 Indeed, for many c­ ompanies, even basic survival is
predicated on a clear understanding of international strategy.
Of course, competing on a global stage isn’t just about protecting oneself from foreign
competition. It also opens up tremendous new opportunities13 although these new opportu-
nities come with an exponential increase in complexity. Just ask the top management team at
Lincoln Electric. Some of the differences between countries that increase complexity and affect
the success of international strategies include variations in:

•  Customer tastes, needs and income levels

•  Government regulations
•  Legal systems
•  Public tolerance for foreign firms
•  Reliability, and even existence, of basic infrastructure, such as roads and electricity
•  Strength of supporting industries, including distribution channels to customers

2500000

2000000

1500000

1000000

500000

0
19 0
19 1
19 2
19 3
74

19 5
19 6
19 7
78

19 9
19 0
19 1
19 2
19 3
19 4
19 5
19 6
19 7
88

19 9
19 0
91

19 2
19 3
94

19 5
96

19 7
19 8
99

20 0
01

20 2
20 3
04

20 5
06

20 7
08

20 3
20 9
20 0
20 1
12

14
20 015
t
es
7
7
7
7

7
7
7

7
8
8
8
8
8
8
8
8

8
9

9
9

9
9

0
0

0
1
1

1
19

19

19

19

19

19

19

20

20

20

20

20
20

16
2

FIGURE 9.1    Global Foreign Direct Investments, 1970–2016 (in 2016 US. dollars)
Source: UNCTAD, Inward and outward foreign direct investment flows, annual, 1970–2016 and OECD FDI in Figures, February 2017.
    Why Firms Expand Internationally  155

This chapter addresses the complexity of international strategy by answering three ques-
tions strategists ask when thinking about going international:

1. Why should we go international? What advantages might we gain?

2. Where should we expand? Of all the countries we could enter, which are the right ones?
3. How should we expand? What international strategy should we employ? How can
we tell if we have the right one? And, what strategic options do we have for entering a
foreign country?

One thing to keep in mind as you read this chapter is that many of the concepts actually
apply to geographic expansion within a country as well as international expansion. We focus
the chapter on international expansion because the complex issues behind a successful expan-
sion strategy are magnified exponentially when you cross international borders.

Why Firms Expand Internationally

There are a number of reasons why firms choose to compete in international markets. These
include increasing sales to grow the company beyond what the home market can offer, becom-
ing more efficient (raising profits by lowering costs), managing risks better, learning from con-
sumers in other markets, and responding to the globalization moves of other firms. globalization  The spread
of businesses across
national borders.
Growth
The need to grow sales is one of the biggest reasons that firms expand internationally.14 Some
firms have saturated their home markets, and entering foreign markets is the only way for them
to sustain growth. This is one of the primary reasons that Harley-Davidson started selling in
foreign markets. It now sells in Europe as well as Asia and the Middle East. Figure 9.2 shows
just how important that foreign expansion has been. When unit sales in the US market have
softened, sales overseas have continued to grow, mitigating Harley-Davidson’s profit loss in the
US market.

Efficiency
Many firms enter additional markets in order to become more efficient. Efficiency takes a num-
ber of forms, including obtaining lower-cost resources, extending the lifespan of products, and
achieving economies of scale and scope.

Lower-Cost Resources  In many cases, key resources may be cheaper in foreign coun-
tries. One of the most common resources firms seek abroad is low-cost labor, which is often
referred to by the buzzwords offshoring or outsourcing. Firms may also expand abroad in search
of lower-cost sources of raw materials.15 For example, the United States is seeing an increase in
foreign companies opening new plants in the United States to take advantage of cheap natural
gas made available through hydraulic fracturing technology, known as fracking.
Beyond looking at the price of a particular resource, though, companies also have to take
into account factors that might increase the cost to use the resource, including labor produc-
tivity, and the transportation and communication costs needed to acquire the resource. More-
over, companies must also consider a variety of other costs of doing business in a particular
country, such as regulations and the challenges of managing in a different culture. Companies
tend to seek an optimal location for expansion, not just the one with the lowest cost resources.
For instance, although sub-Saharan Africa has the cheapest labor in the world, China’s abun-
dance of relatively skilled and productive cheap labor, coupled with excellent communications
and transportation infrastructure and a relatively stable political climate, made it the target
156  C H A PT E R 9   International Strategy

Harley-Davidson Unit Sales: 2008-2016 US vs. Foreign Sales

250000

200000

150000

Unit Sales
100000

50000

0
2008 2009 2010 2011 2012 2013 2014 2015 2016 est.
US Sales Foreign Sales

Harley-Davidson % Change in Unit Sales: 2008-2016 US vs. Foreign Sales

20
15
10
5
% Change in Unit Sales

0
2009 2010 2011 2012 2013 2014 2015 2016 est.
–5
–10
–15
–20
–25
–30
–35
US Change Foreign Change

FIGURE 9.2    Harley-Davidson US and Foreign Sales 2008–2016

Source: (1) Anonymous. December 9, 2015. “Harley-Davidson is Taking Steps to Reverse Its Declining
Sales Trends,” Forbes.
(2) Anonymous, January 28, 2016. “Harley-Davidson Reports Fourth Quarter and Full-Year 2015 Results,”
PRNewswire.
(3) Anonymous. September 13, 2016. “Tough Times Ahead in the Domestic Market,” Forbes.

of choice for many firms for decades. Then China’s labor costs began to rise, and countries in
Southeast Asia began to develop sufficient infrastructure with labor cheaper than China’s, mak-
ing that region more attractive.

product’s life cycle  The stages a Longer Product Life  Sometimes firms enter foreign countries to extend a product’s life
product or service goes through cycle, leveraging their investment in assets and equipment.16 For example, in Chapter  2 we
during its lifespan. introduced the plight of Nokia, a one-time world leader in the cell phone industry. Although
Nokia’s cell phone business, now a subsidiary of Microsoft, is no longer the world’s leading
manufacturer of cell phones and smart phones, the company continues to generate substantial
revenue by selling its older-model phones in Africa, the Middle East, and Southeast Asia.
In addition to leveraging prior investments in their products, firms can also leverage their
capabilities. As discussed in Chapter  3, capabilities that generate competitive advantage for
firms typically are difficult and costly to build. Some firms try to leverage their investments
in building capabilities by using those capabilities in multiple countries.17 Fast-food restau-
rants such as McDonald’s are masters of this technique.18 Manufacturing firms can also gain
efficiencies from leveraging their capabilities. Toyota, for instance, has been quite successful
    Why Firms Expand Internationally  157

in implementing the Toyota Production System in its US auto plants, helping to keep its costs
lower than those of rivals GM and Ford.

Economies of Scale and Scope  Another critical source of efficiency that firms seek
to gain by going international is economies of scale, whether they come in manufacturing,
R&D, or sourcing.19 Recall from Chapter 4 that economies of scale occur when firms are able to
spread the costs of investments in plant, equipment, or knowledge across many sales. As firms
compete in foreign markets, they increase the number of units sold, sometimes radically, pos-
sibly reaping greater economies of scale.
Related to efficiencies gained through economies of scale are economies of scope. Com-
peting in multiple markets allows firms to spread their costs across more units in multiple prod-
uct categories. Unilever, a Dutch company, takes advantage of economies of scope by selling,
all over the world, products as diverse as food products, such as ketchup, noodles, salt, flour,
and tea, and personal products, such as soap and shampoo—all things one can buy at a super-
market. Economies of scale and economies of scope, indeed.

Managing Risk
Operating in more than one country can also provide firms with a measure of protection against
disaster, both economic and natural.20 Even when there are worldwide economic downturns,
such as during the period from 2007 to 2012, problems are not usually spread evenly across
all countries. During that period, the United States and the European Union fell into recession,
while China continued to grow at a fairly rapid pace. When firms have sales in multiple coun-
tries, a slowdown in one country may be offset by continued sales in another. For instance,
many observers thought that General Motors would lose a good portion of its market share in
2007, when the US market for automobiles collapsed. However, within a short time, GM had
actually increased its worldwide market share, regaining the title of the largest auto company
based mostly on sales growth in China.
The same principle works for other types of disasters, such as natural disasters or social
upheaval. If firms have operations in multiple locations they may be able to relocate produc-
tion or increase sales in another country to make up for the shortfall in the area where the
disaster occurred.

Knowledge
Another reason for expanding into other countries is to generate more knowledge, the basis for
innovation. When a firm sells in different countries, to people with different tastes and needs, it
often gains new insights about its products and services. Serving multiple types of customers
can help a firm to identify unmet needs in multiple markets. Those insights can be valuable for
increasing sales in many locations. Gathering information from customers in multiple countries
can also help organizations more easily identify changes in customer needs, making it more
likely that they will be at the forefront of the next big innovation in their industry. Research sug-
gests that generating more knowledge may be the greatest advantage a multinational organi-
zation has over purely domestic companies.21
As an example, GE’s Healthcare division developed an inexpensive, portable ultrasound
machine to serve the rural Chinese market, where health-care providers couldn’t afford GE’s
large, expensive ones. GE realized that there were also markets for an inexpensive, portable
ultrasound machine in Europe and the United States, specifically with first responders who
don’t have space in ambulances and fire trucks for large ultrasound machines. GE now sells the
product in all of its markets.
Not only can companies generate knowledge from diverse customers but also from their
own units in different locations. For instance, Europe has higher energy costs than the United
States does. US firms that operate in Europe have been learning how to save energy costs more
rapidly than those that aren’t in Europe.
158  C H A PT E R 9   International Strategy

Responding to Customers or Competitors

Last, but not least, firms may expand internationally in response to either customers or com-
petitors. This is particularly true of business-to-business (B2B) firms that perform intermediate
steps of the value chain for large customers.22 For example, the “Big 4” accounting firms—
Deloitte Touche Tohmatsu, Ernst & Young, KPMG, and PricewaterhouseCoopers—have all
expanded globally to better serve their largest clients, who are multinationals with operations
around the globe. Indeed, sometimes customers demand that their suppliers go international
when they do.
Sometimes firms feel compelled to go global because their rivals do. If the rivals gain any
of the advantages previously discussed, they may use those advantages to subsidize aggressive
sales and marketing campaigns in the home markets of their competitors.23 If a firm doesn’t
expand to replicate those advantages it may be at a distinct disadvantage. This is one of the
primary reasons Lincoln Electric expanded abroad—to respond to ESAB, a Swedish welding
company, that had just entered the United States. The is also true of Harley-Davidson. It had to
aggressively pursue international expansion because part of its decline in domestic sales came
at the hands of foreign competitors. Better to force your competition to compete in its home
market as well than to let it gain international economies of scale and beat you without having
to fight on multiple fronts.

Where Firms Should Expand

After a firm has decided to go international, the next question it must answer is where to expand.
The easiest answer is to enter the country with the largest number of potential ­customers—
often, a country with a huge population, such as China or India. However, wise managers also
think about how likely they are to succeed in a particular foreign market. After all, the word
foreign means different, and different can be difficult to get right. Research on the risks of inter-
national expansion refers to this as the liability of foreignness.
Successful international expansion requires a clear understanding of the possible risks.
Some risks are market driven—will foreign customers buy your products at the same rate as
your home country customers? Will distribution work the same way or will it cost more to get
products to the end customer?
Other risks are political. Sometimes foreign governments enact policies that place addi-
tional burdens on foreign firms, such as tariffs that increase the cost of foreign products, laws
requiring a certain percentage of each product be made in the foreign country or a certain
percentage of managers be locals, or laws prohibiting foreign ownership of local firms. Other
burdens come from the uneven application of local laws. For instance, in some countries it is
difficult for foreign firms to protect their intellectual property as local courts may side primarily
with local firms. And sometimes nationalistic sentiment leads governments to threaten foreign
firms with additional tariffs, lawsuits in both local and world courts (such as the World Trade
Organization), inspections and fines not levied against local firms, and even seizure of plants
and equipment. Companies entering foreign markets need to be well aware of the possibility
of government action.
Finally, other risks are economic in nature. Not all markets are equally stable. Some coun-
tries are more susceptible to economic recessions, directly affecting the bottom line of the firms
selling in those markets. Foreign countries may also be susceptible to monetary crises, where
the value of the local currency fluctuates wildly as shown in Figure 9.3. The currencies of some
countries, even when not in crisis, may fluctuate significantly compared to the US dollar. This
can create an adverse exchange rate. This matters because a firm selling in a foreign market
earns profit in that market’s currency, and those producing in a foreign country buy goods and
pay labor in the local currency. If that currency fluctuates, the costs and profits, when transferred
    Where Firms Should Expand  159

Exchange Rate of US Dollar vs. European Euro 2012-March 2017

1.00

0.90

0.80

0.70

0.60
2013 2014 2015 2016 2017

FIGURE 9.3    Exchange Rate of US Dollar vs. European Euro 2012–2017

Source: XE Corporation. https://www.xe.com/currencycharts/?from=USD&to=EUR&view=5Y, accesse
March 20, 2017

back into the home currency, fluctuate as well. This can make a significant difference in how
competitive a firm is. If the exchange rate is favorable, they can lower their prices and steal
market share from other firms. If the exchange rate is not favorable, the opposite can happen.
In fact, this is one of the reasons that Harley-Davidson’s domestic sales started to slump in late
2014 through 2017. As Figure 9.3 shows, the dollar strengthened considerably against the euro
during that time. That means that European companies wanting to sell in the United States
could suddenly do it much more cheaply than they could before, increasing the competition for
Harley-Davidson products in its home market.
Organizations considering international expansion need to carefully consider the market,
political, and economic risks of each country they are thinking about entering. Since com-
panies want to do business in the countries where they are most likely to succeed, that means
choosing locations that have the lowest risks. Another way to think about managing the risk
of expansion is to consider the distance between countries. Even though transportation and
communication have advanced to the point where firms can realistically do business in nearly
every country on the planet, the distance between countries still matters. In addition to geo-
graphic distance, there are three other kinds of distance that managers should consider when
undertaking international expansion: cultural, administrative, and economic distances.24
A useful mnemonic for remembering the four types of distance is CAGE—cultural, administrative,
geographic, and economic.25
Even if there are a lot of potential customers, a country might not be the right one to enter
if the likelihood of success is low because of greater distance. The lower the distance deter-
mined by a CAGE analysis, with an emphasis on the distance that most affects your specific
industry, the greater the likelihood of a successful expansion.

Cultural Distance
Cultural distance refers to differences in language and culture, the way people live and think cultural distance  The degree of
about the world. People in another country might hold different beliefs about a host of signifi- difference between the cultures of
cant issues, including how people should interact and how business should be conducted. two nations.
160  C H A PT E R 9   International Strategy

They might have very different worldviews about human nature and the role of individuals and
companies in society. All of these can add up to a very foreign environment that makes it diffi-
cult for firms to understand their customers and local employees.26
Although it’s only one aspect of culture, the issue of language is influential. Firms are
42 percent less likely to do business in a country with a different language.27 Language
­differences are relatively easy to fix, but potential problems increase rapidly when companies
move into countries with deeper, more difficult to overcome types of cultural distance. These
may include differences in:

•  Religion
•  Ethnicity
•  Trust for outsiders28
•  How genders are expected to behave
•  The degree to which the culture is focused on individuality or collective action
•  How people accept ambiguity or follow rules and laws
•  The degree to which people allow abuses of political or market power29

Many of these types of cultural differences can be subtle but still have a significant impact on
consumer behavior and shape the market demand for foreign products.
Not all industries are affected the same way by cultural distance. Firms that sell com-
modity products, such as corn, wheat, oil, or cement, don’t tend to have difficulty with cultural
distance. However, firms with products that have high linguistic content, such as TV shows,
movies, music, and even textbooks, have to be careful. Likewise, products that affect how
people see themselves, such as food and clothing, are affected by cultural distance. This is
particularly true if those products clash with religious or national identities. It is difficult to
sell pork products in the Middle East, as pork is forbidden in both Judaism and Islam. Other
products might not directly clash with religion, but they might not match cultural norms. For
instance, in Germany parents have a tendency to prefer well-crafted, wooden toys for their
children. Firms that focus on less-expensive plastic toys do much better in markets such as
the United States.
Sometimes, however, cultural distance can be a selling point for multinationals. For
­instance, in Russia, foreign products are often seen as superior to local ones. Likewise, being
associated with a particular country can sometimes increase sales of a product worldwide, as
is the case for German luxury automobiles, Italian fashion, and US fast food.

Administrative Distance
administrative distance  The Administrative distance refers to differences in the legal, political, and regulatory institutions
degree of differences between the between countries. For example, are laws and government policies similar or different between
legal and regulatory frameworks two countries? This is important for firms because understanding the political and legal envi-
of two nations.
ronment is often a key to success in a foreign country.30
You can have the best product or service at the cheapest price, but if you don’t under-
stand how contracts will be enforced or how local and national policies apply to foreign firms,
you may fail. Administrative distance can cause some challenges for US firms in industrialized
nations such as France (which relies on a different legal system than the United States and the
United Kingdom), but it can become bewildering in many emerging and Third World markets,
where regulations and laws may be applied capriciously.
Low administrative distance can increase the rate of entry by foreign firms into a country
by as much as 300 percent.31 Administrative distance is low among countries that: (1) use the
same legal system, such as the common law system used in the Anglo sphere (the United
Kingdom and its former colonies, including the United States, Canada, Australia, and India);
(2) used to be part of a colonizer/colony network, such as some European countries and their
former African colonies; (3) use the same currency; or (4) are part of the same trading bloc, such
as NAFTA in North America or the European Union.
    Where Firms Should Expand  161

Industries most directly affected by administrative distance are those in which gov-
ernments are most likely to have a stake. This includes industries that provide equipment
or services critical to national security, such as providers of steel or telecommunications;
those that employ large numbers of people; those that serve government directly, such as
mass-transportation equipment manufacturers; those that extract natural resources; and
those that produce staple goods that most people buy, such as rice in Thailand or corn in
Mexico. A specific firm might also confront increased administrative distance if it competes
head-to-head with a local champion, a local firm that government sees as important to its
future, such as Airbus, the EU airplane manufacturer, or Gazprom, the Russian state-owned
natural gas firm.

Geographic Distance
At its most basic, geographic distance refers to how many miles separate two countries. geographic distance  The
Companies are more likely to succeed in nearby countries, because physical proximity lowers distance in miles, or kilometers,
both transportation and communication costs. That’s one reason most US companies expand between two countries.
first to Canada and Mexico. Even with fast air travel and consistent, reliable container ship-
ping, research suggests that for each 1 percent increase in the distance between countries
there is a 1 percent decrease in the number of foreign firms selling in those countries.32
Clearly, miles still matter.
In addition to the actual physical distance between countries, however, geographic dis-
tance is also influenced by how easy it is to travel between countries. For instance, firms enter
countries with seaports much more frequently than they expand to landlocked nations. Com-
panies are also more likely to enter countries with good transportation infrastructure. For most
firms, geographic distance increases the cost of managing daily operations and coordinating
activities. Despite the availability of instant communications and video conferencing, many
overseas operations require hands-on help from headquarters. When those operations are
many hours away from headquarters by plane, the communication and transportation costs
start to add up.
Not all industries are affected the same way by geographic distance. Firms, such as Google,
that sell electronic products that can be transmitted to the other side of the world in fractions
of a second at almost no cost don’t have to worry as much about geographic distance as firms
that sell heavy, bulky products such as finished computers. That is one reason that companies
such as Dell buy their parts from all over the world but then put them together near their target
markets. Other industries that are heavily affected by geographic distance are those that sell
fragile products that might be damaged in transport, or perishable products, such as fresh-cut
flowers, that must be transported rapidly. Even for Google, however, the need to oversee oper-
ations means that the company must set up local offices in some countries, such as Russia,
because the product still needs to be localized (if only for language and currency reasons) and
constant travel from California is too unwieldy.

Economic Distance
Economic distance refers primarily to differences in the average income of customers in two economic distance  The degree
countries, usually measured as per capita GDP (Gross Domestic Product). Firms from wealthy of difference between the average
nations tend to expand to other wealthy nations because the customers there earn enough income of people in two different
countries.
income to buy similar products. This is clearly true for expensive products such as cars or home
appliances but is also true of a wide variety of products that wealthier customers tend to think
of as inexpensive, such as laundry detergent or snack food (see the Strategy in Practice for
an example).
The industries most affected by economic distance are those for which the demand for
products is very elastic—meaning demand changes dramatically as prices go up or down. In
these types of industries, demand is significantly affected by customers’ purchasing power and
the ability of producers to lower prices.
162  C H A PT E R 9   International Strategy

Strategy in Practice

How Unilever Manages Economic Distance than 1.5 million small retail outlets that Hindustan Unilever oper-
ates, the vast majority live in rural villages, with little to no infra-
in Rural India
structure connecting them.34
Laundry soap isn’t something that most of us give much thought to. Hindustan Unilever’s response to the distribution problem
We can buy it in small boxes or giant packages, but no matter how was to create Shakti Ammas in the rural villages. Many of these
we buy it, the cost per use is small enough that few in Organization villages had developed women’s self-help groups where women
for Economic Co-operation and Development (OECD) countries give counseled each other and pooled their money to help each other
it much thought. The same is not true in other places around the financially. Combined with micro-loans, Hindustan U ­nilever
world. While India has been making great strides, it still has mil- ­created a direct sales force of women in thousands of rural
lions of people who live on less than $2 a day. At that wage no one ­villages. Each woman sold to her own village, as well as smaller
can afford to buy a box of laundry detergent, not even the generic ones nearby. Most of these women have been successful enough
brand. So if you are a manufacturer of laundry soap, how do you that they have been able to double their family’s income. To date
reach these customers? After all, they represent nearly 750 m ­ illion Hindustan Unilever has nearly 70,000 Shakti Ammas reaching
people worldwide.33 That is not a customer segment you want more than 162,000 rural villages and 4 million rural households
to ignore. with a variety of household products beyond laundry soap that
Unilever, in a joint venture with an Indian firm, called ­Hindustan have been manufactured to meet the budget of the poorest of
Unilever, has figured out how to bridge that economic distance the poor. It has been successful enough that Hindustan Unilever
and sell to the poorest of the poor in India. They call the approach has expanded the project to include husbands of Shakti Ammas,
Project Shakti, which means Project Strength. They first had to called Shaktimaans, who can reach villages farther away than
learn how to break their product down into the smallest ­possible their wives. There are now 48,000 Shaktimaans.35 The impact of
packages and figure out how to reduce manufacturing costs. this program on the poorest in India is striking. The head of the
The big problem, however, was how to deal with distribution. While Project Shakti, Sharat Dhall, called it “the biggest rural operation
many poor live in the big cities, and can be serviced by the more in the history of India.”36

How Firms Compete Internationally

As companies expand internationally, they often find themselves torn by two competing
local responsiveness  A firm’s pressures.37 The first pressure is toward local responsiveness, the need to tailor their prod-
adjustments to products, services, ucts, marketing, and distribution strategies to the local customers in a foreign country. For
and processes in order to account instance, Coca-Cola isn’t the same in every country. In fact, Coca-Cola demonstrates its
for local culture and needs.
responsiveness by manufacturing more than 48 different flavors of Coke alone (not to men-
tion the more than 100 non-cola beverages sold worldwide by Coca-Cola) to suit local tastes.
Coca-Cola also changes its distribution method to fit local markets.
However, adapting products and operations to fit local circumstances isn’t cheap. In gen-
eral, the more a company tailors a product or service to a local market, the higher the cost.
standardization  Making products Higher costs are risky, because companies with lower costs can beat their competition through
and/or processes consistent lower prices. When firms begin to compete on a global stage, the number of rivals can increase
across different units within a firm dramatically, putting intense pressure on firms to cut costs. Furthermore, many firms expand
and/or across different countries internationally in order to increase efficiency and to lower costs. Firms achieve economies of
the firm operates in.
scale by standardizing their products, producing them without variations, or integrating their
global integration  The processes on a global scale, called global integration. Thus, firms have two competing
standardization of processes ­pressures they must address: local responsiveness and cost reduction.
within a single business in
There are three primary strategies firms can use to manage this strategic tension:
different locations around
the world.
1. Multidomestic strategy—emphasizes local responsiveness over standardization
2. Global strategy—emphasizes global standardization and economies of scale over local
responsiveness
3. Arbitrage strategy—takes advantage of country-comparative advantages—sources of low
cost (e.g., cheap labor) or unique resources (e.g., skilled workers)
    How Firms Compete Internationally  163

Global
High strategy

standardization
Pressures for

Multidomestic
strategy
Low

Low Pressures for local High

responsiveness

FIGURE 9.4    International Strategies and Local Responsiveness versus Standardization

The first two strategies deal directly with the tug-of-war between local responsiveness
and cost-reducing standardization differently as illustrated in Figure  9.4. The third strategy,
arbitrage, can focus on either local responsiveness or standardization, but does so from a posi-
tion of taking advantage of country differences rather than trying to overcome them.
Each strategy is appropriate for a different set of industry dynamics and firm capabilities.
We’ll discuss each in turn as well as discussing combining strategies. The three primary strat-
egies are not mutually exclusive. Some firms are successful at pursuing two at the same time,
although it becomes increasingly complicated to manage operations and maintain strategic
focus when doing so. At the end of the chapter we’ll introduce a tool for determining which
strategy is best for any given firm.

Multidomestic Strategy—Adapt to Fit the Local Market

The multidomestic strategy centers on tailoring products and operations to individual mar- multidomestic strategy  A
kets.38 Firms in industries where customer needs and preferences vary widely from country to strategy involving tailoring
country, such as food or media, often use this strategy. By tailoring their products and services products or services to
local markets.
to better meet the needs of local customers, firms can maximize their responsiveness, increas-
ing their sales and market share in each country. They usually succeed through a differentiation
strategy rather than a cost leadership strategy. Unilever uses this strategy. They sell more than
1000 brands worldwide. In most of the countries it enters it uses different brand names (i.e., in
the case of bar soap - Dove in the United States, Block & White in the Philippines, and Gessy
in Brazil).
As firms enter more countries and the differences between the home country and each
foreign country increase, firms must expand the degree of tailoring, or adaptation. Conse-
quently, many firms that pursue a multidomestic strategy put autonomous decision-making
authority into the hands of managers in charge of individual regions or countries.39
To enable such autonomous decisions, significant parts of the value chain have to be repli-
cated in each country. For instance, each country may have a product development and design
lab, manufacturing plants, and sales and distribution personnel. Replicating these different
functions in each country comes at a significant cost. Not surprisingly, firms find it hard to tap
into economies of scale if they are designing and producing something different in each country.
As companies decentralize their operations to be locally responsive, it also makes it diffi-
cult to share valuable knowledge across the firm globally. As a consequence, firms that pursue
a multidomestic strategy often find it difficult to develop a worldwide competitive advantage.
At best, they produce a series of local competitive advantages.
164  C H A PT E R 9   International Strategy

Strategy in Practice

National Competitive Advantage the forefront of innovation. Japanese consumers tend to be

ahead of the curve in demanding the latest in camera tech-
Have you ever wondered how firms from the same country domi- nology, giving Japanese digital camera firms direction in
nate their industries worldwide? For example US companies Apple, developing new products.
Google, and Microsoft control the worldwide industry for computer
3. Related and supporting industries. If a country has mul-
operating systems; Japanese companies Nikon, Sony, and Olympus
tiple parts of the value chain located near each other, it
lead the digital camera industry; German organizations dominate
is easier to coordinate innovation, speeding up the pace.
in machine tools; and Italian firms lead in the sale of leather goods.
Italy is known not just for leatherworking but leatherwork-
Michael Porter developed a tool, the Porter’s Diamond of National
ing machinery, fashion, and shoes. The four industries
Competitive Advantage, that explains how this happens.
being co-located allows for closer coordination and faster
Four factors help push organizations toward greater innova-
innovation.
tion with those companies that innovate the most having an advan-
tage in international competition: 4. Firm strategy, structure, and rivalry. Different types of
firm structure are suited to particular types of industries.
1. Factor conditions. An abundance of critical resources includ­ Laws governing how firms are started and how they interact
ing skilled labor, a technologically advanced knowledge base, with labor have a large impact on the international strat-
easy access to capital, and solid infrastructure provide firms egies that firms pursue. Rivalry also plays a large role.
with the tools they need to innovate. Germany is known for While rivalry, according to the five forces model discussed
an educated, manufacturing-oriented workforce, giving it an in Chapter 2 and illustrated in Figure 9.5, tends to decrease
advantage in the machine tool industry. profit, it also spurs innovation. Firms that survive high
2. Demand conditions. The more a country’s customers demand levels of rivalry are usually more prepared to take on inter-
innovation, the more likely domestic firms are going to be at national competition.

Firm Strategy, Structure,

and Rivalry

Factor Conditions Demand Conditions

Related and Supporting

Industries

FIGURE 9.5    Porter’s Diamond of National Competitive Advantage

Source: Adapted from Michael E. Porter, The Competitive Advantage of
Nations (New York: Free Press, 1990).

factor conditions  Land, natural In most industries, firms find a pure multidomestic strategy unworkable. Cost pressures
resources, and labor that allow for become too intense. The key to successfully pursuing this strategy is to manage the variation
production of goods and services.
that occurs across countries. Firms can manage variation in three major ways:
demand conditions The
conditions in a market that 1. Focus adaptations. Some firms manage the variation by tightly focusing on a particular
determine the degree of demand product, customer segment, or geographic area. Such highly focused firms still tailor
for a product or service. their products, but the amount of variety they face is more manageable by maintaining a
related and supporting tight focus.
industries  Industries that 2. Externalize adaptations. Some firms externalize the work of adapting the product for local
produce products or services that needs, generally by arranging for local customers to do it. Methods of externalization
are inputs or complements to the
industry you are studying.
include franchising and alliances, which are discussed later in this chapter.
3. Design adaptability. A third method for managing the costs of localization involves
designing a product so that it can be adapted while still maintaining some economies of
scale. Some companies design for cheap adaptation by investing in flexible manufacturing
    How Firms Compete Internationally  165

that reduces the costs of short manufacturing runs. Others modularize their product,
­creating a set of standard interfaces that allow many different types of alternatives to plug
into one another. For example, appliance manufacturers such as GE and LG offer a variety
of refrigerators, with different sizes, different number of doors, and other features, but all
their different refrigerators are designed to share a common set of core components. This
allows some economies of scale while still adapting refrigerators to local tastes.

Global Strategy—Aggregate and Standardize to Gain

Economies of Scale
A global strategy centers on capturing the efficiencies that can come with expanding over- global strategy  A strategy
seas, particularly economies of scale, learning, and leveraging firm capabilities. Most firms involving selling standardized
that pursue a global strategy standardize their products, marketing, and operational prac- products, using standardized
processes, around the world.
tices, and aggregate, or centralize, them in only a few locations, to achieve economies of
scale.40 Individual country-level units are tasked mostly with implementing decisions made at
a central headquarters,41 and the firm uses the same tactics in most, if not every, country
where it competes.
The most extreme versions of a global strategy might have all functions located in
the same place, with country units overseeing only local sales. For example, Red Bull, the
energy drink, is manufactured in a single location next to its headquarters in Fuschl am See,
Austria (did you know Red Bull was an Austrian firm?). In 2016, it produced approximately
2.5 billion cans of Red Bull, all in the same factory. And while their marketing might seem
like it is tailored to different locations, it actually follows the same format everywhere Red
Bull is sold—sponsoring extreme sporting events. In practice, many global firms have fac-
tories on multiple continents, producing the same product, in order to reduce transporta-
tion costs and manage risk. Moreover, when factories in different locations are producing
the same products, they are more likely to share best practices, helping firms reduce the
learning curve.
A global strategy is typically a low-cost strategy, with low costs achieved through econ-
omies of scale. However, it can also be used effectively as a differentiation strategy that the
company applies in the same way, to the same customer segment, worldwide. Apple is a
great example of a firm that standardizes its products to achieve economies of scale but dif-
ferentiates them from other smart phones, computers, or tablets in order to increase the
price customers are willing to pay for them. Firms that pursue a global strategy tend to enter
countries that have a large, ready-made market for their products. They also tend to be in
industries where cost pressures are high and standardized products can meet relatively
universal needs. For instance, elevators are used the same way in Hong Kong as they are in
Chicago, making elevator manufacturing firms, such as Otis Elevator, prime candidates for a
global strategy.
The downside of a global strategy, however, is that standardized products may not meet
the needs of customers in particular countries. As a consequence, global firms may not be able
to compete in as many markets as multidomestic firms, and they may not be able to pene-
trate those markets as deeply.42 Another disadvantage is that, although global firms share
knowledge between units with greater ease than multidomestic firms do, a global firm gen-
erates less knowledge overall, because it isn’t as actively trying to meet a wider variety of cus-
tomer needs. So, in the short term, global firms may miss sales by not being responsive and in
the long term they may miss changes in local market conditions.
However, just as there are ways to manage the cost of variation in multidomestic firms,
there are also methods for dealing with excessive centralization and standardization in global
firms. First, a firm need not centralize all parts of the value chain. The greatest cost savings from
economies of scale often occur in R&D and manufacturing. A global firm can centralize some
functions while localizing others in order to penetrate local markets more fully. For instance,
in the 1980s and 1990s, the household appliance manufacturer Whirlpool pursued compo-
nent manufacturing and R&D primarily on a global scale, but carried out product design, final
assembly, marketing, and sales at regional and local levels.
166  C H A PT E R 9   International Strategy

Ethics and Strategy

Is Economic Arbitrage Ethical? Won’t It Lead •  320 workers share 24 toilets and 24 showers. No hot water.
Rusted pipes. No shower heads. Workers are forced to use
to Worker Exploitation?
buckets or pans to bathe.
In recent years, numerous news reports have emerged detail- •  Cafeteria facilities are inadequate. Workers are fed inadequately.
ing the exploitation of low-cost labor in foreign countries. China Food often has foreign matter in it.
Labor Watch, a nonprofit working to raise awareness of worker •  In practice, during peak months, no leave or sick leave
exploitation issues in China, found that suppliers of Disney toys is approved.
have been accused of exploiting lax enforcement of labor laws in
order to keep costs low. China Labor Watch calls it The Dark World Such abuses are common across a wide range of industries,
of Disney.43 and not just in China but also in many low-wage countries. Indeed,
Mistreatment of workers includes: in one case in Bangladesh, more than 1,100 workers were killed
when an eight-story building housing multiple garment factories
•  Workers work with toxic chemicals all day long yet are given little collapsed in 2013. The factories had not installed appropriate safety
to no training and little to no protective gear. measures. Many companies, including Nike, Apple, and Walmart,
•  Workers earn only $1.38 (USD) per hour, so low that it is insuf- have been accused of exploiting workers in foreign countries.44
ficient to pay for basic living necessities without overtime pay. Economic arbitrage, in and of itself, is not necessarily uneth-
Many workers live in the factory, a perk for which they pay (and ical. In many cases, foreign firms pay better than average wages and
need overtime to cover the cost). bring improved safety and labor practices to their factories and their
supplier’s factories.45 However, when many firms in the same industry
•  Workers typically work 11 to 12 hours a day, with 90 overtime
are seeking a cost advantage by utilizing an arbitrage strategy, the
hours per month—2.5 times the upper limit set by Chinese
pressure to decrease costs can be immense, and firms have to be vigi-
labor law.
lant that workers aren’t exploited. To that end, companies such as Nike
•  In the dormitories, 16 workers share a 16-square-meter and Apple have developed a supplier code of conduct, which they use
(172-square-foot) room—just larger than a typical child’s to audit their overseas suppliers.46 Although this doesn’t always work,
bedroom in the United States. because suppliers sometimes find ways around the audits,47 it does
decrease the incidence of unethical exploitation of workers.48

Arbitrage Strategy
arbitrage strategy  A strategy An arbitrage strategy is the third of the three primary international strategies. While the other
involving buying where costs two strategies view foreign markets as sales opportunities with the need to manage differ-
are low and selling where ences  between countries, the essence of arbitrage is taking advantage of those differences.
prices are high.
Arbitrage, at its simplest, is defined as using differences between markets to buy low in one
economic arbitrage  Capitalizing location and sell high in another.
on differences in costs by buying
It can involve economic, cultural, administrative, or capital arbitrage. One of the most
where costs are low and selling
where prices are high. This is the common modern forms of arbitrage is also one of the basic reasons firms expand internation-
traditional, age-old, definition of ally, to find the lowest-cost source of labor or raw materials. This is called economic arbitrage,
arbitrage. and it often involves offshoring manufacturing or R&D to countries with low labor costs. How-
capital arbitrage  Capitalizing on ever, some firms also practice capital arbitrage. For example, CEMEX, a Mexican cement man-
differences in the cost of capital by ufacturer, operates plants in Spain so that it can raise capital in the European Union, where
acquiring capital where it is less interest rates are often lower than they are in Mexico.
expensive. Not all arbitrage involves sourcing low-cost resources, however. Some forms of arbi-
cultural arbitrage  Capitalizing trage take advantage of differences between countries to sell products. Cultural arbitrage
on differences in culture between trades on the culture of one nation to sell in another. US-based fast-food restaurant chains
countries by actively using the are popular worldwide partly because they embody US culture. Likewise, for centuries the
culture of one country as a selling French were able to sell wine at a premium price because it came from France. Some firms
point for products being marketed
also utilize what is known as administrative arbitrage, taking advantage of differences
in another country.
between countries that are created by laws and government regulations. Many companies
administrative arbitrage 
incorporate in the Cayman Islands because of low corporate tax rates. Likewise, nearly
Capitalizing on differences in taxes,
regulations, and laws between one-third of all foreign capital flowing into China actually originates in China, but the inves-
countries by operating where they tors process their financial transactions through Hong Kong in order to avoid government
are lower or more lax. regulation.
    How Firms Compete Internationally  167

Combining International Strategies

As many industries have become increasingly global, the pressures for both local responsive-
ness and the efficiency that comes from standardization have become more intense. Some
companies try to use a hybrid of the multidomestic and global strategy in order to be glocal.
These firms typically begin with a strong emphasis in a single strategy and then work to mini-
mize the downsides associated with that strategy as much as possible as they begin to imple-
ment the second strategy. As shown in Figure 9.6, competing with both a multidomestic and a
global strategy, in order to achieve both local responsiveness and standardization, is often
called a transnational strategy.49 Strategy combinations, of course, can also include multi- transnational strategy  A
domestic and arbitrage strategies or global and arbitrage strategies as well. strategy involving a combination
Procter & Gamble is an example of a firm that started with a strong position in a multido- of both local responsiveness and
standardization.
mestic strategy and then added a global one. When P&G first expanded internationally, it repli-
cated its operations in each country where it competed. However, beginning in the 1980s, P&G
began to balance adaptation with a greater focus on centralized decision making to allow for
greater economies of scale across countries. It established global business units (GBUs), one for
each major product category, which operated concurrently with the traditional country units
using the IT systems to tie the two types of organizations together. They also required executive
career paths to include both organizations. Although it took more than a decade, P&G succeeded
in gaining some of the benefits of a global strategy without losing its multidomestic focus.
At the end of this chapter we present a tool, the international strategy triangle, that can
help you assess the international strategies that firms currently pursue or help you determine
which international strategy a firm should pursue if it is considering doing business overseas.

Global Transnational
High strategy Strategy
standardization
Pressures for

Multidomestic
strategy
Low

Low Pressures for local High

responsiveness

FIGURE 9.6    International Strategies and Local Responsiveness versus Standardization

Strategy in Your Career

Why should you develop a deep understanding of international generate a lot of good will from those above you if those
strategy? What good might it do you in your career? Some points goals have to include transferring some company opera-
to consider: tions overseas.

1. Companies are looking to hire and promote those with a 4. Companies are increasingly likely to have a diverse, interna-
global outlook. tional company culture. And if they don’t, they likely deal with
2. It used to be that few employees spent time overseas. Now suppliers and/or buyers who do. Companies these days are
being transferred abroad for a period of time is much more less hierarchical and accomplish a lot more with teams. If you
likely to happen. have a global outlook and can work with people from different
cultures, you will be more successful.
3. Understanding and supporting your company’s international
goals will help you further develop your skills and may also
168  C H A PT E R 9   International Strategy

How a Firm Gets into a Country:

Modes of Entry
modes of international market In this final section, we discuss four different modes of international market entry: (1) export-
entry  Methods for entering a ing, (2) licensing and franchising, (3) joint ventures and alliances, and (4) wholly owned sub-
foreign market for the purposes sidiaries. Entering foreign markets can be very risky. There are pros and cons to each entry
of either selling or producing
products or services.
mode. The best method for a firm is often based on which international strategy the firm has
chosen: global, multidomestic, or arbitrage. We will look at each mode in turn, starting with
those that involve the least risk and least control and moving to those with the most risk and
most control.

Exporting
exporting  Sending goods Exporting involves producing goods in a single location and selling them in foreign markets. 50
or services to another Although most exporting happens from a home country, firms can also use it with an arbitrage
country for sale. strategy by producing in a low-cost location and exporting to other countries from there.
Exporting is the first entry mode most companies choose when they decide to go interna-
tional.51 Exporting allows a firm to ramp up production in a single location, thereby increasing
economies of scale. As we saw earlier, exporting is how Red Bull has captured the majority
market share in the energy drink business. It also is how Samsung is keeping pace with Apple in
the smartphone and tablet computer industries.
Exporting works well when little adaptation of a product is required and good distribu-
tion networks are in place in the foreign market. It is also the least risky of the entry modes, as
it involves the least investment in the foreign country. If cultural or administrative distance is
large, exporting might be the right decision, because you avoid the challenges of managing a
culturally different workforce in a foreign country. It is also a good choice if speed to market is
important, as products can be shipped and sold in foreign markets quickly.
Of course, exporting also has its limitations. Transportation costs and government trade
tariffs can both increase the cost of selling in a foreign market. Your company and its products
will likely be viewed as “foreign,” which can be a problem in some countries. Exports also may
suffer if the value of the home nation’s currency rises compared to the currency of target foreign
markets.52 As the exchange rate fluctuates, so does the price of a firm’s product in the foreign
market. For instance, in 2007, one US dollar cost 121 Japanese yen. By 2012, the dollar was
trading for only 77 yen.53 The yen had strengthened compared to the dollar. The consequences
were that a product manufactured in Japan and sold in the United States for $100  brought
the Japanese company 12,100 yen in 2007, but only 7700 yen in 2012, a 36% drop in profit
for no other reason than changes in the currency exchange rate. Although firms can try to cut
costs to compensate for such involuntary price changes, exporters are often at the mercy of
exchange rates.

Licensing and Franchising

licensing  Granting another Licensing and franchising both involve selling the rights to produce a firm’s products or ser-
business the permission to use or vices.53 The licensee or franchisee typically pays a negotiated fee (usually 5 percent to 10 per-
sell a firm’s product, technology, cent) as a royalty, based on the number of units sold. As described in Chapter 8, Disney receives
or process.
royalties from the Oriental Land Company on revenues derived from Tokyo Disneyland. This is
franchising  A license that allows an example of licensing. Franchising is a special form of licensing with a longer-term commit-
a person or firm access to a
ment, the use of the brand name, and more often involves a transfer of firm knowledge and
business’s proprietary knowledge,
processes, or trademarks in order business processes. In addition to negotiating a contract concerning royalty payments, firms
to allow them to sell a product or that franchise usually impose strict rules on franchisees concerning how the business is oper-
service under the business’s name. ated and marketed, and provide them with ongoing support and oversight.
    How a Firm Gets into a Country: Modes of Entry  169

Licensing and franchising are good entry modes for firms that have unique know-how or
a solid brand that can be easily valued (so the price of the license or franchise can be negoti-
ated), but do not have the capital or resources and capabilities to expand abroad themselves.
Because they involve only the transfer of knowledge, rather than building operations in a
foreign country, these two modes of entry require less investment and are often among the
faster ways to earn a profit in foreign markets. The lower risk and speed of entry make these
attractive entry choices when the risk is otherwise high because of large distances (any of the
four distances) between countries.
As with each mode of entry, there are downsides to licensing and franchising. First, they
offer the least amount of control of all the various modes of entry.54 Firms may try to include
contractual safeguards, but the firm that buys the license or franchise is ultimately in charge of
manufacturing and marketing. Sometimes the licensee or franchisee does not invest enough in
the business to maintain quality and build a strong brand. Lack of control also can make it hard
to tap into local knowledge and innovation. Moreover, any knowledge being generated from
the foreign operations belongs to the licensee or franchisee. Extracting that knowledge for use
in other locations can be problematic.
Finally, there is a risk that the firm licensing the product or service can become a com-
petitor. If you let others manufacture your product or operate your business model, they are
going to gain critical capabilities in your business. RCA, a US-based manufacturer of color tele-
visions, met its death this way. It licensed its technology to Japanese firms in the 1970s, only to
have them enter the US market soon after their licenses expired and put RCA out of the televi-
sion business.

Alliances and Joint Ventures

Alliances (discussed in detail in Chapter 8) involve sharing resources, risks, and rewards.55 They alliances  An agreement between
are an increasingly favored way to enter markets that are distant (i.e., more risky) from the two businesses to cooperate on
home market.56 Following its initial international failures, Lincoln Electric now usually forms a a mutually beneficial project. It
usually involves the sharing of
joint venture, a type of alliance, with a local partner when it enters a country with high admin- resources and/or knowledge.
istrative distance from the United States.
Many companies use alliances to access complementary assets.57 For instance, a common complementary assets  Assets
way to enter a distant, foreign market is to create an alliance with a local company that knows owned by another company that
what consumers want and knows how to navigate local government regulations and distri­ are needed in order to successfully
commercialize and market a
bution channels. An alliance with a local firm also mitigates some of the foreignness of the product or service.
entering firm, allowing the alliance to be perceived by both government and consumers as
local. Sometimes this is the only way to enter a market. For example until recently, in many
industries India did not allow foreign retailers to enter the country unless they partnered with
a local firm.
A joint venture is a special form of alliance involving the joint creation of a new firm. Most joint venture  An alliance
joint ventures involve a 50/50 share of ownership; each company puts in 50 percent of the value between firms involving the
and gets 50 percent of the rewards. If the venture doesn’t work, the home-country firm loses creation of a new entity where
both firms provide assets and/
only half the overall investment in the joint venture. When General Mills wanted to enter the or knowledge, processes or
European Union in the early 1990s, it created a joint venture with Nestlé. The complementary technology.
asset was Nestlé’s distribution system that put Nestlé products in every big and little store in
the many different countries in Europe. Indeed, between the two companies the distribution
system was considered important enough that the products are under the Nestlé brand. So, if
you buy Cheerios in Hungary, you will be buying Nestlé Cheerios.
Although alliances allow faster and less risky access to new markets than wholly owned sub-
sidiaries (discussed next), they also present significant management challenges. Overcoming
cultural and linguistic barriers to bring together teams of managers from both companies
increases the difficulty of operations. Each party in the alliance may also hold different stra-
tegic goals. These challenges cause many alliances to fail. Moreover, as with licensing, the lack
of tight control can create serious problems by allowing the partner firm to develop resources
and capabilities that enable it to become a competitor. Indeed, the Chinese government forces
170  C H A PT E R 9   International Strategy

foreign firms in strategic industries to form joint ventures with Chinese firms for the explicit
purpose of learning their technology in order to compete against them.

Wholly Owned Subsidiaries

wholly owned subsidiary  A unit Wholly owned subsidiaries are local units owned outright by the entering firm. This type of
in a foreign country that is wholly entry requires the most investment and creates the most risk, as the firm has to put up all of the
owned by the parent company. capital itself. Wholly owned subsidiaries can, however, overcome trade and transportation bar-
riers by producing locally. They may also allow a foreign firm to appear more local to host-
country governments and consumers.
In addition, this mode offers the firm the most control over what its local subsidiary does.
Many high-tech firms form wholly owned subsidiaries as a way to control access to their tech-
nology and avoid leaking it to a licensee or alliance partner. A wholly owned approach gives
firms that use a combination of international strategies sufficient control to realize economies
of scale. For example, wholly owned entry can allow a firm enough control to coordinate a
worldwide value chain with key elements of the value chain located in the lowest-cost location
to gain an arbitrage advantage. Such a firm might manufacture all of a certain type of compo-
nent in one location in order to gain economies of scale and then ship the components from
one location to another for assembly.
greenfield investment  A wholly There are two ways of entering with wholly owned subsidiaries: (1) a greenfield investment,
owned subsidiary in which the in which the firm builds operations from scratch; or (2) acquiring a local firm. Greenfield invest-
firm involved builds the facility ments give the firm the greatest amount of control, because they build the operations,
from the ground up.
marketing, and distribution from the ground up. However, they are also the slowest entry
mode, as it takes time to build capabilities. Moreover, although the firm maintains tight control
over its own technology and processes, it also has to learn about the local market and
government regulations on its own. As Lincoln Electric learned in Japan, the learning process
can take a long time and sometimes leads to failure.
Acquisitions involve buying local firms. Such a purchase allows the entering firm to acquire
local resources, knowledge, and expertise while still maintaining control through 100 percent
ownership. However, acquisitions typically involve paying a price premium and they can also
be notoriously difficult to integrate into the rest of the firm’s worldwide operations. Merging
two firms is difficult enough within the same country. Cultural differences complicate the pro-
cess considerably, often resulting in a slower integration process and a higher risk of failure.58
Table 9.2 summarizes some of the key differences among the modes of entry.

TA BLE 9 .2     Entry Modes

Licensing/ Alliance/Joint Wholly Owned

Exporting Franchising Venture Subsidiary
Investment required Low Low Medium High

Level of risk Low Low Medium High

Overcome trade barriers? No Yes Yes Yes

Speed of entry Fast Fast Medium Slow (faster for acquisition

than greenfield)

Acquire local resources, No No Yes Yes

including knowledge?

Viewed as insider or outsider? Outsider Insider Possibly insider Possibly insider

Degree of control Low Low Medium High

   Summary 171

Choosing a Mode of Entry

The choice of which mode to use is based on the firm’s situation, including its access to cap-
ital and need for local resources or capabilities, as well as the firm’s primary international
strategy. Global strategies require more control, moving firms toward exporting and wholly
owned subsidiaries, whereas multidomestic strategies encourage local innovation, which
could involve joint ventures, franchising, or autonomous wholly owned subsidiaries. Arbitrage
strategies require ownership, suggesting that exporting and licensing/franchising will not be
good choices.
The choice of which mode to use is also based on a firm’s international experience. Most
firms start their international expansion by first exporting, or selling to target country whole-
salers. Firms may then move to joint ventures, and finally to wholly owned subsidiaries as
they become more comfortable managing operations in the foreign market. Figure 9.7 high-
lights this effect of learning over time in a more nuanced fashion. It shows the typical paths
followed by firms who first enter a foreign market through exporting, licensing, or franchising.
The beginning points for most firms are on the left with most firms moving toward the right as
they gain experience.

Length of Time to Enter

(Greenfield, Acquisition)
Franchising

Wholly Owned
Licensing
Control

Joint Venture

Exporting Risk

FIGURE 9.7    Experience and Entry Modes

Source: Adapted from F.R. Root, Entry Strategies for International Markets (San Francisco: Jossey-Bass,
1994), p. 18.

Summary
•  There is a clear trend toward increased international trade. •  There are four types of distance—cultural, administrative, geo-
Indeed, the trend has become so prevalent that a large propor­ graphic, and economic (CAGE)—that firms should keep in mind
tion of US firms, including small- and medium-sized firms, when entering a particular country. The shorter the overall distance,
participate in international trade, and thus need an international the greater the likelihood of success.
strategy. •  There are three types of international strategy—multidomestic,
•  Firms expand internationally for many reasons, the most impor- global, and arbitrage.
tant of which are growth, efficiency, managing risk, gaining •  Exporting, licensing/franchising, alliances/joint ventures, and wholly
access to more knowledge, and responding to customers and/or owned subsidiaries are four different ways of entering a country.
competitors.
172  C H A PT E R 9   International Strategy

Key Terms
administrative arbitrage  166 exporting 168 local responsiveness  162
administrative distance  160 foreign direct investment  154 modes of international market entry  168
alliances 169 franchising 168 multidomestic strategy  163
arbitrage strategy  166 geographic distance  161 multinational firms  154
capital arbitrage  166 global integration  162 product’s life cycle  156
complementary assets  169 globalization 155 standardizing 162
cultural arbitrage  166 global strategy  165 transnational strategy  167
cultural distance  159 greenfield investment  170 wholly owned subsidiary  170
economic arbitrage  166 joint venture  169
economic distance  161 licensing 168

Review Questions
1. What are the five main reasons that firms expand into interna- 7. Describe the ways that managers can help keep multidomestic
tional markets? strategies from becoming too costly and global strategies from failing
2. Describe the four types of distance that firms should consider when to meet local needs.
choosing which foreign markets to enter. What factors help managers 8. Explain the international strategy triangle that follows in Figure 9.8
determine which type of distance is most likely to affect the success of and list the steps to construct one.
an international expansion? 9. Explain how you would you use the international strategy triangle
3. Describe the concepts of local responsiveness and standardization. to identify which international strategy a firm should use. Explain how
Determine which international strategy is best suited to each pressure you would use it to evaluate the strategies of firms that have already
and explain why. gone international.
4. Describe the three primary international strategies. 10. What is a mode of entry? Describe the four main types of
5. What does a multidomestic strategy look like? What are the key ele- entry modes.
ments? Comparatively, what are the key elements of a global strategy? 11. Which type of entry mode is most appropriate for each of the pri-
Can you name a firm that pursues each strategy? mary international strategies? List the factors that firms using each pri-
6. What makes an arbitrage strategy different from a multidomestic or mary strategy should consider when choosing an entry mode.
global one? Name the four types of arbitrage and explain how each
one works.

Application Exercises
Exercise 1: Pick a firm of your choice or one that your 1. Choose a firm that has not yet expanded internationally. Choose a
professor has assigned you. market for the firm to enter. Use the four types of distance to evaluate
the firm’s likelihood of successfully entering that market.
1. If the firm has already expanded internationally, using the reasons
why firms go global (the first major section of this chapter), determine 2. Choose a firm that has already expanded internationally. For one or
the primary reason that your firm went global. more of the firm’s markets, measure all four types of distance between
the firm’s home country and the country entered. Evaluate the degree
2. If your firm has not yet expanded internationally, determine what
to which distance played a role in the success or failure of the expan-
forces are likely to drive it to go global.
sion. Which type of distance mattered the most? Why?
Exercise 2: Use the four types of distance to evaluate
3. Read the Samsung case. Use the case, along with data you gather
the likelihood of a successful foreign expansion effort from outside sources, to measure the distance, using all four types of
(choose one of the following or the one that your professor distance, between each company’s home (South Korea for Samsung,
has assigned): the Netherlands for Philips, and Japan for Panasonic) and a target
   Strategy Tool 173

expansion country of your choice. Based on your measurements, do they say about the firms’ efforts to adapt to changing conditions?
which firm is most likely to succeed in entering the country? Why? Which firm is succeeding?
Exercise 3: Develop and interpret an International Strategy Exercise 4: Determine the appropriate mode of entry
Triangle (choose one of the following or the one that your (choose one of the following or the one that your professor
professor has assigned): has assigned):
1. For the industry of your choice, determine the correct measures 1. Choose a firm that has not yet expanded internationally. Choose a
for each axis, and find the median and 90th percentile points for the market for the firm to enter. Determine which mode of entry is the right
industry. Pick the top three competitors and draw their triangles. What one for the firm to use. Justify your choice.
do your results say about the strategy of each firm and its competitive 2. Choose a firm that has already expanded internationally. Choose
advantage? one foreign market that the firm entered. Determine which mode of
2. Use data from the Samsung case. Draw the triangles for two or more entry it used. Given the firm’s international strategy, evaluate whether
of the four companies on Figure 9.9 (a generic international strategy it used the right mode of entry.
triangle). Create triangles for 1960 (estimating the points on the axes 3. Use the Samsung case. Assume that none of the four firms has
from the descriptions of the firms in the case) and 2016 (use older entered any African markets. Given their respective strategies, deter-
data if the case doesn’t have up to date data.). What do your results mine which mode of entry each firm should use to enter the African
say about the international strategy that each firm has pursued? What market of your choice. Justify your decision.

Strategy Tool
The International Strategy Triangle—Determining Which competitors in the medical diagnostic imaging industry: Philips, GE,
Strategy to Use and Siemens. The farther along an axis a company ranks, the more the
company should follow that strategy. One point of Philips’s triangle, for
Professor Pankaj Ghemawat has developed a tool for assessing the
example, is quite far toward the end of the multidomestic axis, while
international strategy of firms, the international strategy triangle—or
the other two points are closer toward the center of the global and
the AAA triangle, as Ghemawat labels it—AAA for adaptation (multi-
arbitrage axes. This indicates that Philips should pursue, if it doesn’t
domestic strategy), aggregation (global strategy), and arbitrage. The
already, a multidomestic strategy. The two corners of GE’s triangle that
triangle can be a helpful tool for determining which international
are farthest from the center are along the global and arbitrage axes,
strategy a company should pursue, for helping outsiders analyze the
suggesting that GE might be pursuing a two-pronged approach com-
international strategies of firms, and can also help a firm assess the
bining a global strategy with an arbitrage strategy. Siemens’s triangle
current strategic positions of competitors.
suggests that its most promising strategy might be a global strategy.
The international strategy triangle plots the strengths of a firm
How are the firm’s places along each axis calculated? The meas-
and its primary competitors along three axes, each axis correspond-
ures you use for the three axes depend on the type of industry you are
ing to one of the primary strategies: multidomestic, global, or arbi-
analyzing. For many industries, the following ratios of costs as percent-
trage. Figure 9.8 shows an international strategy triangle for the major
ages of sales are good measures:

Multidomestic Global •  Multidomestic axis—Ratio of advertising costs to sales

•  Global axis—Ratio of R&D costs to sales
•  Arbitrage axis—Ratio of labor costs to sales

Other measures are possible, depending on a company’s goals or

the industry it is in. These could include the following:

•  Multidomestic axis—Percentage of local employees in country-level

Philips management positions or rate of new product development at the
Siemens country level
GE •  Global axis—System integration across countries, standardization
of business practices, or the percentage of revenue from customers
that are global in nature
•  Arbitrage axis—Percentage of back-office activities (labor other than
manufacturing labor) that are offshored to low-cost countries
Arbitrage
Remember that the Appendix can help you find sources for the
FIGURE 9.8    International Strategy Triangle—Medical data you will need to compute these ratios.
Diagnostic Imaging Industry  After you have determined the appropriate measures for the axes,
Source: Adapted from P. Ghemawat, Redefining Global Strategy you’ll need to obtain information to help you plot two points along
(Cambridge: Harvard Business School Press, 2007). each axis:
174  C H A PT E R 9   International Strategy

1. The median of the industry you are analyzing This tool can be very helpful in determining what international
2. The 90th percentile of the industry you are analyzing—the point strategy a firm should use. If a firm ranks at any point beyond the
below which 90 percent of the firms in the industry rank on that median along any axis, managers should consider pursuing that strat-
particular measure egy. If a firm ranks beyond the 90th percentile it is critical that a firm
consider that strategy.
To find the median and 90th percentile points, you will need It is also useful to plot a firm’s biggest rivals. This can tell you a
to get information about a variety of firms in your industry, particu- lot about the dynamics of competition in the industry, including who
larly the most important firms, such as those with the most market is likely to win and who is likely to lose. For example, refer to the inter-
share or the most recognized brand names. The appendix at the end national strategy triangle for the Medical Diagnostic Imaging Industry
of the book contains extensive information about how to obtain such in Figure  9.8. Although Siemens’s triangle suggests that it pursues a
information. global strategy, notice that Siemens does not rank as strongly on the
Figure 9.9 shows an international strategy triangle for a generic global axis as GE does. This suggests that, unless things change, Sie-
industry. The median and 90th percentile points are connected, mens might be at a cost disadvantage to GE, losing sales on price.
highlighting two triangles, to help you visualize how you might con- The triangle also suggests that Siemens would also likely lose
struct your international strategy triangle. As an illustration, in this sales to Philips, which is better at meeting local needs, as indicated
generic triangle, the median ratio of labor costs to sales, the bottom by the firms’ positions on the multidomestic axis. Furthermore, this
axis, is 20 percent, and the 90th percentile is 50 percent—meaning triangle also shows that Philips, although the most adapted, is likely
that 90 percent of firms in the generic industry have a labor-to- to have the highest cost structure. Although GE does not have Philips
sales percentage of less than 50 percent. When you use the trian- strengths for adapting to local needs, GE might nonetheless be able to
gle, the median and 90th percentile points—as well as the measures meet a good portion of local demand at a much lower price, enough so
you use on each axis—should be customized to the industry that that Philips can’t count on maintaining market share, even though it
you analyze. may meet local needs better.
The steps in using the international strategy triangle are summa-
Multidomestic Global rized as follows:
Advertising to Sales R&D-to-Sales
1. Determine the appropriate measures to use for the three axes. For
10% 10% many manufacturing industries, these measures will be:
8% 8% •  Multidomestic axis—Advertising to sales
6% 6%
•  Global axis—R&D to sales
4% 4%
90th percentile
2% 2% •  Arbitrage axis—Labor to sales
Median
20% 2. Plot the median and 90th percentiles for the industry as a whole on
each axis. You will do this by gathering data on the measure for each
40% axis from the most important firms in the industry you are exam-
ining. When you have that data calculate the median and the 90th
60% percentile point, where 90 percent of the firms are below that point.
80% This is likely to be close to the firm who is farthest along the axis.
3. Plot the appropriate point on each axis for the firm you are ana-
100% lyzing. Draw a triangle connecting these three dots. You might
Arbitrage also want to carry out this process for two or more of the firm’s
Labor-to-Sales major competitors.
FIGURE 9.9    Generic International Strategy Triangle  4. Use the shape of the triangle to help determine the appropriate
Source: Adapted from P. Ghemawat, Redefining Global Strategy international strategy for the firm being analyzed and to under-
(Cambridge: Harvard Business School Press, 2007). stand competitive dynamics in the firm’s industry.

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